<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 1996 COMMISSION FILE NUMBER 0-25524
HELLO DIRECT, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3043208
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5884 EDEN PARK PLACE 95138-1859
SAN JOSE, CALIFORNIA (Zip Code)
(Address of principal executive offices)
(408) 972-1990
(Registrant's telephone
number, including area code)
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. 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.
Outstanding at
Class October 31, 1996
Common Stock, Par Value $.001 5,007,226
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HELLO DIRECT, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)
SEPTEMBER 30, 1996
1. Interim Financial Statements
In the opinion of the Company, the accompanying unaudited financial statements
include all adjustments, consisting only of normal recurring adjustments
necessary to present fairly the financial information set forth therein.
Results of operations for the three and nine month periods ended September 30,
1996 are not necessarily indicative of future financial results.
Certain notes and other information have been condensed or omitted from the
interim financial statements in the Quarterly Report on Form 10-Q. Accordingly,
these financial statements should be read in conjunction with the audited
financial statements for the fiscal year ended December 31, 1995 in the
Company's Annual Report on Form 10-K/A.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This Management's Discussion and Analysis section contains forward-looking
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statements that involve risks and uncertainties. The Company's actual results
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may differ significantly from the results discussed in the forward-looking
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statements. Factors that might cause such a difference include, but are not
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limited to, those discussed below and in the Company's reports filed with the
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Securities and Exchange Commission including the Company's Annual Report on Form
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10-K/A for the year ended December 31, 1995 and the Quarterly Reports on Form
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10-Q for the quarters ended March 31 and June 30, 1996. Readers are cautioned
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not to place undue reliance on these forward-looking statements, which speak
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only as of the date hereof. Forward-looking statements are identified with an
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asterisk (*).
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RESULTS OF OPERATIONS
1996 COMPARED TO 1995
Net Sales. Net sales reflect total sales less a provision for returns. Net
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sales increased $3,808,000 or 40.9% to $13,111,000 in the three month period
ended September 30, 1996 from $9,303,000 for the comparable period in 1995. This
increase was primarily attributable to a 43.2% increase in the number of
catalogs mailed (to 6,723,000), a 41.0% increase in the number of orders
received (to 78,000), a 0.5% increase in the average order size (to $217) and a
28.8% increase in the number of active accounts (to 137,700). During the
quarter, the Company continued to use a 60 page prospecting catalog (introduced
as of April 1, 1996) in addition to the full line catalog of 100 pages which is
mailed to the house list. The Company is testing the effectiveness of this 60
page catalog at converting prospective customers into actual customers.*
For the nine month period ended September 30, 1996, net sales increased
$10,479,000 or 38.7% to $37,566,000 from $27,087,000 for the comparable period
in 1995. This increase was primarily attributable to a 39.1% increase in the
number of catalogs mailed (to 17,618,000), a 38.8% increase in the number of
orders received (to 217,000), a 1% increase in the average order size (to $217),
and the 28.8% increase in the number of active accounts discussed above. The
Company continually sources and adds new products to its catalog on a quarterly
basis and also deletes products that do not meet revenue expectations*. Any
significant decrease in net sales from new products added to the catalog could
have a material negative effect on the Company's operating results.
Gross Profit. Gross profit increased $1,651,000 or 33.0% to $6,648,000 in the
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three month period ended September 30, 1996 and $4,695,000 or 31.8% to
$19,482,000 in the nine month period ended September 30, 1996 from the
comparable periods in 1995. As a percentage of net sales, gross profit for the
three month period was 50.7% for 1996 versus 53.7% for 1995 and for the nine
month period 51.9% in 1996 versus 54.6% in 1995. This
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* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations due to factors
described in the Company's Annual Report on Form 10-K/A and Quarterly Report on
Form 10-Q.
<PAGE>
decrease in gross margin was the result of a shift in product mix toward a
larger percentage of branded and private label products which carry a lower
gross margin but also have lower product development and marketing expenses (as
a percentage of net sales) associated with them.
