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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 (Fee Required).
For the fiscal year ended December 31, 1998
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 (No Fee Required).
For the transition period from ________________ to ________________
Commission file no. 0-25524
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HELLO DIRECT, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 94-3043208
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
5893 RUE FERRARI, SAN JOSE, CALIFORNIA 95138
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (408) 972-1990
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ______X_______
The aggregate market value of the Registrant's Common Stock, par value
$.001 per share, held by non-affiliates of the Registrant, based upon the
closing price at March 1, 1999 was approximately $34,140,000. For purposes of
this disclosure, shares of Common Stock held by persons who hold more than 5% of
the outstanding shares of Common Stock and shares held by officers and directors
of the Registrant have been excluded because such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily conclusive
for other purposes.
The number of shares of Registrant's Common Stock, par value $.001 per
share, outstanding at March 1, 1999 was 5,209,360.
Documents Incorporated By Reference
1. Portions of the Proxy Statement sent to stockholders in connection with the
Annual Meeting of Stockholders to be held on April 28, 1999 are incorporated by
reference into Part III) of this Report. Such Proxy Statement, except for the
parts therein which have been specifically incorporated by reference, shall
not be deemed "filed" for the purposes of this report on Form 10-K.
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<PAGE>
HELLO DIRECT, INC.
FORM 10-K
YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
PART I
Item 1. Business
Factors Affecting Operating Results and Market Price of Stock
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
PART III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and
Management
Item 13. Certain Relationships and Related Transactions
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K
<PAGE>
PART I
Item 1. Business
This Business section and other parts of this Annual Report on Form 10-K
contain forward-looking statements that involve risks and uncertainties.
The Company's actual results may differ significantly from the results
discussed in the forward-looking statements. Factors that might cause
such a difference include, but are not limited to, those discussed below
and in "Management's Discussion and Analysis of Financial Condition and
Results of Operations." The forward-looking statements contained herein
are made as of the date hereof, and the Company assumes no obligation to
update such forward-looking statements or to update reasons actual
results could differ materially from those anticipated in such forward-
looking statements. Forward-looking statements are identified with an
asterisk (*).
Founded in 1987, Hello Direct, Inc. ("Hello Direct" or the "Company") is
a Delaware corporation with principal executive offices located at 5893
Rue Ferrari, San Jose, California 95138. The Company's main telephone
number is (408) 972-1990.
The Company is a leading developer and direct marketer of desktop
telephony products and equipment interface solutions to business end
users. The Company designs and sells its own products and also offers a
wide variety of products and accessories from other manufacturers. The
Company's primary marketing channels to its customers are direct mail
solicitation through catalogs, outbound telemarketing and the Internet.
During 1998, the Company distributed 28.0 million catalogs and processed
315,000 orders from customers.
Products
The Company sells telecommunications products that are divided into two
main categories: Hello Direct Proprietary products, which amounted to
approximately 56% of net sales in 1998 and National Branded products,
which accounted for the remaining 44% of net sales.
Hello Direct Proprietary Products The Company's proprietary product
offerings include approximately 80 SKUs of commercial-grade headset
products including corded headset tops, amplifiers, cordless headset
systems, and a variety of related accessories. The Company's exclusive
headset brands include Ultralight?, Solo?, Executive?, Cordless?, and
Office Rover?. Headsets are offered in multiple variants to address
user preferences for features, price, fit, and feel. Headset products
have been a key Hello Direct product category since 1988. Hello Direct
introduced the first commercial-grade wireless telephone headset by
incorporating 900-Megahertz technology, which provided the wireless
headset with greater range and sound clarity than earlier technology.
Since then, the Company has released a series of innovations to its
corded and cordless headset product offerings. The Company has also
expanded its proprietary product offering to include an equipment-
equipment interface solution - the LineSteinTM Digital Adapter, a
revolutionary self-learning analog-to-digital phone line adapter
introduced in 1998. The LineStein Digital Adapter solves the problem of
incompatibility of telephone systems with much of the peripheral
equipment that can be connected to them. In addition, the Company
introduced the Ultralight? EX telephone headset in 1998, which
incorporates the latest in lightweight ergonomic design to achieve the
highest possible level of comfort in a headband-style headset. For a
discussion of the risks related to the Company's dependence on headset
products, see "Factors Affecting Operating Results and Market Price of
Stock-We Depend on Headset Products." For a discussion of the risks
related to the Company's need to develop new products, see "Factors
Affecting Operating Results and Market Price of Stock-We Need to Develop
New Products Successfully."
National Branded Products Hello Direct's nationally branded product
line includes selected telephones, small business telephone systems
(under 16 stations), audio and video conferencing equipment, wireless
telephones, telephone accessories, amplification products and office
communications accessories. Leading brand names include AT&T, Nortel
Networks, Panasonic, Uniden, Vtech, Nextel and Polycom.
Development of Proprietary Products
A key element of the Company's business strategy is to develop and
introduce innovative proprietary products. In addition to strengthening
the product offering, increasing sales and providing higher gross
margins, the Company believes offering proprietary products enhances
awareness of the Hello Direct brand name. The Company's product
development team generates new product specifications and manages the
development process. Hello Direct works with third parties for most
engineering and design and for all manufacturing.
The Company relies upon customer feedback and input as a primary source
of new product ideas and enhancements to current products. The Company
developed its wireless headset as a result of customer requests and has
continued to enhance this product, in response to customer feedback.
Similarly, based on customer feedback regarding existing corded
headsets, the Company has developed a proprietary family of corded
headsets that addresses specific customer preferences for features,
price, comfort, fit and feel. In addition to individual customer
contacts, Hello Direct regularly conducts target customer surveys and
focus groups to solicit customer feedback and generate product
development ideas. The Company also obtains product development ideas
from trade shows, industry journals and suppliers.
Hello Direct concentrates its proprietary product development in two
critical interface areas: the human-equipment interface and the
equipment-equipment interface. Hello Direct's human-equipment interface
leadership is well known and respected. Through advancements in design
and engineering, Hello Direct headsets and amplifiers have continually
been leaders in comfort, ease of use and sound quality. It has been
estimated that less than 5% of office workers in the United States use
telephone headsets. This percentage is expected to grow for two reasons:
first, a headset frees both hands to operate computer and fax equipment,
take notes, etc.; and second, headsets result in less neck strain than
cradling traditional handsets between neck and shoulder. The next
technological wave in human-equipment interface will involve "voice
recognition" by computers and other devices, and Hello Direct has begun
to explore ways the most recent advancements in this field may be
adapted to its proprietary products. *
Providing solutions for equipment-equipment interface issues is less
well understood, but just as important for Hello Direct customers. The
integration of telephony products such as headsets, teleconferencing
units and modems with business telephone systems is a source of
significant confusion and frustration for end users and installers.
Unless properly configured, analog telephony products are incompatible
with digital phone systems such as PBXs. The problem is compounded as
other technologies, including computer, fax and video, rely on
connectivity with telephone systems. For a discussion of the risks
related to new products and product enhancements, see "Factors Affecting
Operating Results and Market Price of Stock-We Need to Develop New
Products Successfully."
As part of its development process, the Company has entered, and expects
to continue to enter, into development agreements whereby the Company
will pay all or a portion of product development costs, license
technology and make royalty payments based on product sales.* The
Company's product development expenses were $2,036,000, $1,592,000, and
$1,598,000, in 1998, 1997 and 1996, respectively. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations."
LearnItTM Telephone accessories such as headsets and external
speakerphones typically access networks through the handset jack. Since
each manufacturer uses different interface protocols, suppliers have had
to provide telephone-specific accessories or, like the Company,
universal accessories which users must manually configure. The problem
has been exacerbated by the proliferation of proprietary telephone
systems and accessories. During 1993, the Company began development of
LearnIt, which uses two custom integrated circuits to interface
automatically with the protocols of a particular unit and thereby
eliminate the need for manual adjustments. LearnIt, which was initially
incorporated into its headset products, improves product performance by
enhancing sound quality and makes products more user-friendly by
simplifying the installation process. LearnIt technology can also be
used to provide access through the telephone handset jack to other
communications products such as teleconferencing units, facsimiles and
modems. The SuperProTM headset amplifier and the LineStein universal
adapter incorporate Hello Direct's patent-pending LearnIt chip, which
eliminates the need for customers to reconfigure DIP switches manually
each time their telephone equipment must be interfaced with other
telephone systems. Instead, LearnIt "learns" the protocol of the other
equipment and automatically configures the interface to ensure optimum
voice and data transmission quality.
Sales, Marketing and Customer Service
Inbound Sales
The Company relies primarily on promotional materials delivered by mail
to its customers and rented lists of prospective customers to market its
products. The Company's promotional materials contain information on
how to place an order with the Company by phone, Internet, fax or mail.
The Company believes that prompt and courteous sales assistance and
customer service are critical in encouraging customers to make repeat
purchases from Hello Direct. The objective of the Company's inbound
sales organization, which is responsible for inbound sales, technical
support, customer service and all sales-related order processing
functions, is to provide excellent sales assistance and customer
service. The Company currently has approximately 75 people in this
organization.
The Hello Direct catalog, the Company's primary sales tool, is a direct-
response catalog designed to provide all the information necessary for a
customer to purchase any of the Company's telecommunications products.
The catalog includes product descriptions, full-color photographs,
product specifications and prices as well as information concerning the
use and applications of telecommunications products. It has an end-user
orientation and is designed to appeal to both technical and non-
technical users. The product copy follows the generally accepted direct
response principles of presenting user benefits, explaining product
features and soliciting orders. The catalog also features a complete
easy-to-use index and "Fast Facts," a service by which the Company will
fax its customers detailed information on specific products offered in
the catalog.
In 1998, the Company's catalogs ranged from 60 to 64 pages each. The
Company distributed 28.0 million catalogs during 1998, a decrease of
1.8% from the 28.5 million catalogs distributed in 1997. The Company
publishes four editions of its catalog annually. Each edition is
produced in at least four versions, featuring different covers and
updated product offerings. The Company's customers receive up to 12
catalogs per year.
The Company's full-color catalogs are produced in-house on advanced
desk-top publishing equipment ("DTP"). Substantially all of the text,
graphics and photos used in the catalog are completely digitized. Use
of DTP equipment for page production has provided the Company with
significant flexibility, speed and cost savings over traditional catalog
production methods.
Outbound Telemarketing
The Company maintains a comprehensive database of customers' purchasing
history which is used by the direct marketing group to identify both
high-volume and potential high-volume customers and to target special
promotions and product offerings. Representatives from the corporate
accounts sales force (outbound telemarketing) cultivate customers
targeted through this program and provide them with a specific
representative to serve their individual needs. The Company currently
has approximately 40 people in this organization, which includes both
the corporate account sales associates as well as administrative
assistants to identify potential target customers.
The Company's outbound telemarketing efforts target corporate accounts
with a focus on the small-to-medium-sized call center environments. The
Company believes this is a rapidly growing market segment which
typically purchases higher-margin products in larger order sizes and
does significant repeat business. The Company believes its focused
outbound telemarketing efforts represent a cost effective and
complementary sales channel to its catalog. Outbound telemarketing
sales grew substantially in 1998 and now contribute nearly one-third of
the Company's total revenue.
