##### Table of Contents

---

U. S. SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





---




FORM 10-Q


(Mark One)





|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------




For the quarterly period ended November 1, 2002





OR





| ̈ |  | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
|- |  | ---------------------------------------------------------------




For the transition period from         to





Commission file Number 001-14137





---




HLM Design, Inc.


(Exact Name of Registrant as
Specified in Its Charter)





---




Delaware

56-2018819(State or Other Jurisdiction of Incorporation or Organization)

(I.R.S Employer Identification
No.)





121 West Trade Street, Suite 2950


Charlotte, North Carolina 28202


(Address of principal executive offices) (Zip
Code)





Registrants Telephone Number, Including Area Code: (704) 358-0779





Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No  ̈





Indicate by check mark
whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).


Yes  ̈ No  x





Indicate the number of shares outstanding of each of the issuers classes of common stock, as of December 11, 2002:





Common stock, par value $.001 per share

2,402,815 shares


---



---

##### Table of Contents




HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES


INDEX TO FORM 10-Q





PAGE NO.PART I .    FINANCIAL INFORMATIONITEM 1.

Financial StatementsConsolidated Balance SheetsMay 3, 2002 and November 1, 2002

3Consolidated Statements of OperationsSix Month Periods Ended November 2, 2001 and November 1, 2002 and Three Month Periods Ended November 2, 2001 and November 1, 2002

5Consolidated Statement of Stockholders EquitySix Month Period Ended November 1, 2002

6Consolidated Statements of Cash FlowsSix Month Periods Ended November 2, 2001 and November 1, 2002

7Notes to Unaudited Consolidated Financial Statements

8ITEM 2.

Managements Discussion and Analysis of Financial Condition And Results of Operations

16ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk

25ITEM 4.

Controls and Procedures

26PART II.    OTHER INFORMATIONITEM 2.

Changes in Securities and Use of Proceeds

27ITEM 4.

Submission of Matters to a Vote of Security Holders

27ITEM 6.

Exhibits and Reports on Form 8-K

28SIGNATURES

29







---

##### Table of Contents

PART I FINANCIAL INFORMATION





ITEM 1. FINANCIAL STATEMENTS





HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES


CONSOLIDATED BALANCE SHEETS





May 3,2002

November 1, 2002(Unaudited)ASSETS:Current Assets:Cash

$
460,870

$
435,910Trade and other receivables, less allowance for doubtful accounts at May 3, 2002 and November 1, 2002 of $1,768,221 and
$2,067,507 respectively


13,856,090


13,614,948Costs and estimated earnings in excess of billings on uncompleted projects


7,639,530


8,230,962Prepaid expenses and other


1,261,092


1,191,400Total Current Assets


23,217,582


23,473,220Other Assets:Goodwill, net


20,834,104


21,919,340Non-compete agreements, net


302,084


272,917Deferred income taxes


531,661


651,362Other non-current assets


1,061,272


1,233,353Total Other Assets


22,729,121


24,076,972Property and Equipment:Leasehold improvements


2,471,340


3,099,260Furniture and fixtures


5,250,567


5,363,108Property and equipment, at cost


7,721,907


8,462,368Less accumulated depreciation


5,758,626


6,323,311Property and equipment, net


1,963,281


2,139,057TOTAL ASSETS

$
47,909,984

$
49,689,249





See notes to unaudited consolidated financial statements.




3




---

##### Table of Contents

HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES


CONSOLIDATED
BALANCE SHEETS





May 3,2002


November 1, 2002(Unaudited)LIABILITIES AND STOCKHOLDERS EQUITY:Current Liabilities:Current maturities of long-term debt and capital lease obligations

$
11,262,014


$
3,601,528Accounts payable


10,525,274



9,316,120Billings in excess of costs and estimated earnings on uncompleted projects


2,282,782



3,182,237Accrued payroll


1,056,328



1,065,082Income taxes payable


567,555



888,175Deferred income taxes


2,357,550



1,763,283Accrued expenses and other


2,156,163



2,685,564Total Current Liabilities


30,207,666



22,501,989LONG-TERM DEBT


4,941,667



12,478,050MINORITY INTEREST


99,015



64,235OTHER


138,050



138,050TOTAL LIABILITIES


35,386,398



35,182,324Commitments and contingenciesSTOCKHOLDERS EQUITY:Capital Stock:Preferred, $.10 par value, authorized 800,000 shares, no shares outstanding6.5% Series A Cumulative Convertible Preferred Stock, $.10 par value, non-voting, authorized 200,000 shares, no shares
outstanding and 61,000 shares outstanding at May 3, 2002 and November 1, 2002, respectively






6,100Common, $.001 par value, voting, authorized 9,000,000 shares; issued 2,939,082 and 2,952,159 at May 3, 2002 and
November 1, 2002, respectively (includes 620,998 and 549,344 to be issued on a delayed delivery schedule at May 3, 2002 and November 1, 2002, respectively)


2,939



2,952Additional paid in capital


9,467,106



10,490,865Retained earnings


3,069,407



3,755,869Accumulated other comprehensive (loss) income


(15,866
)


251,139Total stockholders equity


12,523,586



14,506,925TOTAL LIABILITIES AND STOCKHOLDERS EQUITY

$
47,909,984


$
49,689,249





See notes to consolidated financial statements.




4




---

##### Table of Contents

HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES


CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)





Six Months Ended November 2, 2001


Six Months Ended November 1, 2002

Three Months Ended November 2, 2001


Three Months Ended November 1, 2002REVENUES:Fee Income

$
27,844,119


$
32,861,823

$
13,647,307


$
15,808,539Reimbursable Income


2,028,667



2,485,972


597,680



1,707,873Total Revenues


29,872,786



35,347,795


14,244,987



17,516,412CONSULTANT EXPENSE


9,751,352



9,126,897


5,158,579



4,555,067PROJECT EXPENSES:Direct Expenses


479,188



1,224,434


222,545



536,522Reimbursable Expenses


1,295,789



1,059,312


646,119



501,034Total project expenses


1,774,977



2,283,746


868,664



1,037,556NET PRODUCTION INCOME


18,346,457



23,937,152


8,217,744



11,923,789DIRECT LABOR


6,539,676



7,712,412


3,035,629



3,970,752INDIRECT EXPENSES


12,000,714



14,303,704


5,784,499



7,006,121OPERATING (LOSS) INCOME


(193,933
)


1,921,036


(602,384
)