Selling, General and Administrative Expenses. Selling, general and
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administrative expenses increased $1,714,000 or 37.4% to $6,297,000 in the three
month period ended September 30, 1996 and $5,289,000 or 43.3% to $17,493,000 in
the nine month period ended September 30, 1996 from the comparable periods in
1995. As a percentage of net sales, these expenses for the three month period
were 48.0% for 1996 versus 49.3% for 1995 and for the nine month period 46.6% in
1996 versus 45.1% in 1995. The increase for the three and nine month periods in
1996 expense compared to 1995 was the result of planned headcount additions to
the Company's administrative management group, product management team, and
customer care activities. A significant portion of the Company's selling,
general and administrative expenses are related to the distribution of its
catalog. Any significant increases in the cost of paper or postage, or
deterioration in the response rates from mailings, could have a material
negative effect on the Company's operating results. As a percentage of net
sales, the Company expects that total selling, general and administrative
expenses for the three months ending December 31, 1996 will be approximately the
same as for the three months ended September 30, 1996.*
Product Development Expenses. Product development expenses decreased $6,000 or
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1.9% to $313,000 in the three month period ended September 30, 1996 and
increased $401,000 or 40.6% to $1,388,000 in the nine month period ended
September 30, 1996 from the comparable periods in 1995. As a percentage of net
sales, these expenses for the three month period were 2.4% for 1996 versus 3.4%
for 1995 and for the nine month period 3.7% in 1996 versus 3.6% in 1995. The
decrease in the three month period ended September 30, 1996 from the comparable
period in 1995 was due to the completion of development of two new products that
were introduced in the October 1996 catalog. The increase for the nine month
period ended September 30, 1996 from the comparable period in 1995 was the
result of expenses incurred in connection with the development of several new
and in process products which were introduced in October 1996 or are currently
planned for introduction in 1997.* It is anticipated these expenses will
fluctuate from time to time based upon the number and character of the products
being developed, however, the Company believes that these expenses, as a
percentage of net sales, will be approximately the same for the year ending
December 31, 1996 as they were for the year ended December 31, 1995.*
CellBase Expenses. In December 1995, the Company announced that it had
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discontinued the development and marketing of CellBase. The expenses presented
for the three and nine month periods ended September 30, 1995 represent costs
incurred during these periods related to the development and marketing of
CellBase. No expenses related to this product were incurred in the comparable
1996 periods.
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* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations due to factors
described in the Company's Annual Report on Form 10-K/A and Quarterly Report on
Form 10-Q.
<PAGE>
Other Income-net. Other income includes interest income of $197,000 and
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$568,000 for the three and nine month periods, respectively, ended September 30,
1996 versus $204,000 and $319,000, respectively, for the comparable periods in
1995. There was no interest expense in 1996 or during the three month period
ended September 30, 1995. The nine month period ended September 30, 1995
includes interest expense of $169,000. The interest income relates to interest
earned on the remaining proceeds from the Company's initial public offering in
April 1995. The interest expense is related to the $2,000,000 Subordinated
Promissory Note issued in May 1994 and retired in April 1995 with a portion of
the proceeds from the initial public offering.
Extraordinary Item. Reflects the net of tax write-off of the unamortized
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financing costs associated with the Subordinated Promissory Note issued in May
1994 and retired in April 1995.
Net Income. Net income decreased $686,000 or 82.6% to $145,000 in the three
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month period and $1,500,000 or 68.0% to $705,000 in the nine month period ended
September 30, 1996 from the comparable periods in 1995. This decrease was due to
the reasons enumerated above and the effect on the provision (credit) for income
taxes from the application of tax loss carryforwards in accordance with
Statement of Financial Accounting Standards No. 109 in 1995.
Quarterly and Seasonal Fluctuations. The Company has experienced in the past
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and will experience in the future quarterly variations in net sales and net
income as a result of many factors, including the timing of catalog mailings;
catalog response rates; product mix; the level of selling, general and
administrative expenses; the timing and level of product development expenses;
and the timing and success of new product introductions by the Company or its
competitors.* The Company's planned operating expenditures are based on sales
forecasts. If net sales are below expectations in any given quarter, operating
results would be materially adversely affected. Due to the foregoing factors, it
is possible that in some future quarter the Company's operating results will be
below the expectations of public market analysts and investors. In such event,
the price of the Company's Common Stock would likely be materially adversely
affected.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of liquidity have been cash flow from operations,
proceeds from its initial public offering, venture capital equity and debt
financing, and borrowings under its revolving bank line of credit.
Cash provided by operating activities during the nine month period ended
September 30, 1996 was $530,000. This was the result of $1,498,000 provided by
operations including net income, depreciation and amortization and other non-
cash charges offset by $968,000
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* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations due to factors
described in the Company's Annual Report on Form 10-K/A and Quarterly Report on
Form 10-Q.