Internet
The Company offers its full catalog product offering on the Internet at
its web site www.hellodirect.com. The revenue generated from the
Internet is currently about 5% of net sales, and both order volume and
average order value are increasing.* The Company has been selling over
the Internet since 1994, and its Internet site has won numerous awards
from the direct marketing industry. The Internet seamlessly complements
the Company's catalog and outbound telemarketing efforts and has been a
very successful sales channel. The Company anticipates that the rate of
growth of its Internet sales channel will continue to exceed that of its
other sales channels in 1999.*
Procurement
The Company purchases most of its products in large volumes directly
from manufacturers who deliver the merchandise to the Company's
distribution center. The Company believes that, because of its volume
purchases and its direct response channel, it has benefited from
favorable pricing, payment and delivery terms and promotional allowances
from its suppliers. The Company believes it has good relationships with
its suppliers and to date has not experienced any difficulty in
obtaining products.
A substantial portion of the Company's purchases of brand-name and
private-label products are concentrated with a relatively small number
of manufacturers. However, the Company believes that alternate sources
of supply are available for almost every third-party product it carries.
Sales of brand-name products represented approximately 44% of net sales
in 1998. The failure of an existing significant supplier to provide
products would materially adversely affect the Company's operating
results until the Company could develop an alternate source of supply or
an alternate product. Certain vendors provide advertising allowances to
the Company to promote sales of their products. In addition, the Company
typically receives price protection for on-hand inventory should a
vendor subsequently lower product prices. Under most of the Company's
purchase agreements, the Company can return unsold inventory to its
suppliers.
All of the Company's proprietary products are manufactured by
independent contractors according to specifications and conditions set
by the Company. Each independent contractor must meet the Company's
specifications relating to the manufacturing process and quality
assurance before such contractor is selected by the Company to
manufacture Hello Direct products. The Company's strategy is to continue
using independent contractors to meet its manufacturing requirements.*
For a discussion of the risks related to its reliance on manufacturers,
see "Factors Affecting Operating Results and Market Price of Stock-We
Depend on Limited Source Suppliers and Foreign Manufacturing."
Quality Assurance
Hello Direct's quality assurance program is dedicated to maximizing
customer satisfaction. To achieve this goal, the Company oversees
various aspects of quality assurance related to catalog content,
customer qualification, order entry, product fulfillment, post-sales
support and customer follow-up. The Company tests and evaluates every
product considered for inclusion in the Hello Direct catalog. The
Company's quality assurance personnel work with the Company's product
development team to assure all new proprietary products adhere to the
Company's quality standards.
Management Information and Call Processing Systems
Hello Direct is committed to using a high level of information and
communications systems to manage all aspects of its business. The
Company currently uses a Hewlett-Packard 3000 Model 928 to support
sales, marketing, procurement, accounting and distribution. The system
allows the Company, among other things, to monitor sales trends, make
informed purchasing decisions and provide product availability and order
status information. In addition to the main system, the Company has a
system of networked personal computers, which facilitates data sharing
and provides an automated office environment. The Company has purchased
new sales and customer interaction software and is currently working
with the vendor to customize and increase the functionality of the
software. For a discussion of the impact of the year 2000 issue, see
Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Impact of the Year 2000 Issue."
The Company uses an Aspect 200-R Automated Call Distributor, which
includes a fully redundant hardware and software platform and desktop
software tools to provide each supervisor with accurate call management
information. Future enhancements will include the Aspect Agility
Interactive Voice Response, which will enable automated responses to
customer requests, and computer-telephony integration.*
The Company's success is in part dependent on the accuracy and proper
utilization of its management information systems and call processing
systems. These investments are intended to continue to improve the
Company's customer care capabilities and the Company's customer
information database.*
Competition
The market for customer-premise telecommunications products is highly
competitive. The Company competes with a variety of traditional dealers,
distributors and retailers, including catalog companies, electronics
specialty stores and office products and computer superstores. A variety
of external and internal factors could adversely affect the Company's
ability to compete. These include the functions, performance, price and
reliability of the products offered by the Company and its competitors
and the effectiveness of the marketing efforts of the Company and its
competitors. Certain competitors of the Company have greater financial,
technical, sales and marketing and other resources than the Company.
There can be no assurance that the Company will compete effectively
against existing competitors or new competitors that may enter the
market. In addition, while the Company currently does not know of any
competitor specializing in distributing a broad line of
telecommunications products directly to business end-users via catalog,
outbound telemarketing and the Internet, there can be no assurance that
the Company will be able to compete successfully in the future in these
direct marketing channels, which may attract new market entrants, or in
other channels that the Company may enter or that may be developed for
telecommunications products for such customers. See "Factors Affecting
Operating Results and Market Price of Stock - Our Business is Highly
Competitive."
Sales of the Company's proprietary commercial-grade headset products
accounted for more than 50% of the Company's total net sales for 1998.
Hello Direct faces competition in this product category from a variety
of sources. The Company believes Plantronics, Inc. is the leading
manufacturer of telephone headset products, but only in limited
circumstances do they sell directly to end users. In traditional
telecommunications sales channels, such as distributors and telephone
systems dealers, headset products are generally sold as "add-on sales"
in connection with other purchases. The Company believes specialized
headset product distributors such as Communitech and GBH Distributors
generally focus their sales efforts on fulfilling existing demand from
traditional high-volume headset users, such as large call centers, and
devote little or no resources to marketing to small and medium-sized
businesses. Hello Direct, through its outbound telemarketing efforts,
markets to these relatively under-served small and medium-sized
businesses. Certain office and computer products dealers also sell
headset products which are primarily lower quality consumer-grade.
Telecom and cellular products are sold through a wide variety of
channels ranging from large discount chains and mass merchandisers to
specialized catalog operations. Hello Direct faces strong competition in
this area and has responded by focusing its efforts on providing strong
customer service and product support and by focusing on a selection of
superior, high-quality, value-added national brand products that may be
difficult to find elsewhere or are sufficiently early in their product
life cycles to appeal to customers seeking innovative telecommunications
solutions. This product category is comprised primarily of brand-name
products which are widely available through alternate suppliers. The
Company competes with such suppliers on the basis of features and price;
however, because the Company limits its branded product offering to
innovative and high quality value-added products, the Company does not
compete for commodity sales.
In the call-processing product category, Hello Direct faces competition
primarily from dealers of specialty systems which sell telephone systems
using direct sales forces. Such dealers, however, generally focus their
resources on call-processing systems and products in the $5,000 and over
price range. In contrast, Hello Direct is a direct marketer of
commercial-grade telecommunications products selling for under $5,000.
While certain retail stores sell lower-priced processing systems and
accessories, selection and support in such retail outlets is minimal.
Intellectual Property Rights
The Company relies on a combination of patent, copyright, trademark and
trade secret laws and contractual provisions to protect its proprietary
rights. As part of its confidentiality procedures, the Company generally
enters into non-disclosure agreements with its employees, distributors
and corporate partners, and limits access to and distribution of its
software, documentation and other proprietary information. Despite these
precautions, it may be possible for a third party to copy or otherwise
obtain and use the Company's products or technology independently. In
addition, effective protection of intellectual property rights may be
unavailable or limited in certain foreign countries.
There are currently no pending material claims that the Company's
products, trademarks or other proprietary rights significantly infringe
the proprietary rights of third parties. In the event of litigation and
an adverse ruling in such litigation, the Company might be required to
discontinue the use and sale of infringing products, expend significant
resources to develop non-infringing technology or obtain licenses to
infringing technology. In the event of a successful claim against the
Company and the failure of the Company to develop or license a
substitute technology, the Company's business and operating results
would be adversely affected. See "Factors Affecting Operating Results
and Market Price of Stock - We Face Risks Associated with Intellectual
Property Rights."
Personnel
The Company had 224 full-time employees at March 1, 1999. The Company
sponsors a number of employee benefit plans including medical/dental
insurance plans, life and long-term disability insurance plans, flexible
spending accounts, an employee stock purchase plan, a 401(k) salary
deferral plan, and an employee profit-sharing plan. None of the
Company's employees are represented by a collective bargaining
agreement. The Company believes that its relations with its employees
are good.
Executive Officers of the Company
Name of Executive Officer Age Positions with the Company
- ------------------------- --- --------------------------
E. Alexander Glover 55 President, Chief Executive Officer
and Director
Ronald J. Becht, Jr. 43 Vice President of Product Marketing
Ruth Grouell 52 Vice President of Organizational
Development
Dennis P. Waldera 50 Vice President of Direct Marketing
Dean Witter III 52 Chief Financial Officer and
Secretary
Michael Young 48 Vice President and Chief Information
Officer
The Company's executive officers are traditionally elected to office at
the first meeting of the Board of Directors following the Annual Meeting
of Stockholders. Each officer holds office until the first meeting of
the Board following the next Annual Meeting and until a successor is
chosen. Biographical information for the executive officers follows:
E. Alexander Glover joined the Company in 1995. From 1983 to 1994, Mr.
Glover was Senior Vice President, Marketing and R&D for Kransco Group
Companies ("Kransco"), a toy and sporting goods company. Mr. Glover was
also a member of the Corporate Executive Committee at Kransco. From 1969
to 1983, Mr. Glover progressed through various senior marketing
management positions with Procter & Gamble Co., in its Paper and
Packaged Soap/Detergent Divisions. Mr. Glover holds a B.A. from Harvard
and an M.B.A. from Stanford University.
Ronald J. Becht, Jr. joined the Company in 1993. From 1991 to September
1993, he was President and Chief Executive Officer of Personal Computing
Tools, a direct marketer of data acquisition and control products which
was acquired by Software Developers Corporation, a direct marketer of
engineering, software and hardware products. From 1981 to 1991, he
served in various marketing positions with Inmac Corp., a direct
marketer of computer hardware and software products, most recently as
Director of Worldwide Marketing. Mr. Becht holds a B.S. in Business
from the University of San Diego.
Ruth Grouell joined the Company in 1998. From 1995 to 1997, she was
Director of Human Resources for Geron Corporation, a biotech company.
From 1993 to 1995, she managed the training and development department
for Syntex Pharmaceuticals. From 1988 to 1991, she led efforts to re-
engineer business processes at Ford Aerospace. Earlier, she was an
organizational development consultant for the US Army in Europe. Ms.
Grouell holds a B.A. in English from the University of Iowa and a M.S.
in Counseling from San Diego State University.
Dennis P. Waldera joined the Company in 1996. From 1983 through early
1996, Mr. Waldera held various positions, lastly Executive Vice
President, Managing Director, with Clarion Marketing and Communications,
one of the largest marketing consulting, sales promotion, and direct
marketing services firms in the United States. He was also a member of
Clarion's Management Committee and Board of Directors. From 1978
through 1982, Mr. Waldera was a Vice President of Glendinning
Associates, a marketing, promotion and sales consulting company. Mr.
Waldera began his career at Procter & Gamble Co. where from 1972 to 1978
he progressed through various marketing management positions in the
Paper Products Division. Mr. Waldera holds a B.B.A. from the University
of Wisconsin and an M.B.A. degree from Northwestern University.
Dean ("Kip") Witter III was appointed interim Chief Financial Officer
and Secretary of the Company in February 1999. Mr. Witter is a senior
consultant in The Brenner Group LLC, an interim management and financial
advisory services firm. He had previously served as acting CFO for
Telcontar, GenOA Corporation, and BusinessBots, Inc., before which he
was a principal in two start-ups. From 1976 until 1989 Mr. Witter
worked at Amdahl Corporation, where he rose to the position of Vice
President and Treasurer. Mr. Witter holds a B.A. from Harvard and an
M.B.A. from Stanford University.