946,916INTEREST EXPENSE


671,795



758,565


333,408



347,680(LOSS) INCOME BEFORE INCOME TAXES AND MINORITY INTEREST


(865,728
)


1,162,471


(935,792
)


599,236INCOME TAX (BENEFIT) EXPENSE


(358,068
)


412,906


(395,368
)


222,200(LOSS) INCOME BEFORE MINORITY INTEREST


(507,660
)


749,565


(540,424
)


377,036MINORITY INTEREST IN (LOSS) INCOME


(15,934
)


50,219


896



9,944NET (LOSS) INCOME

$
(491,726
)

$
699,346

$
(541,320
)

$
367,092NET (LOSS) INCOME PER SHAREBasic

$
(0.20
)

$
0.23

$
(0.21
)

$
0.12NUMBER OF SHARES USED TO COMPUTE PER SHARE DATABasic


2,521,517



2,944,557


2,526,205



2,947,738NET (LOSS) INCOME PER SHAREDiluted

$
(0.20
)

$
0.23

$
(0.21
)

$
0.12NUMBER OF SHARES USED TO COMPUTE PER SHARE DATADiluted


2,521,517



3,020,876


2,526,205



3,100,375





See notes to unaudited consolidated financial statements.




5




---

##### Table of Contents




HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES


CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY


(Unaudited)





Preferred Stock

Common Stock

Additional Paid-In Capital

Retained Earnings


Accumulated Other Comprehensive (Loss) Income


Total Stockholders EquityShares

Amount

Shares

AmountBalance, May 3, 2002



$


2,939,082

$
2,939

$
9,467,106

$
3,069,407


$
(15,866
)

$
12,523,586Warrants issued in connection with the acquisition of SOTA












145,765










145,765Issuance of common stock






13,077


13


23,994










24,007Issuance of preferred stock

61,000


6,100







854,000










860,100Comprehensive income:Net income















699,346Dividends on preferred stock















(12,884
)Foreign currency translation adjustment



















267,005Total comprehensive income























953,467Balance, November 1, 2002

61,000

$
6,100

2,952,159

$
2,952

$
10,490,865

$
3,755,869


$
251,139


$
14,506,925





See notes to unaudited consolidated financial statements.




6




---

##### Table of Contents




HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES


CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)





Six Months Ended November 2, 2001


Six Months Ended November 1, 2002CASH FLOWS FROM OPERATING ACTIVITIES:Net (loss) income

$
(491,726
)

$
699,346Adjustments to reconcile net income to net cash provided by operating activities:Depreciation


483,124



564,685Amortization of intangible assets


29,168



29,167Amortization of deferred loan fees


99,870



129,038Deferred income taxes


139,299



(709,861
)Other






(34,780
)Changes in assets and liabilities, net of acquired assets and foreign currency exchange, which provided (used)
cash:Trade and other accounts receivable


(175,914
)


515,218Costs and estimated earnings in excess of billings on uncompleted projects


1,418,141



(533,746
)Prepaid expenses and other assets


348,420



(186,754
)Accounts payable


(51,697
)


(1,397,714
)Billings in excess of costs and estimated earnings on uncompleted projects


560,030



867,879Income tax payable






312,420Accrued expenses, payroll and other


(88,457
)


406,575Net cash provided by operating activities


2,270,258



661,473CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment


(226,595
)


(740,461
)Payment for purchase of SOTA, net of cash acquired


(141,576
)


Net cash used in investing activities


(368,171
)


(740,461
)CASH FLOWS FROM FINANCING ACTIVITIES:Payment on long-term borrowings


(475,963
)


(1,366,140
)Net borrowings on revolving credit facility


(531,385
)


279,698Borrowings on long-term debt


457,593



308,116Net proceeds from issuance of preferred stock






860,100Dividends on preferred stock






(12,884
)Proceeds from issuance of common stock under the Employee Stock Purchase Plan


25,439



24,007Net cash (used in) provided by financing activities


(524,316
)


92,897Effective of currency exchange rate changes on cash






(38,869
)INCREASE (DECREASE) IN CASH


1,377,771



(24,960
)CASH BALANCE:Beginning of period


243,148



460,870End of period

$
1,620,919


$
435,910SUPPLEMENTAL DISCLOSURES:Interest paid

$
475,391


$
549,948Income tax (refunds) payments

$
(732,788
)

$
730,826Noncash investing and financing transactions:Acquisition of acquired businesses, net of imputed interest:Fair value of assets acquired and liabilities assumed, net

$
243,669


$
Common stock to be issued on delayed delivery schedule

$
211,530


$
Payment on note payable with trade accounts receivable

$
237,713


$






See notes to unaudited consolidated financial statements.




7




---

##### Table of Contents




HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES





NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS





1.    DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Organization and BusinessHLM Design, Inc. (HLM Design) and Subsidiaries and Affiliates (the Company) provide management
and services to architectural, engineering and planning design entities (Managed Firms) under long-term management and services agreements (MSAs). HLM Design is responsible for providing financing in connection with the
operations and management of these Managed Firms. As of November 1, 2002, the Company had wholly-owned subsidiaries and affiliates as follows:





Affiliates:


| |  |  | HLM Design of North America, Inc. (HLMNA)
| | - |  | -------------------------------------------

| |  |  | HLM Design Architecture, Engineering and Planning, P.C. (HLMAEP)
| | - |  | ------------------------------------------------------------------




Subsidiaries:


| |  |  | JPJ Architects, Inc. (JPJ)
| | - |  | ----------------------------

| |  |  | G.A. Design International Holdings, Ltd. (GAIH)
| | - |  | -------------------------------------------------

| |  |  | BL&P Engineers, Inc. (BL&P)
| | - |  | -----------------------------

| |  |  | HLM Design International Ltd. (HLML)
| | - |  | --------------------------------------

| |  |  | HLM Design USA, Inc. (HLMUSA) (effective May 4, 2002, HLMUSA became a subsidiary)
| | - |  | -----------------------------------------------------------------------------------




In addition, the Company has a wholly-owned subsidiary, SOTA Software Systems, Inc. (SOTA), which is a software company.





Financial Statement PresentationThe accompanying unaudited financial information as of November 1, 2002 and for the six month periods ended November 2,
2001 and November 1, 2002 has been prepared in accordance with accounting principles generally accepted in the United States of America. All significant intercompany accounts and transactions have been eliminated. These unaudited consolidated
financial statements reflect, in the opinion of management, all material adjustments (which include only normal recurring adjustments) necessary to fairly state the financial position and the results of operations for the interim periods presented.
The results for interim periods are not necessarily indicative of the results to be expected for the entire fiscal year. These interim financial statements should be read in conjunction with the Companys audited consolidated financial
statements for the year ended May 3, 2002.