<PAGE>
of changes in operating assets and liabilities. Cash used by investing
activities for the nine month period ended September 30, 1996 was $868,000, due
to purchases of property and equipment ($1,851,000) and the initial financing
for the Company's new facility discussed below ($1,470,000), offset by a
decrease in investments ($2,453,000). Cash provided by financing activities
during the nine month period ended September 30, 1996 was $156,000, relating
primarily to the issuance of common stock pursuant to the Company's employee
stock purchase plan.
Additions to equipment during the nine month period ended September 30, 1996
were $1,851,000 compared to $997,000 for the same period in the prior year. This
increase was anticipated and is reflective of the growth in sales activity and
the tooling requirements for new product introductions.* The Company plans to
expend between $2,000,000 and $2,500,000 in capital expenditures for the year
ending December 31, 1996.* The Company believes that capital expenditures for
the year ending December 31, 1997 will be approximately the same as for the year
ending December 31, 1996.*
The Company has entered into a customized financing arrangement for the
construction of a new corporate headquarters building that will serve the
Company's expansion needs over the long term. Under the arrangement, the Company
has committed $5,000,000 in financing for the construction of a new facility at
a fixed interest rate of 7.5% for a period of 12 years. Following completion of
the new building, expected in January 1997, the Company will enter into a 15-
year lease agreement for the facility.* The Company has advanced $1,470,000 of
the financing commitment as of September 30, 1996, which is reflected in the
financial statements as a note receivable.
The Company believes that funds generated from operations, together with
available funds remaining from the net proceeds of its initial public offering,
will be sufficient to finance its working capital for the foreseeable future.*
However, should the Company need additional funds, it has an unsecured revolving
line of credit with a bank for $5,000,000 at the bank's prime lending rate.
During the three month period ended September 30, 1996, no borrowings were made
against this line, and at present there are no outstanding balances against this
line.
ADDITIONAL FACTORS AFFECTING FUTURE PERFORMANCE
Approximately 56% of the Company's net sales for the nine months ended
September 30, 1996 were derived from sales of the Company's proprietary products
(mainly telephone headset products) which have a higher gross margin than its
other products. The Company anticipates that these headset products will
continue to account for a significant portion of its net sales and profits in
the foreseeable future.* If sales of the Company's proprietary products were to
decline significantly for any reason, or the
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* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations due to factors
described in the Company's Annual Report on Form 10-K/A and Quarterly Report on
Form 10-Q.
<PAGE>
gross margins on such products were to decrease significantly for any reason,
including competitive pressures or technological obsolescence, the Company's
operating results would be materially adversely affected.
A substantial portion of the Company's private label and proprietary
products are manufactured by a relatively small number of manufacturers and most
of such products, including all headset products, are manufactured by only two
sources. To date, the Company has been able to obtain adequate supplies of
these products, although on occasion the Company has incurred additional
delivery costs to air ship products to obtain inventory in a timely manner. The
Company's inability in the future to obtain sufficient quantities of sole or
limited source products, or to develop alternate sources, would result in
shortages of such products, which would have a material adverse effect on the
Company's net sales and operating results.
Substantially all of Hello Direct's proprietary products are manufactured
to its specifications by Seo Won K-Tec, Inc. ("K-Tec"), located in South Korea,
and Sinoca Enterprises Co. Ltd. ("Sinoca"), located in Taiwan and Singapore.
Each of these manufacturers is a substantial supplier to the Company and
products manufactured by Sinoca and K-Tec together represented approximately 52%
of the Company's net sales in the nine month period ending September 30, 1996.
The Company has no long-term contracts with these manufacturing sources and
competes with other companies for production facilities and import quota
capacity. Although the Company believes that it has established close
relationships with these foreign manufacturing sources, the Company's future
success will depend in large measure upon its ability to maintain such
relationships. The Company's business is subject to the risks generally
associated with doing business abroad, in countries in which the Company's
manufacturing sources are located. The Company cannot predict the effect that
such factors will have on its business arrangements with foreign manufacturing
sources. If any such factors were to render the conduct of business in a
particular country undesirable or impractical, or if the Company's current
foreign manufacturing sources were to cease doing business with the Company for
any reason, the Company's business and operating results could be adversely
affected. Further, the Company cannot predict whether additional United States
quotas, duties, taxes or other charges or restrictions will be imposed upon the
importation of its products in the future, or what effect any such actions would
have on its business, financial condition and results of operations.