Michael Young joined the Company in 1998. From 1994 to 1998, he was
Chief Operating Officer for Odwalla, Inc., a leading retailer of fresh
squeezed juices. From 1991 to 1994, he served as Vice President of
Strategic Information Systems at Kransco Group, the largest privately-
held toy and sporting goods firm in the U.S. From 1978 to 1991, he held
various information systems positions with Colgate-Palmolive Company.
Factors Affecting Operating Results and Market Price of Stock
Hello Direct operates in a rapidly changing environment that involves a
number of uncertainties, some of which are beyond our control. In
addition to the uncertainties described elsewhere in this report, these
uncertainties include:
Our Future Operating Results are Uncertain.
We have grown rapidly and achieved profitability as a result of a
substantial increase in catalog mailings, strong growth in the number of
active customers and the success of our product offering, particularly
of our proprietary headset products. We may not be able to maintain
profitability on a quarterly or annual basis or continue to increase our
net sales. Our net sales will continue to grow only if we are able to,
among other things, increase sales to existing customers, grow our
customer base and expand our product offering. Our operating results
could be harmed if we were to experience lower than anticipated catalog
response rates from existing and prospective customers, higher than
anticipated product return rates or higher than anticipated increases in
paper and postal costs. We may not be able to continue to achieve
growth in net sales, and any such growth may not offset increases in
operating expenses. Our operating results could also be harmed by
delays in new product introductions, poor product selection and market
acceptance of new products or increased competition. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations."
Our Quarterly Operating Results are Likely to Fluctuate.
We have experienced and will experience quarterly variations in net
sales and net income as a result of many factors, including the
following:
- - the number and 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 our and our competitors' new product
introductions.
We plan our operating expenditures based on sales forecasts. If our net
sales are below our expectations in any given quarter, our operating
results will suffer. Due to the foregoing factors, in some future
quarter our operating results may be below the expectations of public
market analysts and investors. In such event, the price of our Common
Stock would likely suffer.
We Need to Develop New Products Successfully.
The market for telecommunications products is generally characterized by
rapidly changing technology that can render existing products obsolete
and unmarketable. We believe our current and future success will depend
on our ability to identify, develop or source and successfully introduce
and market, in a timely manner, enhancements to our existing products
and new products that respond effectively to technological change. To
accomplish this, we intend to consult with our direct customer contacts
and use our product development capabilities. We have experienced
delays in the past in introducing certain of our products and could
encounter similar technical difficulties in the future that could result
in delayed product introductions or expensive recalls. We may not
successfully anticipate technological changes or select and develop new
and enhanced products on a timely basis. In addition, if we are able to
develop or source any products, these products may not gain market
acceptance.
We Depend on Headset Products.
We derived more than 50% of our net sales in 1998 from our proprietary
telephone headset products. These products have higher gross margins
than our other products. We anticipate that these headset products will
continue to account for a significant portion of our net sales and
profits in the foreseeable future. * If sales of our telephone headset
products were to decline significantly, or the gross margins on such
products were to decrease significantly, as a result of competitive
pressures or technological obsolescence, our operating results would be
harmed.
We Rely on Sole or Limited Source Suppliers and Foreign Manufacturing.
A relatively small number of manufacturers produce a substantial portion
of our proprietary products. Only three sources manufacture most of
these products, including all of our headset products. To date, we have
been able to obtain adequate supplies of these products, although on
occasion we have incurred additional delivery costs to air ship products
to obtain inventory in a timely manner. If we are unable in the future
to obtain sufficient quantities of sole or limited source products, or
to develop alternative sources, shortages of such products would occur.
This would harm our net sales and operating results.
Seo Won K-Tec, Inc., with operations in South Korea and the Philippines;
Sinoca Enterprises Co. Ltd., located in Taiwan; Tru-Tech Electronics,
located in Malaysia; and Transtech Electronics Pte. Ltd., located in
Singapore, manufacture a substantial portion of our proprietary products
to our specifications. Each of these manufacturers is also one of our
substantial suppliers. Products manufactured by these manufacturers
represented more than 50% of our net sales in 1998. We have contracts
of varying terms with these manufacturing sources, and we compete with
other companies for production facilities. Although we believe that we
have established close relationships with these foreign manufacturing
sources, our future success will depend in large measure upon our
ability to maintain such relationships.
In addition, we face a number of risks inherent in doing business in
international markets, including, among others:
- - unexpected changes in regulatory requirements,
- - potentially adverse tax consequences,
- - tariffs and other trade barriers,
- - fluctuations in currency exchange rates,
- - political unrest,
- - disruptions or delays in shipments, and
- - changes in economic conditions in countries in which our manufacturing
sources are located.
We cannot predict the effect that such factors will have on our business
arrangements with foreign manufacturing sources. If any of these
factors were to render the conduct of business in a particular country
undesirable or impractical, or if our current foreign manufacturing
sources were to cease doing business with us for any reason, our
business and operating results could suffer.
Our Business is Highly Competitive.
The market for customer premise telecommunications products is highly
competitive. We compete with a variety of traditional dealers and
retailers, including catalog companies, electronics specialty stores and
office products and computer superstores. A variety of external and
internal factors could harm our ability to compete, including:
- - the functions, performance, price and reliability of the products
offered by us and our competitors,
- - the timing and success of our and our competitors' new product
development efforts, and
- - the effectiveness of our and our competitors' marketing efforts.
Certain of our competitors have greater financial, technical, sales and
marketing and other resources than we have. We may not be able to
compete effectively against existing competitors or against new
competitors that may enter the market. In addition, while we currently
do not know of any competitor specializing in distributing a broad line
of telecommunications products directly to business end-users via
catalog, outbound telemarketing and the Internet, we may not be able to
compete successfully in the future in these direct marketing channels,
which may attract new market entrants, or in other channels that we may
enter or that may be developed for the sale of telecommunications
products. See "Business - Competition."
Potential Acquisitions Involve Risks.
We have acquired complementary technologies or businesses in the past
and may or may not do so in the future. Future acquisitions may involve
potentially dilutive issuances of stock, the incurrence of additional
debt and contingent liabilities or large one-time write-offs and
amortization expenses related to goodwill and other intangible assets.
Any of these factors could harm our results of operations or stock
price. Acquisitions involve numerous risks, including:
- - difficulties in assimilating the operations, products, technology,
information systems and personnel of the acquired company,
- - diverting management's attention from other business concerns,
- - impairing relationships with our customers,
- - being unable to maintain uniform standards, controls, procedures and
policies,
- - entering markets in which we have no direct prior experience, and
- - losing key employees of the acquired company.
In January 1999, we acquired PhoneZone.com, Inc., an Internet publisher
of a buyer's guide covering telecommunications and networking products
and services. As a result of this acquisition, we entered into
employment contracts with three key employees. We may not be able to
successfully integrate the business and personnel we acquired from
PhoneZone.com or any other businesses, technologies or personnel that we
acquire in the future.
Our Internet Sales Rely on the Continued Growth In Electronic Commerce
and Internet Infrastructure Development.
Sales of telecommunications products using the Internet do not currently
represent a significant portion of overall telecommunications products
sales. However, our future growth may depend on the growing use and
acceptance of the Internet as an effective medium of commerce by end
users. Rapid growth in the use of and interest in the Internet and
other online services is a recent development. No one can be certain
that acceptance and use of the Internet and other online services will
continue to develop or that a sufficiently broad base of consumers will
adopt, and continue to use, the Internet and other online services as a
medium of commerce. We will be able to achieve increased sales over the
Internet only if purchasers of telecommunications products who have
historically used traditional means of commerce to purchase these
products view the Internet as a preferred alternative. If our Internet
efforts are to be successful, these purchasers must accept and use the
Internet as a means of purchasing telecommunications products, and we
cannot predict the rate at which purchasers will do so.
The Internet may fail as a commercial marketplace for a number of
reasons, including potentially inadequate development of the necessary
network infrastructure or delayed development of enabling technologies
and performance improvements. If the number of Internet users or their
use of Internet resources continues to grow, it may overwhelm the
existing Internet infrastructure. Delays in the development or adoption
of new standards and protocols required to handle increased levels of
Internet activity or increased governmental regulation could also have a
similar effect. In addition, growth in Internet usage that is not
matched by comparable growth in the infrastructure supporting Internet
usage could result in slower response times or adversely affect usage of
the Internet.
Costs of Catalog Mailing, Paper and Printing May Increase.
Increases in postal rates and paper and printing costs increase the cost
of our catalog mailings. An increase in postal rates or higher than
anticipated paper and printing costs could harm our financial position
and results of operations to the extent that we are 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. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
We Face Risks Associated with Managing a Growing Business.
We have experienced significant growth in our operations that has placed
significant demands on our administrative, operational and financial
resources. The growth in our customer base and changes in our product
offering have placed, and we expect will continue to place, a
significant strain on our management and operations, including on our
product development, sales, customer service and finance and
administration staffs. Our future performance will depend in part on
our ability to successfully implement enhancements to our management
information systems and to adapt those systems, as necessary, to respond
to changes in our business. If we are unable to successfully integrate
and train new hires, or if we are unable to respond to and manage
changing business conditions, our business could suffer.
We Rely on a Single Facility.
We house our telemarketing, customer service and distribution functions
in a single facility in San Jose, California. We have taken precautions
to protect ourselves from events that could interrupt order fulfillment
and customer service, such as storing computer backup data offsite and
implementing backup power sources. Notwithstanding these precautions, a
fire, flood, earthquake or other disaster affecting our facility may
disable these functions. Any significant damage to this facility would
harm our business.
We Rely on Key Personnel.
Our future success depends to a significant extent on the efforts of our
key management personnel. The loss of the services of any of these
individuals could harm our business. Competition for employees with
technical, management, sales, customer service and other skills is
intense. Our failure to retain and attract additional qualified
employees could harm our business.
We Face Risks Relating to State Sales Tax Collection.
We presently collect retail occupation tax, commonly referred to as
sales tax, or other similar tax, only on sales of products to residents
of the State of California. Several states have sought to impose on
direct marketers the burden of collecting state sales taxes on the sale
of products shipped to residents of those states. The United States
Supreme Court has held that it is unconstitutional for a state to impose
tax collection obligations on an out-of-state mail order company whose
only contacts with the taxing state are the distribution of catalogs and
other advertisement materials through the mail and whose subsequent
delivery of purchased goods is by United States mail or interstate
common carriers. In the event of a change in present law, which we have
no reason to expect, the imposition of a tax collection obligation on us
by states into which we ship products may result in additional
administrative expenses to us and price increases to the customer, which
could harm our business.
We Face Government Regulations Relating to Mailing Lists.
We are seeking to expand our in-house list of customers and potential
customers by continually renting appropriate mailing lists and sending
our catalogs to prospects obtained from these lists. In the event that
the federal or state governments enact privacy legislation resulting in
the increased regulation of mailing lists, we may be unable to enhance
and expand our customer list. In such event, we could also experience
increased costs in complying with potentially burdensome regulations
concerning the solicitation of consents to keep or add customer names to
our mailing lists.
We Face Risks Associated With Intellectual Property Rights.
