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Recent filings: Aug 14, 2000 (Qtrly Rpt) | Apr 02, 2001 (Annual Rpt) | May 15, 2001 (Qtrly Rpt) | Jun 13, 2001 (form8-K)
More filings for HMK available from EDGAR Online  |  Get a Free Trial to Edgar Online Premium

April 02, 2001

HA LO INDUSTRIES INC (HMK)

Annual Report (SEC form 10-K)

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The following table sets forth for the years indicated the percent of net sales represented by each line item presented in the Company's Consolidated Statements of Income:

                                                                            Percent of Net Sales
                                                                ---------------------------------------------
                                                                          Year Ended December 31,
                                                                ---------------------------------------------
                                                                 2000           1999            1998
--------------------------------------------------------------- -------------- --------------- --------------
Net Sales                                                       100.0 %        100.0 %         100.0 %
Cost of Sales                                                    67.4 %         65.4 %          64.3 %
Gross Profit                                                     32.6 %         34.6 %          35.7 %
Selling Expenses                                                 14.9 %         15.6 %          13.7 %
General and Administrative Expenses                              28.1 %         19.4 %          13.8 %
Restructuring and Other Expenses                                 (1.2) %         4.9 %           1.8 %
--------------------------------------------------------------- -------------- --------------- --------------
  Operating Income(Loss)                                         (9.2)%         (5.3)%          6.4 %
Interest Income (Expense), Net                                   (1.0 )%            -            .3 %
--------------------------------------------------------------- -------------- --------------- --------------
Income(Loss) Before Income Taxes                                (10.2)%         (5.3)%          6.7 %
--------------------------------------------------------------- -------------- --------------- --------------
Net Income(Loss)                                                 (8.6)%         (2.9)%          4.0 %
--------------------------------------------------------------- -------------- --------------- --------------
Discontinued Operations, net of tax                                .9%            .5%            .9%
--------------------------------------------------------------- -------------- --------------- --------------
Net Income(Loss) Applicable to Common Stockholders               (8.1)%         (2.4)%          4.8 %
--------------------------------------------------------------- -------------- --------------- --------------
The following table summarizes the concentration of net sales by continuing business segment:

                                                                           Percent of Net Sales
                                                               ---------------------------------------------
Business Segment                                                   2000           1999            1998
-------------------------------------------------------------- ------------- ---------------- --------------
Branded Solutions                                                  85 %           88 %            92 %
Marketing Services                                                 15 %           12 %             8 %


YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999.

The following discussion includes the Company's continuing operations only. Therefore, the effect of the Company's brand strategy and identity and telemarketing subsidiaries, which are reflected in the accompanying consolidated financial statements as discontinued operations, has been excluded.

Net sales for 2000 increased 8.9% to $612.1 million from $562.0 million for 1999. Of the $50.1 million increase, $46.2 million was due to internal growth and $3.9 million was from acquired companies. Branded solutions net sales increased $26.2 million in 2000. Of this amount, $24.0 million was internal, resulting in an internal growth rate for the year of 4.9%. Internal growth in this segment was due to a combination of the addition of new sales representatives, further penetration of existing customers and development of new accounts.

Net sales from the marketing services business segment, which includes the Company's promotion marketing agency, increased $23.9 million in 2000. Of this amount, $22.1 million was internal, resulting in an internal growth rate for the year of 32.1%. Internal growth in this segment was due to increased penetration of existing customers.

Gross profit as a percentage of net sales for 2000 was 32.6% ($199.4 million) compared to 34.6% ($194.5 million) for 1999. Branded Solutions gross profit as a percentage of net sales decreased in 2000 due

a change in the sales mix. Specifically, certain high margin consumer premium sales from 1999 did not recur in 2000. In addition, the decrease was caused by a change in service mix in the marketing services business segment from higher margin execution and strategy work to lower margin production work.

Selling expenses as a percentage of net sales for 2000 were 14.9% ($91.5 million) compared to 15.6% ($87.7 million) for 1999. The decrease in the percentage was primarily due to more efficient leverage of fixed selling expenses in the branded solutions business segment. To a lesser extent, the decrease in the percentage is due to a change in sales mix toward the marketing services business segment. This segment does not have the same selling expense component, primarily commissions, as the branded solutions segment.

Recurring general and administrative expenses as a percentage of net sales for 2000 were 28.1% ($172.1 million), compared to 19.4% ($108.8 million) a year earlier. Principle components of the $63.3 million increase include goodwill amortization related to the acquisition of Starbelly.com ($40.0 million), payroll costs for Starbelly employees ($8.4 million), payroll costs to support the growth in the marketing services business segment ($9.3 million) and non capitalized technology expenditures ($2.1).