Increases in postal rates and paper and printing costs increase the cost of
the Company's catalog mailings. While the Company experienced significant paper
price increases in 1995, the price of paper has stabilized and additional price
increases, if any, in the remainder of 1996 are not anticipated to be material.*
Effective July 1, 1996 the Postal Service implemented requirements for sorting
and bar coding of third class mail which will result in a small discount from
present rates for third class mail. These requirements are expected to reduce
postage expense in the remainder of 1996, although
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* This statement is a forward-looking statement reflecting current
expectations. There can be no assurance that the Company's actual future
performance will meet the Company's current expectations due to factors
described in the Company's Annual Report on Form 10-K/A and Quarterly Report on
Form 10-Q.
<PAGE>
not materially.* Should there be changes in the current outlook, an increase in
postal rates or higher than anticipated paper and printing costs could have a
material adverse impact on the Company's financial position and results of
operations to the extent that the Company is unable to pass such increase
directly on to customers by raising prices or to offset such increase by
implementing more efficient printing, mailing, and delivery systems.
The Company has experienced in the past and will experience in the future
quarterly variations in net sales and net income as a result of many factors,
including the timing of catalog mailings; catalog response rates; product mix;
the level of selling, general and administrative expenses; the timing and level
of product development expenses; and the timing and success of new product
introductions by the Company or its competitors.* The Company's planned
operating expenditures are based on sales forecasts. If net sales are below
expectations in any given quarter, operating results would be materially
adversely affected.
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed of" and SFAS No. 123,
"Accounting for Stock-Based Compensation." The Company expects that the
implementation of those Statements will not have a material effect on its
financial statements.*
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* This statement is a forward-looking statement reflecting current expectations.
There can be no assurance that the Company's actual future performance will meet
the Company's current expectations due to factors described in the Company's
Annual Report on Form 10-K/A and Quarterly Report on Form 10-Q.
<PAGE>
PART II. OTHER INFORMATION
Items 1-5. Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
a. Exhibits
11.1 Computation of net income per share.
27 Financial Data Schedule
b. Reports on Form 8-K.
No reports on Form 8-K were filed with the Securities and Exchange
Commission during the quarter ended September 30, 1996.
SIGNATURES
Pursuant to the Securities Exchange Act of 1934, as amended, the Registrant
has duly caused this report to be signed by the undersigned, thereunto duly
authorized.
HELLO DIRECT, INC.
(Registrant)
/s/ C. Allen Batts
-----------------------------
C. Allen Batts,
President and Chief Executive
Officer
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EXHIBIT INDEX
Exhibit
Number Description of Document
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11.1 Computation of net income per share.
27 Financial Data Schedule
<PAGE>
EXHIBIT 11.1
HELLO DIRECT, INC.
COMPUTATION OF NET INCOME PER SHARE
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
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September 30, September 30,
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1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Income before extraordinary item $ 145,000 $ 831,000 $ 705,000 $ 2,342,000
---------- ---------- ---------- -----------
Net income $ 145,000 $ 831,000 $ 705,000 $ 2,205,000
---------- ---------- ---------- -----------
Weighted average common shares outstanding 4,986,000 4,940,000 4,976,000 4,199,000
Common stock equivalents:
Common stock options, utilizing treasury stock method
when dilutive 57,000 154,000 57,000 162,000
---------- ---------- ---------- -----------
Weighted average shares outstanding 5,043,000 5,094,000 5,033,000 4,361,000
========== ========== ========== ==========
Per share amounts
Income before extraordinary $ 0.03 $ 0.16 $ 0.14 $ 0.54
========== ========== ========== ==========
Net income $ 0.03 $ 0.16 $ 0.14 $ 0.51
========== ========== ========== ==========
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 3,305,000
<SECURITIES> 8,016,000
<RECEIVABLES> 5,054,000
<ALLOWANCES> 0
<INVENTORY> 5,027,000
<CURRENT-ASSETS> 24,672,000
<PP&E> 2,825,000
<DEPRECIATION> 0
<TOTAL-ASSETS> 30,522,000
<CURRENT-LIABILITIES> 5,915,000
<BONDS> 0
0
0
<COMMON> 5,000
<OTHER-SE> 24,602,000
<TOTAL-LIABILITY-AND-EQUITY> 30,522,000
<SALES> 37,566,000
<TOTAL-REVENUES> 37,566,000
<CGS> 18,084,000
<TOTAL-COSTS> 36,965,000
<OTHER-EXPENSES> (568,000)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,169,000
<INCOME-TAX> 464,000
<INCOME-CONTINUING> 705,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 705,000
<EPS-PRIMARY> 0.14
<EPS-DILUTED> 0.14
</TABLE>