We rely on a combination of patent, copyright, trademark and trade
secret laws and contractual provisions to protect our proprietary rights
in our products. As part of our confidentiality procedures, we
generally enter into non-disclosure agreements with our employees,
distributors and corporate partners, and limit access to and
distribution of our software, documentation and other proprietary
information. Despite these precautions, a third party may possibly copy
or otherwise obtain and use our products or technology independently.
In addition, effective protection of intellectual property rights may be
unavailable or limited in certain foreign countries.
No material claims are currently pending regarding the infringement of
the proprietary rights of third parties by our products, trademarks or
other proprietary rights. However, we may receive, in the future,
communications from third parties asserting that our products infringe,
or may infringe, the proprietary rights of third parties. In the event
of litigation to determine the validity of any third-party claims, such
litigation, whether or not determined in our favor, could result in
significant expense to us and divert the efforts of our technical and
management personnel from productive tasks. In the event of an adverse
ruling in such litigation, we might be required to discontinue the use
and sale of infringing products, expend significant resources to develop
non-infringing technology or obtain licenses to infringing technology.
We may not be able to obtain a license for the disputed third-party
technology on reasonable commercial terms or at all. If someone asserts
a successful claim against us and we are unable to develop or license a
substitute technology, our business would suffer.
We May Face Product Liability Claims.
Our sale of proprietary and other products entails the risk of product
liability claims, although we have not experienced any material claims
to date. While we believe that our product liability insurance coverage
is currently adequate, this coverage is limited. We may be unable to
maintain this insurance in the future at a reasonable cost or in amounts
sufficient to protect us against losses due to liability. A successful
product liability claim brought against us in excess of present
insurance coverage could harm our business.
Our Stock Price is Volatile.
The market price of our common stock has been volatile and may be
significantly affected by a number of factors, including:
- - actual or anticipated fluctuations in our operating results,
- - announcements of technological innovations or new products by us or
our competitors,
- - developments with respect to intellectual property and proprietary
rights,
- - conditions and trends in the telecommunications and telephone headset
industries,
- - changes in earnings estimates or recommendations by securities
analysts, and
- - general market conditions.
In addition, the stock market has from time to time experienced
significant price and volume fluctuations that have particularly
affected the market prices for the common stocks of emerging growth
companies and that have often been unrelated to the operating
performance of particular companies. These broad market fluctuations
may also harm the market price of our Common Stock.
- ---------------
* 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. Investors
are strongly encouraged to review the section entitled "Factors
Affecting Operating Results and Market Price of Stock" for a discussion
of factors that could affect future performance.
Item 2. Properties
The Company leases a 76,800 square foot facility in San Jose, California
under a 15-year lease, expiring December 31, 2011. All operations
including sales, technical support, marketing, engineering,
distribution, warehousing and administration are located in this
facility. The Company anticipates this facility will meet its growth
needs for the foreseeable future.* See "Factors Affecting Operating
Results and Market Price of Stock - We Rely on a Single Facility."
Item 3. Legal Proceedings
No material legal proceedings are pending on the date hereof to which
the Company is a party or to which any property of the Company is
subject.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters
The Company's Common Stock has been quoted on the Nasdaq National Market
under the Nasdaq symbol "HELO" since the Company's initial public
offering in April 1995. The following table sets forth, for the periods
indicated, the high and low closing sale prices for the Common Stock on
such market.
High Low
1997:
First quarter ended March 31, 1997 $5.88 $4.75
Second quarter ended June 30, 1997 7.00 5.13
Third quarter ended September 30, 1997 7.25 5.63
Fourth quarter ended December 31, 1997 8.13 5.88
1998:
First quarter ended March 31, 1998 $9.25 $6.06
Second quarter ended June 30, 1998 12.06 5.63
Third quarter ended September 30, 1998 9.25 4.56
Fourth quarter ended December 31, 1998 10.06 4.25
At March 1, 1999, the Company had 76 holders of record of its Common
Stock. The Company estimates the number of beneficial owners of the
Company's Common Stock at March 1, 1999, to be 3,600.
The market price of the Company's Common Stock has been volatile. For a
discussion of the factors affecting the Company's stock price, see
"Factors Affecting Operating Results and Market Price of Stock-Our Stock
Price is Volatile."
The Company has not paid cash dividends on its Common Stock or other
securities. The Company currently anticipates that it will retain all
of its future earnings for use in the expansion and operation of its
business and does not anticipate paying any cash dividends on its Common
Stock in the foreseeable future.* Under the Company's existing credit
facility, the Company cannot declare and pay dividends without prior
written approval from the lender.
Recent Sales of Unregistered Securities.
On January 20, 1999, the Company issued an aggregate of 50,000 shares of
Common Stock to the former shareholders of PhoneZone.com, Inc. in
exchange for the entire issued share capital of PhoneZone.com, Inc. No
underwriters were used in connection with this issuance. This issuance
was deemed exempt from registration under the Securities Act of 1933, as
amended, pursuant to Rule 506, of Regulation D thereunder.
Item 6. Selected Financial Data (in thousands except per share data):
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales ................................... $68,731 $63,846 $51,590 $36,823 $26,216
Cost of goods sold .......................... 31,772 30,759 25,181 16,916 12,179
---------- ---------- ---------- ---------- ----------
Gross profit .......................... 36,959 33,087 26,409 19,907 14,037
Selling, general and administrative
expenses ................................. 31,294 29,234 24,277 17,050 11,335
Product development expenses ................ 2,036 1,592 1,598 1,326 843
CellBase expenses ........................... -- -- -- 2,096 523
---------- ---------- ---------- ---------- ----------
Operating income (loss) ............... 3,629 2,261 534 (565) 1,336
Interest income (expense), net .............. 799 667 720 579 (195)
Other income (expense), net ................. 17 32 (20) (37) 142
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes ..... 4,445 2,960 1,234 (23) 1,283
Provision (credit) for income taxes ......... 1,776 1,184 493 (2,112) 34
---------- ---------- ---------- ---------- ----------
Income before extraordinary item ...... 2,669 1,776 741 2,089 1,249
Extraordinary item .......................... -- -- -- 137 --
---------- ---------- ---------- ---------- ----------
Net income (1) ........................ $2,669 $1,776 $741 $1,952 $1,249
========== ========== ========== ========== ==========
Basic per share amounts:
Income before extraordinary item ........... $0.52 $0.35 $0.15 $0.48 $0.46
========== ========== ========== ========== ==========
Net income ................................. $0.52 $0.35 $0.15 $0.44 $0.46
========== ========== ========== ========== ==========
Weighted average common shares and
equivalents ............................. 5,108 5,036 4,982 4,387 2,726
========== ========== ========== ========== ==========
Diluted per share amounts:
Income before extraordinary item ........... $0.51 $0.35 $0.15 $0.46 $0.39
========== ========== ========== ========== ==========
Net income ................................. $0.51 $0.35 $0.15 $0.43 $0.39
========== ========== ========== ========== ==========
Weighted average common shares and
equivalents(2) .......................... 5,199 5,117 5,043 4,525 3,204
========== ========== ========== ========== ==========
Balance Sheet Data:
Working capital ............................. $19,233 $17,271 $16,282 $14,397 $5,267
Total assets ................................ $35,021 $31,832 $28,966 $25,716 $8,408
Long-term debt and capital lease obligations $ -- $ -- $ -- $20 $1,958
Redeemable preferred stock and stockholders'
equity .................................... $29,354 $26,657 $24,643 $23,727 $4,333
</TABLE>
- ---------
(1)Results in 1995 and 1994 reflect the application of tax loss carryforwards.
Assuming a 40% combined federal and state statutory tax rate, net income
(loss) would have been $(121,000) and $770,000 and basic net income (loss)
per share would have been $(0.03), and $0.28 in 1995 and 1994, respectively.
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
This Management's Discussion and Analysis section and other parts of
this Annual Report on Form 10-K contain forward-looking statements that
involve risks and uncertainties. The Company's actual results may
differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are
not limited to, those discussed below and in "Business." The forward-
looking statements contained herein are made as of the date hereof, and
the Company assumes no obligation to update such forward-looking
statements or to update reasons actual results could differ materially
from those anticipated in such forward-looking statements. Forward-
looking statements are identified with an asterisk (*).
Results of Operations
The following table sets forth statement of operations data as a
percentage of net sales for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net sales ................................ 100.0% 100.0% 100.0%
Cost of goods sold ....................... 46.2% 48.2% 48.8%
------------ ------------ ------------
Gross profit ........................ 53.8% 51.8% 51.2%
Selling, general and administrative
expenses ............................. 45.5% 45.8% 47.1%
Product development expenses ............. 3.0% 2.5% 3.1%
------------ ------------ ------------
Operating income .................... 5.3% 3.5% 1.0%
Other income (expense):
Interest income (expense), net ....... 1.2% 1.1% 1.4%
Other, net ........................... -- -- --
------------ ------------ ------------
Income before income taxes .......... 6.5% 4.6% 2.4%
Provision for income taxes ............... 2.6% 1.8% 1.0%
------------ ------------ ------------
Net income .......................... 3.9% 2.8% 1.4%
============ ============ ============
</TABLE>
1998 Compared to 1997
Net Sales Net sales reflect total sales less a provision for returns.
Net sales increased $4,885,000, or 7.7%, to $68,731,000 in 1998 from
$63,846,000 in 1997. This increase was primarily attributable to an
increase in sales generated by the Company's corporate (outbound)
telemarketing group and an increase in the average order size, to $261
from $251 despite an 1.8% reduction in the number of catalogs
distributed, to 28.0 million from 28.5 million.
Gross Profit Cost of goods sold includes merchandise cost, freight and
duties, warranty expense, and packaging and shipping supplies. Gross
profit increased $3,872,000, or 11.7%, to $36,959,000 in 1998 from
$33,087,000 in 1997. As a percentage of net sales, gross profit
increased to 53.8% in 1998 from 51.8% in 1997 This increase in gross
margin was primarily the result of a shift in product mix toward higher
margin products including a larger percentage of proprietary products
which carry higher gross margins. The Company generally realizes a
higher gross margin on sales of its proprietary products than on sales
of private label or brand name products. Because the Company is
responsible for the design and development of its proprietary products,
the Company is able to realize the profit attributable to these
activities.
Selling, General and Administrative Expenses Selling, general and
administrative expenses increased $2,060,000, or 7.0%, to $31,294,000 in
1998 from $29,234,000 in 1997. As a percentage of net sales, these
expenses decreased to 45.5% in 1998 from 45.8% in 1997, primarily due to
a reduction in catalog costs, a reduction in telephone expenses and
process improvements. The Company expects selling, general and
administrative expenses to increase in absolute dollars in 1999.*
Increases in postal rates, paper and printing costs increase the cost of
the Company's catalog mailings. A postal rate increase, effective in
early January 1999 will increase the cost of mailing the Company's
catalogs; however, this increase is not expected to materially affect
the cost of mailing. While the Company experienced no significant paper
price increases in 1998, there can be no guarantee paper costs will not
increase in 1999.* See "Factors Affecting Operating Results and Market
Price of Stock-Costs of Catalog Mailing, Paper and Printing May
Increase."