New Accounting StandardsIn October 2001, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets which supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be disposed while retaining many of its fundamental provisions. Additionally, this statement expands the scope of discontinued operations to include more disposal transactions. As of May 4, 2002, the Company adopted SFAS No.
144. The adoption of this statement did not have a material impact on the Companys consolidated financial statements.





In January
2002, the FASB issued Emerging Issues Task Force (EITF) 01-14, Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred. EITF 01-14 requires reimbursements for out-of-pocket expenses
incurred to be characterized as revenue in the income statement. As of May 4, 2002, the Company adopted EITF 01-14. The adoption of this EITF did not have an impact




8




---

##### Table of Contents




HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES





NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





1.    DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIEScontinued





on the Companys consolidated financial statements.





In April 2002, the FASB issued
SFAS No. 145, Recission of FASB Statements 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This statement eliminates the exception to applying APB Opinion No. 30, Reporting the Results of Operations-Reporting the Effects
of the Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, to all gains and losses related to extinguishments of debt. In addition, this statement requires sale-leaseback accounting for
certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The Company is currently assessing the impact of this statement, which will be effective for the Company for fiscal year 2004.





In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This new standard requires that a
liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. This standard establishes that fair value is the objective for initial measurement of the liability. This new standard is effective for
exit or disposal activities initiated after December 31, 2002. Management does not believe SFAS No. 146 will have a material impact on its consolidated financial statements.





2.    LIQUIDITY





As discussed in Note 5, the Company modified
and obtained waivers on certain covenants contained in its Whitehall Business Credit Corporation and Bank of Scotland debt agreements. The modified agreements contain financial requirements which, if not achieved, will cause the Company to be in
default of the debt agreement(s) and the lender(s) could call for the payment of all outstanding indebtedness. The Companys ability to comply with these covenants depends on its achieving financial projections and/or successfully completing
the sale of the Companys 6.5% Series A Cumulative Convertible Preferred Stock by January 31, 2003. Although management believes that the Company will be able to meet the debt covenants, there is a possibility that such covenants will not be
met. In the event that the Company does not meet the covenants and the Lender(s) exercise their right to accelerate the debts maturity, the Company would not have the ability to pay the lender and the Company would have to either renegotiate the
debt or enter into a new arrangement to sustain its current operations.





3.    CONTRACTS IN PROGRESS





Information relative to contracts in progress is as follows:





May 3, 2002

November 1,2002Costs incurred on uncompleted projects (excluding overhead)

$
137,392,893

$
120,448,928Estimated earnings thereon


101,121,913


82,699,797Total


238,514,806


203,148,725Less billings to date


233,158,058


198,100,000Net underbillings

$
5,356,748

$
5,048,725





Net underbillings are included in the accompanying balance sheets as follows:





May 3, 2002


November 1, 2002Costs and estimated earnings in excess of billings on uncompleted projects

$
7,639,530


$
8,230,962Billings in excess of costs and estimated earnings on uncompleted projects


(2,282,782
)


(3,182,237
)Net underbillings

$
5,356,748


$
5,048,725




9




---

##### Table of Contents




HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES





NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





4.    GOODWILL AND OTHER INTANGIBLE ASSETS





Effective April
28, 2001, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, (SFAS No. 142), which establishes new accounting and reporting requirements for goodwill and other intangible assets. Under SFAS No. 142, all goodwill
amortization ceased effective April 28, 2001. The Company identified reporting units based on the current reporting structure and assigned all goodwill and other assets and liabilities, to the extent that they related to those reporting unit. As
required by SFAS No. 142, subsequent impairment losses, if any would be classified as an indirect expense on the Companys consolidated statements of operations. The Company completed the first step of the transitional goodwill impairment test
by comparing the fair value of each reporting unit to its carrying value and determined that no impairment existed at the effective date of the implementation of the new standard. The Company also completed its annual goodwill impairment test as of
May 3, 2002 and determined that no impairment existed as of that date.





Fair value of each reporting unit was measured using a valuation
by an independent third party as of April 28, 2001 and May 3, 2002, which were based on the market multiples, comparable transactions and discounted cash flow methodologies.





These valuations indicated an aggregate fair value of the reporting units significantly in excess of the Companys market capitalization as of April 28, 2001 and May 3, 2002. The Company believes
the market capitalization is not representative of the fair value of the Company because the Common Stock of the Company is not actively traded.





Annually, the Company will obtain an independent valuation as the basis for its goodwill impairment test. At least quarterly, management will evaluate to determine if an event or change in circumstances has occurred that would more
likely than not reduce the fair value of a reporting unit below its carrying amount. The Company, if appropriate, will perform a goodwill impairment test between the annual dates. Impairment adjustments recognized after adoption, if any, will be
recognized as an operating expense.





Impairment indicators which may be considered include, but are not limited to, the following:





| |  |  | A significant adverse change in legal factors or in the business climate
| | - |  | ------------------------------------------------------------------------




| |  |  | Unanticipated competition
| | - |  | -------------------------




| |  |  | A significant decline in the operating performance
| | - |  | --------------------------------------------------




| |  |  | Adverse action or assessment by a regulator
| | - |  | -------------------------------------------




The financial information for acquired intangible assets is as follows:





May 3, 2002

November 1, 2002Amortized intangible assets-non-compete agreements:Original cost

$
400,000

$
400,000Accumulated amortization


97,916


127,083




10




---

##### Table of Contents

HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES





NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





|4. |  | GOODWILL AND OTHER INTANGIBLE ASSETScontinued
|-- |  | ----------------------------------------------




The non-compete intangible assets are amortized over their contractual life ranging from four to nine years. Amortization expense for the three and six months ended November 1, 2002 and November 2,
2001 was $14,584, $29,167, $14,585 and $29,168, respectively and annual estimated amortization for non-compete agreements are as follows:





Fiscal 2003

$
58,333Fiscal 2004

$
43,749Fiscal 2005

$
33,336Fiscal 2006

$
33,336





The change in carrying amount of goodwill for the six months ended November 1, 2002 is as
follows:





Balance at May 3, 2002

$
20,834,104Goodwill acquired during the period


196,911Effect of foreign currency exchange


888,325Balance at November 1, 2002

$
21,919,340





The Company has not identified any other intangibles with indefinite lives as of November
1, 2002.