The above translates to a recurring operating loss of $64.2 million, excluding a non recurring restructuring reversal ($7.7M), for twelve months ended December 31, 2000 versus recurring operating income of $784,000, excluding the $30 million restructuring charge discussed below, for the same period last year. The decrease in the operating performance is primarily related to funding of technology development in the branded solutions business segment and decreased gross margins in the marketing services business segment.

Accretion to the redemption value of preferred stock relates to the amortization of the net present value discount assigned to the preferred stock issued in the Starbelly.com acquisition.

Net interest expense in 2000 was $6.4 million compared to net interest income of $29,000 in 1999. The change was due to borrowing necessary to complete Starbelly.com acquisition and the subsequent funding of its operations.


YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998.

The following discussion includes the Company's continuing operations only. Therefore, the effect of the Company's brand strategy and identity and telemarketing subsidiaries, which are reflected in the accompanying consolidated financial statements as discontinued operations, has been excluded.

Net sales for 1999 increased 11.0% to $562.0 million from $506.5 million for 1998. Net sales from acquired companies were $92.1 million while internal sales declined by $36.5 million. Promotional product net sales increased 6.1%, or $28.4 million in 1999. In the promotional product segment, acquisitions contributed $66.4 million in sales while internal sales declined $38.0 million or 8.2%. The decline in internal sales was primarily due to a decrease in the Company's consumer premium business.

Net sales from the marketing services business segment, which includes the Company's promotion marketing agency, increased 65.3% or $27.2 million in 1999. Virtually all of the growth relates to an acquisition completed in December of 1998.

Gross profit as a percentage of net sales for 1999 was 34.6% ($194.5 million) compared to 35.7% ($180.6 million) for 1998. Excluding the effect of $2.7 million of non-recurring write-offs resulting from the Company's restructuring plan (see below), 1999 gross profit as a percentage of net sales would have been 35.1%. The decrease in the recurring percentage was primarily due higher margin consumer premium business from 1998 that did not recur in 1999.

Selling expenses as a percentage of net sales for 1999 increased to 15.6% ($87.7 million) compared to 13.7% ($69.4 million) for 1998. The increase was primarily due to fixed cost investments, primarily people, to support promotional product sales growth which did not materialize.

Recurring general and administrative expenses as a percentage of net sales for 1999 were $108.8 compared to $69.9 million in 1998. Of the $38.9 million increase, $18.4 million is attributable to acquired companies. The remaining increase was caused by a combination of two factors. First, investments in personnel and facilities to support rapid growth in the marketing services business segment. Secondly, the Company invested in infrastructure, primarily personnel and information systems, necessary to support growth in the branded solutions segment that was not achieved.

Operating results for 1999 and 1998 include other expenses of $30.0 million and $9.3 million, respectively. The 1999 expenses relate to the Company's restructuring plan to consolidate operations (see below) while the 1998 expenses primarily relate to completed acquisitions accounted for using the pooling-of-interests accounting method.

Net interest income in 1999 was $.029 compared to net interest income of $1.6 in 1998. The change was due to a reduction in the average balance in short-term investments. The short-term investments were used to fund the acquisition of additional promotional product companies.


RESTRUCTURING PLAN

As discussed in Note 10 to the consolidated financial statements, the Company recorded a restructuring charge of $30 million in the third quarter of 1999. Major components of the charge related to lease buyouts and accruals, asset write-downs, severance and termination costs and other charges. In the fourth quarter of 2000 the company reversed $7,672,000 of the reserve as the plan was implemented more efficiently than originally projected. The remaining reserve of $3,430,000 is expected to be utilized in the first half of 2001.


SEASONALITY

Some of the Company's customers tend to utilize a greater portion of their advertising and promotional budgets in the latter half of the year, which historically has resulted and may continue to result in a disproportionately large share of the Company's net sales being recognized in the second half of the year. The Company incurs general and administrative expenses evenly throughout the year, which historically has resulted and may continue to result in a disproportionate share of its net income being reported in the second half of the year.


LIQUIDITY AND CAPITAL RESOURCES

The Company has a credit facility that provides a commitment of $80 million. Maximum borrowings are based on eligible accounts receivable, are secured by the Company's domestic assets and bear interest based on a defined ratio at either between prime and prime plus 1.50% or the London Interbank Offered Rate (LIBOR) plus 3.00%. As of December 31, 2000, outstanding borrowings on the facility were $64.2 million.