Product Development Expenses A key element of the Company's strategy is
the development of proprietary products. The Company expenses all its
product development costs as incurred. Product development expenses
increased to $2,036,000 in 1998 from $1,592,000 in 1997, and increased
as a percentage of net sales to 3.0% in 1998 from 2.5% in 1997. The
Company expects product development expenses to increase in both dollars
and as a percentage of net sales, in 1999.*
Other Income, net Interest income included in Other Income, net,
increased to $799,000 in 1998 from $680,000 in 1997. The Company
anticipates a decline in interest income in 1999 resulting from lower
yields on cash investments, cash paid for an acquisition that occurred
in January 1999 and continued investment in capital equipment.*
Provision for Income Taxes The provision for income taxes of $1,776,000
in 1998 and $1,184,000 in 1997, represents a combined federal and state
effective tax rate of 40%. The Company anticipates no change in the
effective tax rate for 1999.*
Net Income Net income increased to $2,669,000 in 1998 from $1,776,000
in 1997 for the reasons stipulated above.
1997 Compared to 1996
Net Sales Net sales reflect total sales less a provision for returns.
Net sales increased $12,256,000, or 23.8%, to $63,846,000 in 1997 from
$51,590,000 in 1996. This increase was primarily attributable to a 19%
increase in the number of catalogs mailed, a 4% increase in the number
of orders and a 16% increase in the number of active customer accounts.
Gross Profit Cost of goods sold includes merchandise cost, freight and
duties, warranty expense, and packaging and shipping supplies. Gross
profit increased $6,678,000, or 25.3%, to $33,087,000 in 1997 from
$26,409,000 in 1996. As a percentage of net sales, gross profit
increased to 51.8% in 1997 from 51.2% in 1996. The increase in gross
margin in 1997 was principally due to changes in product mix and higher
gross margin for branded products. The Company generally realizes a
higher gross margin on sales of its proprietary products than on sales
of private label or brand name products. Because the Company is
responsible for the design and development of its proprietary products,
the Company is able to realize the profit attributable to these
activities. During 1997, the Company began the process of culling lower
margin branded product from the catalog. Although branded products as a
percentage of net sales increased from 45% to 48%, this increase in
lower margin product as a percentage of net sales was offset by an
improvement in the gross margin on these branded products attributable
to the culling process.
Selling, General and Administrative Expenses Selling, general and
administrative expenses increased $4,957,000, or 20.4%, to $29,234,000
in 1997 from $24,277,000 in 1996. As a percentage of net sales, these
expenses decreased to 45.8% in 1997 from 47.1% in 1996, primarily due to
a reduction in catalog costs, a reduction in advertising expenses and
process improvements.
Increases in postal rates, paper and printing costs increase the cost of
the Company's catalog mailings. As a result of a three-year printing
contract entered into in the fourth quarter of 1996 the Company's
printing costs per catalog page were down in 1997 when compared to 1996.
See "Factors Affecting Operating Results and Market Price of Stock-
Increase in Costs of Catalog Mailing, Paper and Printing."
Product Development Expenses A key element of the Company's strategy is
the development of proprietary products. The Company expenses all its
product development costs as incurred. Product development expenses
decreased to $1,592,000 in 1997 from $1,598,000 in 1996, and decreased
as a percentage of net sales to 2.5% in 1997 from 3.1% in 1996.
Other Income, net Interest income included in Other Income, net,
decreased to $680,000 in 1997 from $733,000 in 1996.
Provision for Income Taxes The provision for income taxes of $1,184,000
in 1997 and $493,000 in 1996, represents a combined federal and state
effective tax rate of 40%.
Net Income Net income increased to $1,776,000 in 1997 from $741,000 in
1996 for the reasons stipulated above.
Inflation The Company does not believe that inflation has had a
material effect on its results of operations in recent years. However,
there can be no assurance that the Company's business will not be
affected by inflation in the future, including higher than anticipated
increases in paper and printing costs and postal rates.
Quarterly and Seasonal Fluctuations 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 number and
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 Company expects that its
business will continue to exhibit some measure of volatility between
quarters in future periods.*
Liquidity and Capital Resources
Hello Direct'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 in 1998 was $3,434,000. This was
the result of $4,600,000 provided by operations including net income,
depreciation and amortization and other non-cash charges offset by
$1,166,000 of changes in operating assets and liabilities. Cash used by
investing activities for 1998 was $2,837,000 primarily related to
equipment purchases of $3,088,000 and a $30,000 increase in short term
investments partially offset by payments received on notes receivable of
$281,000. Cash provided by financing activities was $13,000, arising
primarily from $259,000 raised through the issuance of common stock
under both the employee stock purchase plan and the employee stock
option plan, offset by $246,000 utilized for the purchase of treasury
stock.
Capital expenditures of $3,088,000 in 1998 represented an increase of
$651,000 over the $2,437,000 expended in 1997. The capital expenditures
in 1998 included investments in computer hardware infrastructure, sales
and customer interaction software and associated costs, and tooling for
proprietary products. In 1999, the Company expects to continue to
purchase additional capital equipment for enhancements to its management
information systems and tooling for proprietary products, and such
purchases are expected to exceed 1998 levels.*
In the fourth quarter of 1998, the Company used $246,000 for the
purchase of 38,000 shares of treasury stock at an average purchase price
of $6.47 a share pursuant to a stock repurchase program approved by the
Company's Board of Directors on October 7, 1998. The Board of Directors
authorized the repurchase of up to 1,000,000 shares of Common Stock in
the open market from time to time subject to market conditions and other
restrictions. The number of shares of Common Stock eventually acquired
by the Company will depend on subsequent developments and corporate
needs, and the repurchase program may be interrupted or discontinued at
any time. Any shares repurchased would be available for re-issuance
under the Company's employee stock plans.
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 fund its needs for working capital for
the foreseeable future.* However, should the Company need additional
funds, it has an unsecured line of credit of $7,000,000 with a major
bank at the bank's prime lending rate. At present, the Company has not
directly borrowed under this line, and as of December 31, 1998, the
Company was not contingently liable for any issued and open letters of
credit.
Impact of the Year 2000 Issue
The Year 2000 issue results from computer programs written using a two-
digit date field, rather than four, to define the applicable year.
Certain computer programs utilizing a two-digit date field may recognize
a date using "00" as the year 1900 rather than the year 2000. This could
potentially result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices, or engage in other
similar normal business activities.
The Company's internal information systems include all hardware and
software used in its computer and phone systems. The Company has
completed an assessment of its internal information systems relative to
the Year 2000 issue. The assessment review was broken down between
information systems scheduled for replacement or modification before the
year 2000 as a part of the Company's ongoing technology review and
assessment process and information systems that have not been scheduled
for replacement or modification. In connection with the assessment of
information systems scheduled for replacement or modification, the
Company has confirmed the hardware and software replacing or modifying
existing hardware and software is Year 2000 compliant. The information
systems scheduled for replacement or modification are expected to be
complete no later than the third quarter of 1999.* However, if the
information systems currently scheduled for replacement or modification
are not replaced or are not properly modified, the Year 2000 issue could
have a material effect on the on the operations of the Company by
impairing the Company's ability to process transactions, send invoices
and engage in normal business activities.
In connection with systems not scheduled for replacement, the Company
has performed an accounting of these systems, contacted vendors and
documented its findings. The findings indicate that although some
information systems not scheduled for replacement are not compliant, the
cost of replacing or upgrading those systems will not have a material
effect on the operations of the Company.* To date, the Company has
expensed approximately $50,000 on Year 2000 project costs and total Year
2000 project costs are not expected to exceed $100,000.*
In addition, the Company has initiated formal communications with its
significant suppliers to determine the extent to which the Company is
vulnerable to those third parties' failure to remedy their own Year 2000
issues. The Company has received some assurances regarding these issues
from its vendors, but there are no guarantees these third-party systems
will be compliant and in the event of non-compliance would not have a
material effect on the operations of the Company. For example, if some
of the Company's product vendors are not Year 2000 compliant, it could
impact the Company's ability to obtain products from those vendors on
a timely basis.
The Company has evaluated its exposure to contingencies related to the
Year 2000 issues for products it has sold. Although the Company believes
that its products do not directly contain specific calendar year
functions, it is possible customers may use the Company's products in
conjunction with systems that may perform non-compliant Year 2000 date
computations. Accordingly, there is a risk of litigation associated
with the possible use of the Company's products by customers, including
all the risks, costs and uncertainties associated with litigation.
The Company believes its exposure to the Year 2000 issue will come
mainly from third parties, either the result of these parties not being
prepared or other parties these third parties rely upon not being
prepared. Although there can be no assurance that unforeseen problems
will not be encountered, the Company expects that all critical internal
Year 2000 issues will be resolved as scheduled.*
Subsequent Events
On January 11, 1999, the Company announced that it had entered into a
definitive agreement to acquire PhoneZone.com, Inc. a privately held
company for $2,050,000 in a combination of cash and stock. The
acquisition was completed on January 20, 1999, and will be accounted for
under the purchase method of accounting. PhoneZone.com, founded in 1996
and an emerging authority on the convergence of Internet and telecom
technologies, is an influential source of comparative research,
analysis, and purchase information on telecom and networking solutions
for small and medium-size companies. The Internet site serves a growing
number of regular business end users who have virtually no alternative
single point of contact for conveniently researching, comparing, and
buying such a wide range of telecom solutions. This acquisition
positions the Company to accelerate its electronic commerce initiative
and more quickly exploit the Internet's potential to become the ultimate
direct marketing channel for Hello Direct.*
Recent Accounting Pronouncements
In April 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of
Position 98-5, Reporting on the Costs of Start-Up Activities ("SOP 98-
5"). SOP 98-5 requires that costs of start-up activities be charged to
expense as incurred and broadly defines such costs. The Company has not
deferred any costs as defined in SOP 98-5, accordingly, upon adoption on
January 1, 1999, there will be no charge to earnings for the cumulative
effect of the change in accounting principle for the three months ending
March 31, 1999.
- ---------------
* 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. Investors
are strongly encouraged to review the section entitled "Factors
Affecting Operating Results and Market Price of Stock" for a discussion
of factors that could affect future performance.
Item 8. Financial Statements and Supplementary Data
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Hello Direct, Inc. :
We have audited the accompanying balance sheets of Hello Direct, Inc. as
of December 31, 1998 and 1997, and the related statements of operations,
stockholders' equity, and cash flows for each of the years in the three-
year period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Hello
Direct, Inc. as of December 31, 1998 and 1997, and the results of its
operations and its cash flows for each of the years in the three-year
period ended December 31, 1998, in conformity with generally accepted
accounting principles.
KPMG LLP
Mountain View, California
January 22, 1999
HELLO DIRECT, INC.