5.    FINANCING ARRANGEMENTS





A description of the Whitehall Business Credit Corporation (WBCC) (Formerly IBJ Whitehall Business Credit Corporation) loan arrangement follows.





At November 1, 2002, the Company had $6,435,816 outstanding, bearing interest at 5.25%, under the revolving credit facility with $134,460 available on this
revolving credit arrangement based on the calculated aging of certain domestic assets reported as of October 11, 2002. At November 1, 2002, the Company had $231,111 outstanding under a term loan bearing interest at 6.75 %.





Substantially all domestic assets are pledged under the Companys revolving credit and term loan (collectively WBCC Loans). This financing
arrangement requires that the Company maintain certain financial requirements such as minimum net worth, minimum EBITDA, maximum leverage and senior leverage ratios, maximum fixed charge coverage and senior fixed charge coverage ratios and maximum
capital expenditure commitments.





On June 3, 2002 and September 10, 2002, the Company and WBCC entered into the third and fourth
amendments to its WBCC Loans. These amendments temporarily increased the amount available to borrow under the revolving credit facility, waived certain financial covenants, and temporarily modified certain financial covenants.




11




---

##### Table of Contents




HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES





NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





5.    FINANCING ARRANGEMENTScontinued





At November 1,
2002, the Company was in compliance with the minimum net worth, minimum EBITDA, maximum leverage and senior leverage ratios and maximum capital expenditure commitments. With the fifth amendment to the WBCC Loans (described below), the Company
obtained a waiver from WBCC for the fixed charge coverage and senior fixed charge coverage ratio through November 2003.





In
November 2002, WBCC increased the amount available to borrow under its revolving credit facility by $300,000. This was reduced to zero at the completion of the fifth amendment (discussed below) to the WBCC Loans.





On December 11, 2002, the Company and WBCC entered into the fifth amendment to its WBCC Loans. The material terms of the amendment are:





a)   Revolving Credit Facility.    Modifies the calculation of the amount available to borrow under
the revolving credit facility based on the aging of certain domestic assets resulting in an increase in the Companys amount available to borrow (based on the calculated aging of certain domestic assets reported at October 11, 2002, the
increase in the amount available to borrow as of November 1, 2002 would be approximately $950,000).





b)Term Loan.    Increases the amount available for the Company to borrow under the term loan by an amount equal to the equity contributions in excess of $700,000 received by the Company through
the sale of the Companys 6.5% Series A Cumulative Convertible Preferred Stock (Preferred Stock) between May 3, 2002 and February 28, 2003, up to a maximum amount of $1,000,000(based on the proceeds received on the sale of the
Preferred Stock through November 1, 2002, the maximum increase in the term loan would be approximately $215,000).





c)Extension of Maturity Date.    Extends the maturity date to December 11, 2005 of the WBCC Loans (as such, the WBCC Loans are classified as long term in the Companys November 1, 2002
consolidated balance sheet).





d)Modification to the Computation of Certain
Covenants.    Modifies the EBITDA adjusted calculation used for determining compliance with the EBITDA, fixed and leveraged coverage covenants. The modifications are effective as of the quarter ending January 31, 2003.





e)Modification of Certain Covenants.    Decreases the maximum capital
expenditure level financial covenant from $1 million to $750,000. Increases the minimum net worth level financial covenant effective as of the quarter ending January 31, 2003.





f)Conditions Subsequent.    By no later than November 15, 2003, WBCC shall receive evidence satisfactory that the financial covenants
set forth in the Bank of Scotland loan agreement shall be modified in a manner satisfactory to WBCC. The failure to meet this covenant shall constitute a default.





Based on historical and projected results of operations, the Company expects to be in compliance with the debt covenants in future reporting periods.




12




---

##### Table of Contents

HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES





NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





5.    FINANCING ARRANGEMENTScontinued





A description of the Bank of Scotland
(BOS) loan arrangement follows.





The BOS loan, which matures in January 2007, is denominated in British Pounds and bears
interest at LIBOR plus 2%. At November 1, 2002, the BOS loan had a balance of 2,000,000 Pounds ($3,129,800) bearing interest at 6.1%.





Substantially all assets of GAIH and HLML (collectively, consolidated GAIH) are pledged as collateral under this financing arrangement. This financing arrangement contains certain financial covenants including maximum
debt to equity ratio, minimum accounts receivable to debt, minimum EBIT to senior interest, and minimum EBITDA to total senior charges calculated based on consolidated GAIH amounts. In addition, this financing arrangement requires maintenance of
certain financial covenants for the Company including maximum debt to equity and minimum EBIT to total interest.At November 1, 2002, consolidated GAIH was in compliance with the minimum EBIT to senior interest, minimum EBITDA to total senior
charges and the Company was in compliance with the maximum debt to equity ratio. However, consolidated GAIH was not in compliance with minimum EBIT to total interest. The Company obtained a waiver from BOS as of November 1, 2002 waiving compliance
with these covenants for one year and one day from November 1, 2002.





A description of the note payable to former JPJ and BL&P
shareholders follows.





JPJ-In August 2002, the note payable of $676,151 plus interest at 7% per annum was modified to agreed upon monthly
payments of $52,830 plus interest in September 2002, $95,002 plus interest in October 2002, $52,830 plus interest from November 2002 to July 2003, and final payment of $52,849 plus interest in August 2003. In addition, 69,344 shares of the
Companys common stock, scheduled to be delivered in October 2002, were delayed until January 2003. At December 16, 2002, the Company had paid all payments due under this modified payment arrangement. Management believes it will be able to make
the scheduled payments on these notes or obtain modifications on terms acceptable to the Company.





BL&P-The Company amended its
payment obligations to a former BL&P shareholder to agreed upon payments of $183,600 plus interest at 7% per annum, $183,600 plus interest at 7% per annum and $61,200 plus interest at 7% per annum for quarters ending August 2, 2002, November 1,
2002 and January 31, 2003, respectively. The Company did not make the payments scheduled for August 2 and November 1, 2002. Effective November 1, 2002, the notes payable of $1,619,186 plus interest at 7% per annum was modified to agreed upon monthly
payments of $10,000 plus interest in April 2003, $30,000 plus interest in May 2003, monthly payments of $32,900 plus interest from June 2003 to April 2007, and final payment of $32,887 in May 2007. Management believes it will be able to make the
scheduled payments on these notes or obtain modifications on terms acceptable to the Company.