The Company's credit facility includes various financial covenants, including maintenance of an interest coverage ratio based on operating results for the previous four quarters. The Company violated this covenant at December 31, 2000, and because of the cumulative nature of the calculation, has advised its banks it will be in violation at the end of the first quarter. The existing covenant violation has been waived by the banks. The Company and its banks have discussed the need to redefine the covenant to more attainable levels, but until such redefinition occurs, the Company could be in violation throughout 2001. The Company's financial institutions have been cooperative in working with the Company in its efforts to dispose of certain of its business units and management believes the banks will continue to waive existing violations as long as the Company continues to execute its strategies to reduce outstanding borrowings. Current borrowings on the credit facility are are within the formula amounts defined in the agreement and outstanding borrowings from the bank have fallen from a peak of $71.9 million on February 9, 2001 to $53.5 million at March 27, 2001. Subsequent to the completion of the sale of the entities discussed below, the Company intends to renegotiate its lending arrangements with its financial institutions. The debt outstanding under the Revolver has been classified as a current liability in the accompanying financial statements.

In addition to its credit facility, the Company has an obligation to holders of the redeemable preferred stock. The Company is precluded from borrowing on its credit facility to fund the preferred stock redemption. Management is in the process of renegotiating the terms of the preferred stock and has received preliminary indications from the majority preferred stockholder that this will result in some combination of an extension of payment terms of at least twelve months, modification of conversion rights, and revision of dividend rates for default payments.

Management's strategies to continue reducing its leverage include the following: implementation of a cost reduction program, which will improve operating cash flow, and consummation of a transaction to sell one or both of two business units. Each of these actions are described below.

The Company hired a new Chief Executive Officer on February 22, 2001. At his direction, the Company began an aggressive initiative to identify cost reduction opportunities and eliminate discretionary spending. Some of the identified opportunities have already been implemented, and various discretionary expenditures have been eliminated. The initiative is continuing and the first phase is expected to be completed during the second quarter of 2001, with full implementation occurring before the end of 2001. Management believes the result of the initiative will reduce expenses in 2001 by $10 -$15 million. During this initiative, management will review its business strategy. This review could result in a second quarter restructuring charge and may also result in an impairment charge for certain of its long lived assets.

The Company is actively engaged in the sale of two subsidiaries. (See footnote 6). One of these transactions is in the final stages of contract review. The material terms of the transaction have been agreed to by the parties. The Company has received a fairness opinion on this transaction from its investment banker. The second transaction is subject to a letter of intent which defines the significant terms of the transaction. The buyers in both transactions have completed their due diligence analyses and management believes that both transactions will be completed during the second quarter. The net proceeds from these sales, based on the terms of the contract and the letter of intent, are expected to exceed $50 million, exclusive of earnout consideration to be received during the first quarter of 2002. Additionally, in March 2001, the Company sold a portion of its interest in a joint venture for $6 million. The buyer, a group that includes the former Vice Chairman of the Company, has an option to purchase the remaining interest for an additional $14 million if exercised by April 15, 2001 and closed by April 30, 2001.

Capital expenditures for 2000 were approximately $20.9 million and include significant investment in software development and other technology costs which will not recur. Management expects capital expenditures in 2001 will not exceed $10 million.

In management's opinion the actions identified will be sufficient to meet the needs of the Company for 2001.


ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to market risks relating to fluctuations in currency exchange rates and interest rates. As required by Securities and Exchange Commission (SEC) rules, the Company has calculated the sensitivity of operating results to hypothetical changes in exchange rates and interest rates as if these changes had actually occurred during 2000.

The Company is subjected to a risk from currency translation fluctuations due to their operations in Europe and Canada. Had the US dollar been 10% less favorable compared to foreign currencies during 1999 the Company would have recognized a $4.1 million reduction in net assets, about 1.1% of the total reported at year end. The effect on operations and cash flow in 2000 would have been immaterial. Management does not believe the risk of unfavorable currency fluctuations is significant, and has not entered into any foreign exchange contracts for the purpose of hedging against this risk.

The Company is exposed, through short-term investments and borrowings, to the risk of unfavorable changes in interest rates. Had interest rates during 2000 been 10% less favorable, net income would have been negatively affected by approximately $570,000. Management does not believe that the risk of unfavorable fluctuations in interest rates is significant to the Company's operations.


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial information required by item 8 is included elsewhere in this report (see Part IV, Item 14)


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND

               FINANCIAL DISCLOSURE
None.


Recent filings: Aug 14, 2000 (Qtrly Rpt) | Apr 02, 2001 (Annual Rpt) | May 15, 2001 (Qtrly Rpt) | Jun 13, 2001 (form8-K)
More filings for HMK available from EDGAR Online  |  Get a Free Trial to EDGAR Online Premium
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