Balance Sheets
December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ........................ $5,745,000 $5,135,000
Short-term investments ........................... 3,860,000 3,830,000
Trade accounts receivable, less allowance for
returns and doubtful accounts of $637,000 and
$723,000 in 1998 and 1997, respectively ....... 5,491,000 5,752,000
Inventories ...................................... 6,119,000 5,137,000
Deferred tax assets .............................. 847,000 821,000
Other current assets ............................. 2,474,000 1,771,000
------------ ------------
Total current assets ........................ 24,536,000 22,446,000
Notes receivable .................................... 4,239,000 4,542,000
Property and equipment, net ......................... 6,246,000 4,819,000
Long-term deferred tax assets ....................... -- 25,000
------------ ------------
Total assets ................................ $35,021,000 $31,832,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................. $3,567,000 $3,856,000
Accrued expenses ................................. 1,736,000 1,319,000
------------ ------------
Total current liabilities ................... 5,303,000 5,175,000
Non-current liabilities 364,000 --
------------ ------------
Total liabilities ........................... 5,667,000 5,175,000
Stockholders' equity:
Preferred stock, $0.001 par value; authorized
2,000,000, none issued or outstanding ......... -- --
Common stock; $0.001 par value; authorized
15,000,000; 5,190,000 issued and 5,103,000
outstanding in 1998; 5,112,000 issued and
5,064,000 outstanding in 1997 ................. 5,000 5,000
Additional paid-in capital ....................... 28,319,000 28,045,000
Accumulated deficit .............................. 1,721,000 (948,000)
Less treasury stock, at cost - 87,000 and 49,000
shares in 1998 and 1997, respectively .......... (691,000) (445,000)
------------ ------------
Total stockholders' equity .................. 29,354,000 26,657,000
------------ ------------
Commitments and contingencies
Total liabilities and stockholders' equity .. $35,021,000 $31,832,000
============ ============
</TABLE>
See accompanying notes to financial statements
<PAGE>
HELLO DIRECT, INC.
Statements of Operations
Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net sales ................................ $68,731,000 $63,846,000 $51,590,000
Cost of goods sold ....................... 31,772,000 30,759,000 25,181,000
------------ ------------ ------------
Gross profit ........................ 36,959,000 33,087,000 26,409,000
Selling, general and administrative
expenses ............................. 31,294,000 29,234,000 24,277,000
Product development expenses ............. 2,036,000 1,592,000 1,598,000
------------ ------------ ------------
Operating income .................... 3,629,000 2,261,000 534,000
Other income (expense):
Interest income ...................... 799,000 680,000 733,000
Interest expense ..................... -- (13,000) (13,000)
Other, net ........................... 17,000 32,000 (20,000)
------------ ------------ ------------
Income before income taxes .......... 4,445,000 2,960,000 1,234,000
Provision for income taxes ............... 1,776,000 1,184,000 493,000
------------ ------------ ------------
Net income .......................... $2,669,000 $1,776,000 $741,000
============ ============ ============
Basic per share amounts:
Net income ........................... $0.52 $0.35 $0.15
============ ============ ============
Weighted average shares outstanding .. 5,108,000 5,036,000 4,982,000
============ ============ ============
Diluted per share amounts:
Net income ........................... $0.51 $0.35 $0.15
============ ============ ============
Weighted average shares outstanding .. 5,199,000 5,117,000 5,043,000
============ ============ ============
</TABLE>
See accompanying notes to financial statements
<PAGE>
HELLO DIRECT
STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
<TABLE>
<CAPTION>
Common Stock Additional Retained Total
---------------------- Paid-in Earnings Treasury Stockholders'
Shares Amount Capital (Deficit) Stock Equity
---------- ----------- ------------ ------------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balances as of December
31, 1995 4,926,000 $5,000 $27,632,000 ($3,465,000) ($445,000) $23,727,000
Common stock issued
pursuant to employee
stock purchase
and option plans 81,000 -- 175,000 -- -- 175,000
Net income -- -- -- 741,000 -- 741,000
---------- ----------- ------------ ------------- ----------- ------------
Balances as of December
31, 1996 5,007,000 5,000 27,807,000 (2,724,000) (445,000) 24,643,000
Common stock issued
pursuant to employee
stock purchase
and option plans 57,000 -- 238,000 -- -- 238,000
Net income -- -- -- 1,776,000 -- 1,776,000
---------- ----------- ------------ ------------- ----------- ------------
Balances as of December
31, 1997 5,064,000 5,000 28,045,000 (948,000) (445,000) 26,657,000
Common stock issued
pursuant to employee
stock purchase
and option plans 75,000 -- 259,000 -- -- 259,000
Common stock issued
in exchange for
services 2,000 -- 15,000 -- -- 15,000
Purchase of treasury stock (38,000) -- -- -- (246,000) (246,000)
Net income -- -- -- 2,669,000 -- 2,669,000
---------- ----------- ------------ ------------- ----------- ------------
5,103,000 $5,000 $28,319,000 $1,721,000 ($691,000) $29,354,000
========== =========== ============ ============= =========== ============
See accompanying notes to financial statements.
</TABLE>
<PAGE>
HELLO DIRECT, INC.
Statements of Cash Flows
Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income .......................... $2,669,000 $1,776,000 $741,000
Adjustments to reconcile net income
to net cash provided by
operating activities:
Depreciation and amortization .... 1,596,000 1,323,000 589,000
Deferred income taxes ............ 161,000 854,000 454,000
Deferred rent .................... 180,000 -- --
Disposal of fixed assets ......... 65,000 87,000 187,000
Allowance for returns and
doubtful accounts............. (86,000) 215,000 41,000
Issuance of common stock
for services ................. 15,000 -- --
Changes in items affecting
operations:
Trade accounts receivable .... 369,000 (834,000) (1,485,000)
Inventories .................. (982,000) 150,000 (1,373,000)
Other assets ................. (703,000) (432,000) (335,000)
Accounts payable and
accrued expenses .......... 150,000 872,000 2,360,000
------------ ------------ ------------
Net cash provided by
operating activities ... 3,434,000 4,011,000 1,179,000
------------ ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment.. (3,088,000) (2,437,000) (3,288,000)
Decrease (increase) in investments .. (30,000) 2,177,000 4,462,000
Funding of notes receivable.......... -- (1,503,000) (3,497,000)
Payments received on notes
receivable......................... 281,000 177,000 --
------------ ------------ ------------
Net cash used in investing
activities ................. (2,837,000) (1,586,000) (2,323,000)
------------ ------------ ------------
Cash flows from financing activities:
Payments on capital lease obligations -- (20,000) (26,000)
Purchase of treasury stock .......... (246,000) -- --
Sale of common stock, net ........... 259,000 238,000 175,000
------------ ------------ ------------
Net cash provided by
financing activities ..... 13,000 218,000 149,000
------------ ------------ ------------
Net increase (decrease) in cash and
cash equivalents ................... 610,000 2,643,000 (995,000)
Cash and cash equivalents at beginning
of period .......................... 5,135,000 2,492,000 3,487,000
------------ ------------ ------------
Cash and cash equivalents at end of
period ............................. $5,745,000 $5,135,000 $2,492,000
============ ============ ============
Supplemental disclosure of cash paid
during year:
Interest ........................... $ -- $13,000 $13,000
============ ============ ============
Income taxes ....................... $1,443,000 $336,000 $16,000
============ ============ ============
Noncash financing activities:
Issuance of common stock in exchange
for services ..................... $15,000 $ -- $ --
============ ============ ============
</TABLE>
See accompanying notes to financial statements
<PAGE>
HELLO DIRECT, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
(1) Summary of the Company and Significant Accounting Policies
The Company
Hello Direct, Inc. (the "Company") is a leading developer and direct
marketer of desktop telephony products and equipment interface solutions
to business end users. The Company designs and sells its own products
and also offers a wide variety of products and accessories from other
manufacturers. The Company markets its products through various sales
channels which include full color catalogs, the Internet and outbound
telemarketing efforts aimed at current and prospective customers.
Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity date of three months or less to be cash equivalents.
Cash equivalents consist primarily of government agency obligations,
commercial paper and money market funds.
Short-term Investments
Short-term investments consist of high quality money market instruments,
primarily commercial paper with original maturities greater than three
months and less than twelve months.
Inventories
Inventories are stated at the lower of cost or market. Cost is
determined using the first-in, first-out method.
Catalog Costs
Catalog costs are deferred and amortized over the expected revenue
stream, generally nine months.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated on
the straight-line method over the estimated useful lives of the assets,
generally three to seven years. Amortization of leasehold improvements
is calculated using the straight-line method over the lesser of the
estimated useful life of the asset or the term of the respective lease.
Impairment of Long-Lived Assets
The Company periodically reviews its long-lived assets for impairment.
If events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable, the Company will reduce the carrying
amount of the asset by the amount determined not to be recoverable.
Revenue Recognition
The Company recognizes revenue at the time of the product shipment.
Appropriate provisions are provided for customer returns and exchanges.
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rate is
recognized in income in the period that includes the enactment date.
Net Income Per Share
There were no adjustments to net income for purposes of the calculation
of diluted net income per share. The table below reconciles basic
weighted average shares outstanding to diluted weighted average shares
outstanding:
1998 1997 1996
------------ ------------ ------------
Basic weighted shares outstanding 5,108,000 5,036,000 4,982,000
Common stock options utilizing treasury
stock method when dilutive 91,000 81,000 61,000
------------ ------------ ------------
Diluted weighted shares outstanding 5,199,000 5,117,000 5,043,000
============ ============ ============
Use of Estimates
The Company's management has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure
of contingent assets and liabilities to prepare these financial
statements in conformity with generally accepted accounting principles.
Actual results could differ from those estimates.
Stock Option and Stock Purchase Plan Accounting
Compensation expense associated with stock option grants and stock
purchase plan purchases made subsequent to 1994 is disclosed in the
footnotes to the financial statements. The effect on net income and net
income per share is reflected in pro forma - net income, pro forma -
basic net income per share, and pro forma - diluted net income per share
amounts.
Segment Reporting
Effective for the year ended December 31, 1998, the Company adopted
Statement of Financial Accounting Standards No. 131, Disclosures About
Segments of an Enterprise and Related Information. It establishes
disclosure requirements concerning operating business segments, products
and services, geographic areas and major customers. As of December 31,
1998, the Company determined that it operates in one business segment -
telecommunications product sales.
Concentration of Credit Risk
The Company offers credit terms to customers after an evaluation of a
customer's financial condition. No one customer accounts for a
substantial part of sales or receivables. The Company estimates an
allowance for doubtful accounts based on the creditworthiness of its
customers as well as general economic conditions. Consequently, an
adverse change in those factors could affect the Company's estimate of
its bad debts.
(2) Other Current Assets
A summary of other current assets as of December 31, 1998 and 1997
follows:
1998 1997
------------ ------------
Deferred catalog costs $1,972,000 $1,521,000
Other 502,000 250,000
------------ ------------
$2,474,000 $1,771,000
============ ============
(3) Note Receivable
In 1996 the Company entered into a loan agreement to a developer for the
construction of the Company's corporate facility. Through 1997, the
Company had loaned $5,000,000 under this loan agreement. The borrowings
under this loan agreement are secured by the building and land, bear
interest at 7.5% with principal and interest due in monthly installments
of $53,000 over 12 years. The fair value of the loan as of December 31,
1998 is estimated to approximate its face value which was calculated by
discounting the future cash flows using the current interest rate at
which a similar loan would be made to the developer for the same
remaining maturity. The note contains a provision that if the developer
defaults on the monthly payment, the Company can offset the non-payment
against their monthly rent payment. The lease agreement contains a
similar provision for non-payment.
In connection with the loan agreement, the Company entered into a 15-
year lease agreement. The present value of the total future minimum
lease payments under the lease is approximately $5,928,000 as of
December 31, 1998, which approximates the fair value of the lease using
rates currently available to the Company for a lease with similar terms.