13




---

##### Table of Contents




HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES





NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





6.    STOCKHOLDERS EQUITY





Common Stock Issued:


In June and September 2002, 6,140 and 6,937 shares of Common Stock, respectively, were issued under the HLM Design, Inc. Employee Stock Purchase Plan.





6.5% Series A Cumulative Convertible Preferred Stock (Preferred Stock) Issued:


In August and September 2002, the Company sold and issued an aggregate of 61,000 shares of its Preferred Stock at $15.00 per share. Holders of the Preferred Stock are entitled to receive cumulative cash dividends at a rate of $0.98
per annum per share payable in quarterly installments. Preferred Stock shares are subject to mandatory conversion to Common Stock if the closing price for the Common Stock exceeds $6.50 for twenty consecutive trading days. In addition, Preferred
Stock shares are convertible at any time into shares of Common Stock at the option of the Preferred Stock holder at an initial conversion price of $5.00 per share of Common Stock (subject to adjustment for stock dividends, stock splits, business
combinations and corporate reorganizations) and an initial conversion ratio of 3 to 1. Upon conversion, the number of common shares issued will be determined by dividing the original price per Preferred Stock share by the conversion price then
applicable per the Stock Purchase Agreement. The Company incurred $54,900 in commission and other expenses in the sale of its Preferred Stock.





7.    FOREIGN AND DOMESTIC OPERATIONS





The Company currently has international operations
based only in the United Kingdom. The Company has aggregated the operations of the Managed Firms located in the United Kingdom as follows:








Three Months Ended November 2,
2001

Six Months
Ended November 2, 2001

Three Months Ended November 1,
2002

Six Months
Ended November 1, 2002United KingdomRevenues

$
1,029,343

$
1,788,852

$
4,655,419

$
9,434,369Operating income


155,820


227,082


307,772


645,220Identifiable assets


1,743,957


1,743,957


6,675,755


6,675,755




14




---

##### Table of Contents




HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES





NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)





7.    FOREIGN AND DOMESTIC OPERATIONS-continued





The Company
has aggregated its operations in the United States as follows:





Three Months Ended November 2,
2001


Six Months
Ended November 2, 2001


Three Months Ended November 1,
2002

Six Months
Ended November 1, 2002United StatesRevenues

$
13,215,644


$
28,083,934


$
12,860,993

$
25,913,426Operating (loss) income


(349,753
)


(829,466
)


639,144


1,275,816Identifiable assets


24,057,622



24,057,622



20,398,232


20,398,232





8.    CONTINGENCIES





In the normal course of business, the Company is party to various claims and legal proceedings. The Company records a reserve for these matters when an adverse
outcome is probable and the amount of the potential liability is reasonably estimable. Although the ultimate outcome of these matters is currently not determinable, the Company does not believe that the resolution of these matters will have a
material effect upon the financial condition, results of operations or cash flows for an interim or annual period.




15




---

##### Table of Contents




ITEM 2.    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND


RESULTS OF OPERATIONS





The following discussion of the results of operations and financial condition of the Company should be read in conjunction with the financial
statements and related notes thereto included elsewhere in this report.





Three Months
Ended November 2, 2001


Three Months
Ended November 1, 2002

Six Months
Ended November 2, 2001


Six Months
Ended November 1, 2002Revenues

$
14,244,987


$
17,516,412

$
29,872,786


$
35,347,795Consultant and project expenses


6,027,243



5,592,623


11,526,329



11,410,643Net production income


8,217,744



11,923,789


18,346,457



23,937,152Direct labor


3,035,629



3,970,752


6,539,676



7,712,412Operating costs


5,769,914



6,991,537


11,971,546



14,274,537Amortization of intangible assets


14,585



14,584


29,168



29,167Total costs and expenses


8,820,128



10,976,873


18,540,390



22,016,116Operating (loss) income


(602,384
)


946,916


(193,933
)


1,921,036Interest expense, net


333,408



347,680


671,795



758,565(Loss) income before income taxes and minority interest


(935,792
)


599,236


(865,728
)


1,162,471Income tax (benefit) expense


(395,368
)


222,200


(358,068
)


412,906(Loss) income before minority interest


(540,424
)


377,036


(507,660
)


749,565Minority interest in (loss) income


896



9,944


(15,934
)


50,219Net (loss) income

$
(541,320
)

$
367,092

$
(491,726
)

$
699,346





Cautionary Statement





The forward-looking statements in this report reflects managements best judgment based on factors currently known, including the existence of certain risks and uncertainties. Words
such as expects, anticipates, believes, intends, and hopes, variations of such words and similar expressions are intended to identify such forward-looking statements. The Companys
actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of these risk factors, including but not limited to, the factors discussed in such sections and in particular the factors
discussed under Risk Factors That Might Affect Our Business or Stock Price. Forward-looking information provided by the Company is provided pursuant to the safe harbor established under the Private Securities Litigation Reform Act of
1995 and should be evaluated in the context of these factors.




16




---

##### Table of Contents

ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND


RESULTS OF OPERATIONScontinued





For the three months ended November 1, 2002 and November 2, 2001





Revenues were $17.5 million for the three month period ended November 1, 2002 as compared to $14.2 million for the three month
period ended November 2, 2001. This 23% increase is due to additional revenues of $3.5 million resulting from the acquisition of HLML in February 2002. This increase in revenues is partially offset by a decline in the volume of architecture,
planning and engineering services principally attributable to certain clients delaying project start dates. Management believes that these delays in start date will continue through the remainder of fiscal year ending May 2, 2003. This is a
forward-looking statement. See Risk Factors That Might Affect Our Business Or Stock Price below.





Consultant and project expenses, which
include consultant costs, direct and reimbursable project expenses, total $5.6 million, or 32 % of revenues, for the three month period ended November 1, 2002 as compared to $6.0 million, or 42% of revenues, for the three month period ended November
2, 2001. Consultants are used at the request of a project owner for certain technical expertise not available at the Company. This decrease is primarily due to a decreased need for consultants on certain client projects.





Direct labor cost was $4.0 million, or 33% of net production income, for the three month period ended November 1, 2002 as compared to $3.0 million, or 37% of net
production income, for the three month period ended November 2, 2001. This decrease as a percentage of net production income is due to the Companys focus (initiated in the second quarter of fiscal 2002) on improving the effectiveness and
efficiency of each project and ultimately decreasing direct labor cost as a percentage of net production income. This decrease is partially offset by a continued reduction in certain higher margin projects and, to a lesser extent, an increase in
salary and salary related costs that have not been passed through to the Managed Firms clients in all cases.





Operating costs were
$7.0 million, or 59% of net production income, for the three month period ended November 1, 2002 as compared to $5.8 million, or 70% of net production income, for the three month period ended November 2, 2001. The percentage of net production income
was favorably impacted by a decrease in indirect labor and related fringe benefits and depreciation and equipment rental expense, which was partially offset by an increase in rent and occupancy expenses.





Amortization of intangible assets was $14,584 for the three months ended November 1, 2002 as compared to $14,585 for the three months ended November 2, 2001.
Effective April 28, 2001, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 142, all goodwill amortization ceased effective April 28, 2001.





Interest expense was $0.3 million for the three month period ended November 1, 2002 as compared to $0.3 million for the three month period ended November 2, 2001. The small increase of $14,272 was
principally due to increased debt resulting from the acquisition of HLML, which is partially offset by (i) a decrease in the Companys effective interest rate in the current year and (ii) a decrease in the level of borrowings under the
Companys revolving credit facility with Whitehall Business Credit Corporation (formerly IBJ Whitehall Business Credit Corporation)(WBCC).




17




---

##### Table of Contents




ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND


RESULTS OF OPERATIONScontinued





Income tax expense (benefit) was
$0.2 million for the three month period ended November 1, 2002 as compared to ($0.4) million benefit for the three month period ended November 2, 2001. The effective income tax rate was 37% and 42% for the three month periods ended November 1, 2002
and November 2, 2001, respectively. The effective rate is lower principally due to the fact that approximately 34% of current year income before income taxes and minority interest was provided by HLML, which was not acquired until the fourth quarter
of fiscal 2002. The effective tax rate for HLML is lower than that of the domestic operations. As such, this is causing an overall decrease in the effective income tax rate from the prior year, which is partially offset by an increase in
non-deductible expenses (primarily meals and entertainment).





For the six months ended November 1, 2002 and November 2, 2001





Revenues were $35.3 million for the six month period ended November 1, 2002 as compared to $29.9 million for the six month period
ended November 2, 2001. This 18% increase is due to additional revenues of $7.0 million resulting from the acquisition of HLML in February 2002. This increase in revenues is partially offset by a decline in the volume of architecture, planning and
engineering services principally attributable to certain clients delaying project start dates. Management believes that these delays in start dates will continue through the remainder of fiscal year ending May 2, 2003. This is a forward-looking
statement. See Risk Factors That Might Affect Our Business Or Stock Price below.





Consultant and project expenses, which include
consultant costs, direct and reimbursable project expenses, total $11.4 million, or 32% of revenues, for the six month period ended November 1, 2002 as compared to $11.5 million, or 39% of revenues, for the six month period ended November 2, 2001.
Consultants are used at the request of a project owner for certain technical expertise not available at the Company. This decrease is due to a decreased need for consultants on certain client projects.





Direct labor cost was $7.7 million, or 32% of net production income, for the six month period ended November 1, 2002 as compared to $6.5 million, or 36% of net
production income, for the six month period ended November 2, 2001. This decrease as a percentage of net production income is due to the Companys focus (initiated in the second quarter of fiscal 2002) on improving the effectiveness and
efficiency of each project and ultimately decreasing direct labor cost as a percentage of net production income. This decrease is partially offset by a continued reduction in certain higher margin projects and, to a lesser extent, an increase in
salary and salary related costs that have not been passed through to the Managed Firms clients in all cases.





Operating costs were
$14.3 million, or 60% of net production income, for the six month period ended November 1, 2002 as compared to $12.0 million, or 65% of net production income, for the six month period ended November 2, 2001. The percentage of net production income
was favorably impacted by a decrease in indirect labor and related fringe benefits and office supplies, which was offset by an increase in rent and occupancy expenses.





Amortization of intangible assets was $29,167 for the six months ended November 1, 2002 as compared to $29,168 for the six months ended November 2, 2001. Effective April 28, 2001, the Company adopted
SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 142, all goodwill amortization ceased effective April 28, 2001.




18




---

##### Table of Contents




ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND


RESULTS OF OPERATIONScontinued





Interest expense was $0.8 million
for the six month period ended November 1, 2002 as compared to $0.7 million for the six month period ended November 2, 2001. This increase is principally due to increased debt resulting from the acquisition of HLML, which is partially offset by (i)
a decrease in the Companys effective interest rate in the current year and (ii) a decrease in the level of borrowings under the Companys revolving credit facility with WBCC.





Income tax expense (benefit) was $0.4 million for the six month period ended November 1, 2002 as compared to ($0.4) million benefit for the six month period ended November 2, 2001. The
effective income tax rate was 36% and 41% for the six month periods ended November 1, 2002 and November 2, 2001, respectively. The effective rate is lower principally due to the fact that approximately 43% of current year income before income taxes
and minority interest was provided by HLML, which was not acquired until the fourth quarter of fiscal 2002. The effective tax rate for HLML is lower than that of the domestic operations. As such, this is causing an overall decrease in the effective
income tax rate from the prior year, which is partially offset by an increase in non-deductible expenses (primarily meals and entertainment).





LIQUIDITY AND CAPITAL RESOURCES





Historically, the Company has met working capital and capital expenditure needs
through cash from operations and bank financing. At November 1, 2002, the Companys current assets of $23.5 million exceeded current liabilities of $22.5 million, resulting in working capital of $1.0 million. The increase in working capital is
primarily related to the reclassification of the WBCC revolving credit facility to long term debt due to the extension of the WBCC Loan maturity date from February 2003 to December 2005. See discussion in Note 4 above regarding the loan modification
(fifth amendment to the WBCC Loans). The Company has sold and is continuing to sell shares of its 6.5% Series A Cumulative Convertible Preferred Stock (Preferred Stock) as discussed below.





During the six month period ended November 1, 2002, the Companys operating activities provided $0.7 million in cash from operations before net working
capital changes which used $16,122. The Company used $0.7 million primarily for capital expenditures. The Company provided net cash of $0.1 million from financing activities, primarily proceeds from issuance of its Preferred Stock and borrowings
under the Companys revolving credit facility with WBCC, which was partially offset by certain payments on long-term borrowings.