(4) Property and Equipment
A summary of property and equipment as of December 31, 1998 and 1997
follows:
1998 1997
------------ ------------
Computer equipment and software $4,885,000 $2,673,000
Furniture and fixtures 3,144,000 3,030,000
Production tooling and equipment 2,321,000 1,623,000
------------ ------------
10,350,000 7,326,000
Less accumulated depreciation and amortization 4,104,000 2,507,000
------------ ------------
$6,246,000 $4,819,000
============ ============
(5) Accrued Expenses
A summary of accrued expenses as of December 31, 1998 and 1997 follows:
1998 1997
------------ ------------
Accrued compensation and related liabilities $1,213,000 $1,117,000
Other 523,000 202,000
------------ ------------
$1,736,000 $1,319,000
============ ============
(6) Bank Line of Credit
As of December 31, 1998, the Company had a financing agreement with a
bank to provide a $7,000,000 unsecured revolving line of credit for both
letters of credit and working capital. As of December 31, 1998,
$7,000,000 was available under the agreement. Any borrowings bear
interest at the bank's prime rate (7.75% as of December 31, 1998). The
line of credit will expire on May 15, 1999. The agreement contains
various financial covenants, including profitability and financial
ratios such as quick ratio and debt-to-net-worth. As of December 31,
1998, there were no direct borrowings under the credit facility, and the
Company was not liable for issued and open letters of credit.
(7) Lease Commitments
As of December 31, 1998, the Company was obligated under a noncancelable
operating lease agreement expiring in December 2011, for office and
warehouse space. A summary of future minimum lease payments follows:
Year Ending December 31, Amount
------------------------ ------------
1999 $698,000
2000 698,000
2001 755,000
2002 755,000
2003 815,000
Thereafter 7,346,000
------------
Total future minimum lease payments $11,067,000
============
Rent expense aggregated approximately $825,000, $651,000, and $245,000
for 1998, 1997 and 1996, respectively.
(8) Benefit Plan
The Company has a 401(k) plan that covers all eligible employees as
defined. Employees can elect to defer from 1% to 15% of their
compensation limited to $10,000 in 1998. The Company may make
discretionary contributions and matching contributions. In 1998 and
1997, the Company made matching contributions of $22,000 and $11,000,
respectively. No matching contributions were made in 1996.
(9) Stock Option and Employee Stock Purchase Plans
The Company applies APB Opinion No. 25 in accounting for its various
stock option plans and Employee Stock Purchase Plan (the "stock plans").
Accordingly, no compensation cost has been recognized for the stock
plans. However, if the Company had determined compensation costs
pursuant to SFAS No. 123 for its stock plans, the Company's net income
and net income per share would have been reduced to the pro forma
amounts indicated below for the years noted:
1998 1997 1996
------------ ------------ ------------
Pro forma - net income $2,084,000 $1,483,000 $173,000
Pro forma - basic net income per share $0.41 $0.29 $0.03
Pro forma - diluted net income per share $0.40 $0.29 $0.03
Pro forma net income reflects only options granted after December 31,
1994. Accordingly, the full impact of calculating compensation cost for
the Company's stock plans under SFAS No. 123 is not reflected in the pro
forma net income amounts presented above, as compensation cost is
captured over a stock option's vesting period, and compensation cost for
options granted prior to January 1, 1995 is not considered.
1992 Stock Option Plan
As of December 31, 1998, 19,452 options for the issuance of Common Stock
were outstanding pursuant to the 1992 Stock Option Plan (the "Plan"). No
new stock option grants can be issued under the Plan. Stock options
outstanding pursuant to the Plan vest over two to four years from the
grant date and expire ten years from the grant date.
1995 Employee Stock Purchase Plan
The Company's 1995 Employee Stock Purchase Plan (the "Purchase Plan")
was established in 1995. As of December 31, 1998, a total of 177,097
shares of Common Stock are reserved for issuance and 127,903 shares have
been issued pursuant to the Purchase Plan. The Purchase Plan is
administered by the Compensation Committee of the Board of Directors.
The Purchase Plan permits eligible employees, as defined, to purchase
Common Stock through payroll deductions, which may not exceed 15% of the
employee's base compensation. No employee may purchase more than $25,000
worth of stock in any calendar year. The price of shares purchased under
the Purchase Plan is 85% of the lower of the fair market value of the
Common Stock on (i) the first day of the offering period; or (ii) the
last day of the offering period. Employees may end their participation
in the offering at any time during the offering period, and
participation ends automatically on termination of employment with the
Company.
1995 Director Option Plan
The 1995 Director Option Plan (the "Director Plan") was established in
1995. As of December 31, 1998, a total of 75,000 shares of Common Stock
are reserved for issuance; 57,000 options remain outstanding, and no
shares have been issued pursuant to an exercise of stock options
pursuant to the Director Plan. The Director Plan provides for the grant
of non-statutory stock options to non-employee directors of the Company
("Outside Directors") pursuant to a non-discretionary grant mechanism.
The exercise price of options granted to Outside Directors must be 100%
of the fair market value of the Company's Common Stock on the date of
grant. Options granted to the Outside Directors have a 10-year term, or
shorter upon termination of tenure as a director.
1995 Stock Plan
The Company's 1995 Stock Plan (the "Stock Plan") was established in
1995. As of December 31, 1998, a total of 900,000 shares of Common Stock
are reserved for issuance; 702,565 stock options remain outstanding, and
3,702 shares have been issued pursuant to the Stock Plan. The Stock Plan
provides for the grant to employees (including employee directors and
officers) of incentive stock options and for the grant of non-statutory
stock options and the grant of restricted stock to employees and
consultants. Non-employee directors are not eligible to participate in
the Stock Plan.
The exercise price per share of all incentive stock options granted
under the Stock Plan must be at least equal to fair market value per
share of Common Stock on the date of grant. The exercise price per share
of all non-statutory stock options and the price per share of restricted
stock granted under the Option Plan shall be determined by the
administrator on the date of grant. Options granted under the Stock
Plan generally vest over four years and expire no later than ten years
from the grant date.
The following table summarizes all option activity under the Company's
stock option plans during the three year period ended December 31, 1998:
<TABLE>
<CAPTION>
Weighted-
Weighted- average
average Exercise
Weighted- Grant Options Price
average Date Exercisable of Options
Options Exercise Fair at Exercisable
Outstanding Price Value* Year End at Year End
----------- --------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C>
December 31, 1995 451,611 $6.819 53,573 $2.182
============ ============
Granted 196,065 6.054 $2.543
==========
Exerecised (49,312) 0.032
Canceled or expired (43,747) 8.792
-----------
December 31, 1996 554,617 6.996 186,463 $6.816
============ ============
Granted 197,500 5.293 $2.222
==========
Exerecised (15,253) 2.857
Canceled or expired (163,333) 6.744
-----------
December 31, 1997 573,531 6.591 298,631 $7.028
============ ============
Granted 320,702 6.571 $2.682
==========
Exerecised (31,695) 1.532
Canceled or expired (83,521) 7.732
-----------
December 31, 1998 779,017 $6.667 347,882 $7.090
=========== ============ ============
</TABLE>
The following table summarizes information about the Company's stock
options outstanding at December 31, 1998:
* Fair Value Assumptions:
Black-Scholes option-pricing model
--------------------------------------------
Weighted-
average
Risk Average
Free Expected Dividend
Rate Life Volitility Yield
--------- --------- ----------- ---------
1996 5.28% 2.83 58% 0%
1997 5.50% 2.97 60% 0%
1998 5.42% 2.82 59% 0%
The following table summarizes information about the Company's stock
options outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options Oustanding Options Exercisable
------------------------------------ ------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
- ----------------- ------------ ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
$0.02 - 0.71 13,952 4.46 $0.076 13,952 $0.076
4.13 - 5.50 206,065 8.38 4.827 83,076 4.728
6.25 - 7.00 254,500 8.90 6.391 31,188 6.892
7.50 - 11.50 304,500 7.16 8.444 219,666 8.457
------------ ------------
$0.02 - 11.50 779,017 8.00 6.667 347,882 7.090
============ ============
</TABLE>
(10) Income Taxes
The components of income tax expense for the years ended December 31,
1998, 1997 and 1996 follows:
Year Ended
--------------------------------------
1998 1997 1996
------------ ------------ ------------
Current:
Federal $1,312,000 $77,000 $15,000
State 303,000 253,000 24,000
------------ ------------ ------------
1,615,000 330,000 39,000
Deferred:
Federal 18,000 841,000 481,000
State 143,000 13,000 (27,000)
------------ ------------ ------------
161,000 854,000 454,000
------------ ------------ ------------
$1,776,000 $1,184,000 $493,000
============ ============ ============
A reconciliation between the provision for income taxes and the amount
computed by applying the statutory federal income tax rate to income
before income taxes for the years ended December 31, 1998, 1997, and
1996 follows:
Year Ended
--------------------------------------
1998 1997 1996
------------ ------------ ------------
Statutory rate of 34% applied to
pre-tax income (loss) $1,511,000 $1,006,000 $420,000
State tax (net of federal benefit) 294,000 176,000 --
Other (29,000) 2,000 73,000
------------ ------------ ------------
$1,776,000 $1,184,000 $493,000
============ ============ ============
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities as of
December 31, 1998 and 1997 follows:
December 31,
-------------------------
1998 1997
Deferred tax assets: ------------ ------------
Tax credit carryovers $21,000 $523,000
Accounts receivable principally
due to allowances 273,000 313,000
Employee benefit accruals 121,000 139,000
Inventories principally due to
costs inventoried for tax purpose 263,000 84,000
State income taxes 81,000 --
Other 88,000 11,000
------------ ------------
Deferred tax assets 847,000 1,070,000
------------ ------------
Deferred tax liabilities:
Fixed assets (162,000) (128,000)
State income taxes -- (96,000)
------------ ------------
Deferred tax liabilities (162,000) (224,000)
------------ ------------
Net deferred tax assets $685,000 $846,000
============ ============
Management believes that it is more likely than not that the results of
future operations will generate sufficient income to realize the
deferred tax assets, therefore no valuation allowance is necessary for
1998 or 1997.
The Tax Reform Act of 1986 imposed substantial restrictions on the
utilization of net operating loss carryforwards in the event of an
ownership change, as defined by section 382 of the Internal Revenue Code
of 1986, as amended. As of December 31, 1998, the Company had utilized
all available net operating loss carryovers for federal and state income
tax purposes not subject to the annual limitation. A federal net
operating loss of $159,000, subject to an annual limitation of
approximately $150,000, remains. The net operating loss expires in 2004.
Any unused annual limitation can be carried forward and added to the
succeeding years' annual limitation subject to the expiration date.
(13) Quarterly Results (unaudited)
The following table (presented in thousands, except per share data) sets
forth statement of operations data for each of the four quarters of the
years ended December 31, 1998 and December 31, 1997. The unaudited
quarterly information has been prepared on the same basis as the annual
information presented elsewhere herein and, in the Company's opinion,
includes all adjustments (consisting only of normal recurring entries)
necessary for a fair presentation of the information for the quarters
presented. The operating results for any quarter are not necessarily
indicative of results for any future period.
Three Months Ended
------------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
1998 1998 1998 1998
--------- --------- --------- ---------
Net sales $17,910 $16,620 $17,016 $17,185
Cost of goods sold 8,319 7,670 7,791 7,992
--------- --------- --------- ---------
Gross profit 9,591 8,950 9,225 9,193
Selling, general and
administrative expenses 8,210 7,866 7,771 7,447
Product development expenses 579 323 547 587
--------- --------- --------- ---------
Operating income 802 761 907 1,159
Other income - net 203 204 198 211
--------- --------- --------- ---------
Income before income taxes 1,005 965 1,105 1,370
Income taxes 402 386 441 547
--------- --------- --------- ---------
Net income $603 $579 $664 $823
========= ========= ========= =========
Basic and diluted net income
per share $0.12 $0.11 $0.13 $0.16
========= ========= ========= =========
Three Months Ended
------------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
1997 1997 1997 1997
--------- --------- --------- ---------
Net sales $15,936 $15,318 $16,727 $15,865
Cost of goods sold 7,853 7,542 7,914 7,450
--------- --------- --------- ---------
Gross profit 8,083 7,776 8,813 8,415
Selling, general and
administrative expenses 7,341 6,923 7,816 7,154
Product development expenses 410 371 322 489
--------- --------- --------- ---------
Operating income 332 482 675 772
Other income - net 169 152 177 201
--------- --------- --------- ---------
Income before income taxes 501 634 852 973
Income taxes 201 264 342 377
--------- --------- --------- ---------
Net income $300 $370 $510 $596
========= ========= ========= =========
Basic and diluted net income
per share $0.06 $0.07 $0.10 $0.12
========= ========= ========= =========
(14) Subsequent Events
Subsequent to year end the Company acquired PhoneZone.com for $2,050,000
consisting of a combination of cash and stock. The Company intends to
account for the acquisition under the purchase method of accounting.
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The sections entitled "Election of Directors - Nominees" and "Additional
Information Relating to Directors and Officers of the Company - Section
16(a) Beneficial Ownership Reporting Compliance" of the Company's proxy
statement for the Company's Annual Meeting of Stockholders tentatively
scheduled to be held April 28, 1999 (the "Proxy Statement") are hereby
incorporated by reference. See also, the section entitled "Executive
Officers of the Company" in Item 1 above of this Annual Report on Form
10-K.
Item 11. Executive Compensation
The section entitled "Additional Information Relating to Directors and
Officers of the Company" of the Proxy Statement is incorporated herein
by reference.
Item 12. Security Ownership of Certain Beneficial Owners and
Management
The section entitled "Security Ownership of Certain Beneficial Owners
and Management" of the Proxy Statement is incorporated herein by
reference.
Item 13. Certain Relationships and Related Transactions
The section entitled "Additional Information Relating to Directors and
Officers of the Company - Certain Relationships and Related
Transactions" of the Proxy Statement is incorporated herein by
reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K
(a) The following documents are filed as a part of this Report.
1. Financial Statement Schedule. For the three years ended December
31, 1998, Independent Auditors' Report on Financial Statement Schedule.
Other schedules not included here are not applicable to the Company.
Schedule II - Valuation and Qualifying Accounts. A schedule of the
allowance for doubtful accounts and allowance for returns account is
presented below:
<TABLE>
<CAPTION>
Additions
Balance at Charged to Balance
beginning costs and at end
of year expenses Deductions of year
----------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
Allowance for doubtful
accounts:
December 31, 1998 $373,000 $747,000 $833,000 $287,000
=========== ============ ============ ===========
December 31, 1997 $248,000 $536,000 $411,000 $373,000
=========== ============ ============ ===========
December 31, 1996 $227,000 $428,000 $407,000 $248,000
=========== ============ ============ ===========
Allowance for returns:
December 31, 1998 $350,000 $8,255,000 $8,255,000 $350,000
=========== ============ ============ ===========
December 31, 1997 $260,000 $8,474,000 $8,384,000 $350,000
=========== ============ ============ ===========
December 31, 1996 $240,000 $6,856,000 $6,836,000 $260,000
=========== ============ ============ ===========
</TABLE>
<PAGE>
(b) Reports on Form 8-K.
None.
(c) Exhibits:
3.1 Amended and Restated Certificate of Incorporation of Registrant. (1)
3.2 Amended and Restated Bylaws of the Registrant. (2)
4.1 Specimen Common Stock Certificate. (1)
10.1 Form of Indemnification Agreement with directors and officers. (1)
10.2 1992 Stock Option Plan and forms of agreement thereunder. (1)
10.3 1995 Stock Plan and forms of agreements thereunder. (1)
10.4 1995 Employee Stock Purchase Plan. (1)
10.5 1995 Director Option Plan. (1)
10.6 Manufacturing Agreement with Sinoca Enterprises Co., dated March
10, 1994. (1)
10.7 Amended and Restated Stockholders' Agreement, as amended, dated May
4, 1994. (1)
10.8 Manufacturing Agreement with Seo-Won K-Tec, Inc. dated January 1,
1998. (3)
10.9 Employment Agreement with Dennis P. Waldera, dated February 5,
1996. (2)
10.10 Employment Agreement with E. Alexander Glover dated March 24,
1995. (1)
10.11 Lease Agreement by and between MPJ-A and Registrant, dated May 10,
1996. (4)
10.12 Promissory Note by and between MPJ-A and Registrant, dated May 10,
1996. (4)
10.13 Construction Loan Agreement by and between MPJ-A and Registrant,
dated June 7, 1996. (4)
10.14 Contract between Hello Direct, Inc. and R. R. Donnelley & Sons
Company for printing services through spring 2000, dated November
19, 1996. (5)
10.15 Line of Credit Agreement by and between Wells Fargo Bank and
Registrant, dated May 15, 1998. (6)
10.16 Agreement Between Hello Direct, Inc. and Transtech Electronics (S)
Pte. Ltd., dated May 16, 1997. (7)
10.17 First Amendment to Employment Agreement with E. Alexander Glover,
dated July 1, 1997. (2)
10.18 Loan Agreement between Hello Direct, Inc. and Well Fargo Bank. (6)
10.19 Form of Employee Severance Agreement entered into and between the
Company and each of its executive officers. (6)
10.20 Form of Stock Option Agreement under the 1995 Stock Plan. (6)
23.1 Report on Financial Statement Schedule and Consent of Independent
Auditors
24.1 Power of Attorney
27.1 Financial Data Schedule
(1) Incorporated by reference to the exhibit filed with the Company's
Form S-1 filed with the Securities and Exchange Commission on April
6, 1995.
(2) Incorporated by reference to the exhibit filed with the Company's
Form 10-K filed with the Securities and Exchange Commission on
March 27, 1998.
(3) Incorporated by reference to the exhibit filed with the Company's
Form 10-Q filed with the Securities and Exchange Commission on May
8, 1998.
(4) Incorporated by reference to the exhibit filed with the Company's
Form S-1 filed with the Securities and Exchange Commission on
August 15, 1996.
(5) Incorporated by reference to the exhibit filed with the Company's
Form 10-Q filed with the Securities and Exchange Commission on May
14, 1997
(6) Incorporated by reference to the exhibit filed with the Company's
Form 10-Q filed with the Securities and Exchange Commission on July
24, 1998.
(7) Incorporated by reference to the exhibit filed with the Company's
Form 10-Q filed with the Securities and Exchange Commission on
August 14, 1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this
Report on Form 10-K to be signed on its behalf by the undersigned,
thereunto duly authorized.
Dated: March 29, 1999
Hello Direct, Inc.
By: /S/ Dean Witter III
-------------------------
Dean Witter III
Chief Financial Officer
and Secretary
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose
signature appears below constitutes and appoints E. Alexander Glover and
Dean Witter III, jointly and severally, his attorneys-in-fact, each
with the power of substitution, for him in any and all capacities, to
sign any and all amendments to this Report on Form 10-K, and to file the
same, with exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorneys-in-fact, or his substitute or
substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1934, this
Report on Form 10-K has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates
indicated.
Signature Title Date
- -------------------------- ----------------------------------- -------------
/s/ E. Alexander Glover President, Chief Executive Officer March 29, 1999
- ------------------------- and Director (Principal Executive
(E. Alexander Glover) Officer)
/s/ Dean Witter III Chief Financial Officer March 29, 1999
- ------------------------- and Secretary
(Dean Witter III) (Principal Financial and Accounting
Officer)
/s/ John B. Mumford Chairman of the Board and Director March 29, 1999
- -------------------------
(John B. Mumford)
/s/ Gerald L. Beckwith Director March 29, 1999
- -------------------------
(Gerald L. Beckwith)
/s/ John W. Combs Director March 29, 1999
- -------------------------
(John W. Combs)
/s/ William P. Sousa Director March 29, 1999
- -------------------------
(William P. Sousa)
<PAGE>
Exhibit 23.1
Independent Auditors' Report
The Board of Directors and Stockholders
Hello Direct, Inc.
Under date of January 22, 1999, we reported on the balance sheets of
Hello Direct, Inc. as of December 31, 1998, and the related statements
of operations, stockholders' equity and cash flows for each of the years
in the three-year period ended December 31, 1998, as contained in the
annual report on Form 10-K. In connection with our audits of the
aforementioned financial statements, we also audited the related
financial statement schedule as listed in the accompanying index. This
financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion on this
financial statement schedule based on our audits. In our opinion, such
financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
/s/ KPMG LLP
Mountain View, California
January 22, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted
from the Balance Sheet and Statement of Operations included in the
Company's Form 10-K for the year ended December 31, 1998 and is
qualified in its entirety by reference to such Financial Statements.
</LEGEND>
<MULTIPLIER>1
<S> <C> <C> <C>
<FISCAL-YEAR-END> Dec-31-1998 Dec-31-1997 Dec-31-1996
<PERIOD-START> Jan-01-1998 Jan-01-1997 Jan-01-1996
<PERIOD-END> Dec-31-1998 Dec-31-1997 Dec-31-1996
<PERIOD-TYPE> 12-MOS 12-MOS 12-MOS
<CASH> 5,745,000 5,135,000 2,492,000
<SECURITIES> 3,860,000 3,830,000 6,007,000
<RECEIVABLES> 6,128,000 6,475,000 5,360,000
<ALLOWANCES> 637,000 723,000 508,000
<INVENTORY> 6,119,000 5,137,000 5,287,000
<CURRENT-ASSETS> 24,536,000 22,446,000 20,605,000
<PP&E> 10,350,000 7,326,000 5,109,000
<DEPRECIATION> 4,104,000 2,507,000 1,317,000
<TOTAL-ASSETS> 35,021,000 31,832,000 28,966,000
<CURRENT-LIABILITIES> 5,303,000 5,175,000 4,323,000
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 5,000 5,000 5,000
<OTHER-SE> 29,349,000 26,652,000 24,638,000
<TOTAL-LIABILITY-AND-EQUITY> 35,021,000 31,832,000 28,966,000
<SALES> 68,731,000 63,846,000 51,590,000
<TOTAL-REVENUES> 68,731,000 63,846,000 51,590,000
<CGS> 31,772,000 30,759,000 25,181,000
<TOTAL-COSTS> 31,772,000 30,759,000 25,181,000
<OTHER-EXPENSES> 33,330,000 30,826,000 25,875,000
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 0 13,000 13,000
<INCOME-PRETAX> 4,445,000 2,960,000 1,234,000
<INCOME-TAX> 1,776,000 1,184,000 493,000
<INCOME-CONTINUING> 2,669,000 1,776,000 741,000
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 2,669,000 1,776,000 741,000
<EPS-PRIMARY> $0.52 $0.35 $0.15
<EPS-DILUTED> $0.51 $0.35 $0.15
</TABLE>