The Company expects to continue expanding its operations through internal growth, issuing equity securities and strategic acquisitions. In August 2002, the Board of Directors approved the sale of 200,000 shares at $15.00 per share of
its Preferred Stock to be issued during fiscal 2003 in order to obtain additional funds for operating needs and repayment of certain debt obligations. During the six months ended November 1, 2002, the Company sold 61,000 shares of its Preferred
Stock. The Company sold an additional 11,000 shares of its Preferred Stock in November 2002 at $15.00 per share. The Company believes with the favorable modifications to its WBCC Loans, favorable payment modifications to its notes payable to former
BL&P shareholder, proceeds received from the sale of its equity securities and anticipated funds from future operations, it has sufficient liquidity to meet its operating needs over the next twelve months. This is a forward-looking statement.
However, if the Company is unable to obtain additional capital, its acquisition strategy and operations will be adversely affected.




19




---

##### Table of Contents




ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND


RESULTS OF OPERATIONScontinued





Due to the current shortage in
working capital, the Company has had to delay certain non-material capital expenditures and negotiate extended payment terms with certain consultants and vendors. In addition, the Company has negotiated amendments to the WBCC revolving credit
facility and term loan to address the shortage in working capital.





A description of the Whitehall Business Credit Corporation
(WBCC) (Formerly IBJ Whitehall Business Credit Corporation) loan arrangement follows:





At November 1, 2002, the Company had
$6,435,816 outstanding, bearing interest at 5.25%, under the revolving credit facility with $134,460 available on this revolving credit arrangement based on the calculated aging of certain domestic assets reported as of October 11, 2002. At November
1, 2002, the Company had $231,111 outstanding under a term loan bearing interest at 6.75 %.





Substantially all domestic assets are
pledged under the Companys revolving credit and term loan (collectively WBCC Loans). See Note 4 above for detailed information as to the WBCC Loans and amendments thereto. The WBCC Loans are critical to the Companys ability
to meet its current and future working capital needs.





The Company and WBCC entered into a fifth amendment to the WBCC Loans on December
11, 2002. The amendment extends the maturity date of the WBCC Loans from February 7, 2003, to December 11, 2005. The fifth amendment favorably modifies the calculation used to determine the amount of money available to borrow by lessening the
reserve attached to eligible receivables where the Company has billings in excess of costs incurred. Calculated as of November 1, 2002, the effect of this modification would be to increase the amount available to borrow by approximately $950,000.
This number will vary based upon monthly fluctuations in the Companys eligible receivables. However, the modification will consistently provide the Company with more funds for working capital than would have been available prior to the fifth
amendment.





The fifth amendment decreases the limit on capital expenditures from $1 million to $750,000. Management believes that the new
level is sufficient to meet the Companys current capital expenditure needs. As such, Management does not believe that the lower limit on capital expenditures will negatively impact the Companys current operations.





In addition to extending the term of the WBCC Loans, the fifth amendment WBCC provides for increasing the amount available for the Company to borrow
under the term loan by an amount equal to the equity contributions in excess of $700,000 received by the Company through the sale of the Preferred Stock between May 3, 2002 and February 28, 2003, up to a maximum amount of $1,000,000. The increase in
the term loan credit is based on the Companys sale of its 6.5% Series A Cumulative Convertible Preferred Stock (Preferred Stock) between May 3, 2002 and February 28, 2003.





Based upon the Companys sale of Preferred Stock prior to the fifth amendment effective date, the term loan credit available for the Companys use as of November 1, 2002 is
$215,000. These funds increase the working capital available to the Company for use in maintaining existing operations. As discussed in Note 5, the Company modified and obtained waivers on certain covenants contained in its Whitehall Business Credit
Corporation and Bank of Scotland debt agreements. The modified agreements contain financial requirements which, if not achieved, will cause the Company to be in default of the debt agreement(s) and the lender(s) could call for the payment of all
outstanding indebtedness. The Companys ability to comply with these covenants depends on its achieving financial projections and/or successfully completing the sale of the Companys 6.5% Series A Cumulative Convertible Preferred Stock by
January 31, 2003. Although management believes that the Company will be able to meet the debt covenants, there is a possibility that such covenants will not be met. In the event that the Company does not meet the covenants and the Lender(s) exercise
their right to accelerate the debts maturity, the Company would not have the ability to pay the lender and the Company would have to either renegotiate the debt or enter into a new arrangement to sustain its current operations.




20




---

##### Table of Contents




ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND


RESULTS OF OPERATIONScontinued





Bank of Scotland
(BOS)see description in footnotes





The BOS loan, which matures in January 2007, is denominated in British Pounds and
bears interest at LIBOR plus 2%. At November 1, 2002, the BOS loan had a balance of 2,000,000 Pounds ($3,129,800) bearing interest at 6.1%. Substantially all assets of GAIH and HLML (collectively, consolidated GAIH) are pledged as
collateral under this financing arrangement. See Note 4 above for detailed information as to the BOS Loan and the amendments thereto.





Note Payable to Former JPJ and BL&P Shareholders see description in footnotes





JPJAt November 1, 2002,
$528,312 (plus accrued interest) was payable to the former JPJ shareholders. See Note 4 above for detailed information as to the JPJ notes. Management believes it will be able to make the scheduled payments on these notes or obtain modifications on
terms acceptable to the Company. This is a forward-looking statement. See Risk Factors That Might Affect Our Business or Stock Price below.





BL&PAt November 1, 2002, $1,619,186 (plus accrued interest) was payable to the former BL&P shareholder. See Note 4 above for detailed information as to the BL&P notes. Management believes it will be able to make the
scheduled payments on these notes or obtain modifications on terms acceptable to the Company. This is a forward-looking statement. See Risk Factors That Might Affect Our Business or Stock Price below.





RISK FACTORS THAT MIGHT AFFECT OUR BUSINESS OR STOCK PRICE





Actual results may differ from the forward-looking statements above due to the following risk factors.





Uncertainties Concerning Additional Financings





The Companys operating and growth strategies require substantial
capital resources, particularly since the Company, as the management company, is responsible for the financing of working capital growth, capital growth and other cash needs of the Managed Firms. These requirements will result in the Company
incurring long-term and short-term indebtedness and may result in the public or private issuance, from time to time, of additional debt or equity securities, including the issuance of such securities in connection with the execution of Management
and Services Agreements.





Management is continually reviewing its results of operations and forecasted business plan to determine whether
additional modifications to the financial covenants in its loan agreements may be required. In December 2002, the Company and WBCC entered into the fifth amendment to its WBCC Loans which extended the WBCC Loans maturity date to December 9, 2005. As
a result, the WBCC revolving credit facility is classified as long term debt in the Companys consolidated balance sheet.




21




---

##### Table of Contents

ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND


RESULTS OF OPERATIONScontinued





As discussed in Note 5, the Company modified and obtained waivers on certain
covenants contained in its Whitehall Business Credit Corporation and Bank of Scotland debt agreements. The modified agreements contain financial requirements which, if not achieved, will cause the Company to be in default of the debt agreement(s)
and the lender(s) could call for the payment of all outstanding indebtedness. The Companys ability to comply with these covenants depends on its achieving financial projections and/or successfully completing the sale of the Companys 6.5%
Series A Cumulative Convertible Preferred Stock by January 31, 2003. Although management believes that the Company will be able to meet the debt covenants, there is a possibility that such covenants will not be met. In the event that the Company
does not meet the covenants and the Lender(s) exercise their right to accelerate the debts maturity, the Company would not have the ability to pay the lender and the Company would have to either renegotiate the debt or enter into a new arrangement
to sustain its current operations.





Innovative Strategy





The Companys operating and growth strategies are predicated upon its ability to contract with architectural, engineering and planning firms (AEP
Firms) and to generate profits from those firms. The process of identifying suitable AEP Firm candidates for entering into Management and Services Agreements and proposing, negotiating and implementing economically feasible affiliations with
AEP Firms is lengthy and complex. Such strategies require intense management direction in a dynamic marketplace that is increasingly subject to cost containment and other competitive pressures. There can be no assurance that these strategies will be
successful or that modifications to the Companys strategies will not be required.





Management and Services Agreements with a Limited Number of Firms





The Companys revenues are derived solely from
its contractual relationships with the Managed Firms (for whom the Company is will provide required financing). Currently, the Company has Management and Services Agreements with five subsidiaries (JPJ, GAIH, BL&P, USA and HLML) and two other
firms. These other firms are related to each other and to the Company by two common principal stockholders, Joseph M. Harris and Vernon B. Brannon. There can be no assurance that the Company will be able to successfully enter into Management and
Services Agreements with additional AEP firms.





Uncertainties Concerning Ability to Receive
Payments from Managed Firms





For services provided to the Managed Firms, the Company earns 99% of the net income of the Managed Firms, as
determined in accordance with generally accepted accounting principles. However, for cash management purposes, the Company is to receive 99% of the positive cash flows of the Managed Firms (calculated for any period as the change in the cash
balances from the beginning of the period to the end of the period). The Companys ability actually to receive payments in respect thereof during any particular period will be subject to the cash requirements of the Managed Firms. To the extent
the cash requirements of the Managed Firms continue to exceed 1% of positive cash flows, the Company will be unable to receive payments against such receivables, and such payments will be delayed. The Companys ability to finance existing
operations and to pay dividends on the Common Stock will be adversely affected if the Company is unable to collect such receivables.





Dependence on Key Personnel and Limited Management and Personnel Resources





The
Companys success depends to a significant degree upon the continued contributions of its senior management team and professional personnel. The loss of the services of one or more of these key employees could have a material adverse effect on
the Company. The Company carries key employee life insurance on Joseph M. Harris and Vernon B. Brannon and has employment and/or noncompete agreements with Joseph M. Harris and Brannon as well as with several (although not all) of its senior
professional staff. There can be no assurance, however, that a court would enforce the noncompete agreements as currently in




22




---

##### Table of Contents

ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND


RESULTS OF OPERATIONScontinued





effect. If courts refuse to enforce the noncompete agreements of the Company
or the Managed Firms, such refusals could have a material adverse effect on the Company. In addition, as the Company expands it will likely be dependent on the senior professional staff of any firm with which the Company enters into a Management and
Services Agreement. In addition, the lack of qualified professional staff or employees or the Companys potential candidates for Management and Services Agreements may limit the Companys ability to consummate future agreements.





Dependence on Managed Firms





The Companys revenues depend on fees and revenues generated by various AEP firms managed by the Company. Any material loss of revenue by such firms, whether as a result of the loss of
professionals or otherwise, could have a material adverse effect on the Company. The Company itself is not engaged in the practice of architecture, engineering or planning and, as a result, does not control (i) the practice of architecture,
engineering or planning by professionals or (ii) the compliance with certain regulatory requirements directly applicable to the Managed Firms.





Risks Inherent in Provision of Services





The Managed Firms and certain employees of the
Managed Firms are involved in the delivery of services to the public and, therefore, are exposed to the risk of professional liability claims. Claims of this nature, if successful, could result in substantial damage awards to the claimants that may
exceed the limits of any applicable insurance coverage. Insurance against losses related to claims of this type can be costly and varies widely from state to state. Although the Company is indemnified under its Management and Services Agreements for
claims against the Managed Firms and their employees, the Company maintains liability insurance for itself and negotiates liability insurance for the Managed Firms and the professionals employed by the Managed Firms. Successful malpractice claims
asserted against the Managed Firms, their employees or the Company could have an adverse effect on the Companys profitability.





Competition





The business of providing architectural, engineering and planning related
services is highly competitive. The Companys competition includes many other firms, such as large national firms and regional or small local firms. Several companies that have established operating histories and significantly greater resources
than the Company provide many of the services provided by the Managed Firms. In addition, there are other companies with substantial resources that may in the future decide to engage in activities similar to those in which the Company engages.





Limited Trading Volume of Company Common Stock





The Companys common stock has limited trading volume. Even a small volume of trading can have a significant impact on the price of the common stock. Until
a larger volume of trading is achieved, the share price of the common stock may not be a good indicator of the price that would be required to purchase a significant position in the Companys common stock.




23




---

##### Table of Contents

ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND


RESULTS OF OPERATIONScontinued





CRITICAL ACCOUNTING POLICIES AND ESTIMATES





The preparation of financial statements in conformity with accounting principles generally accepted in United States requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. The most significant estimates impacting the condensed consolidated financial statements relate to revenue recognition under the percentage of completion method and the allowance for doubtful accounts.





The majority of the Companys revenues are recorded from fixed fee contracts on a percentage of completion basis based on
assumptions regarding estimated direct labor costs to complete. Each month actual labor costs incurred to date are accumulated on each project and estimated labor cost to complete is forecasted for each project. Actual labor costs incurred to date
and estimated labor costs to complete are added together to determine projected final labor cost. The percentage complete is determined by dividing the actual labor cost incurred to date by the projected final labor cost. This percentage complete is
multiplied by the contract value, net of direct costs, which may include direct subconsultants, travel, printing, etc. to determine the amounts of revenue that can be recognized. Provisions for estimated losses on uncompleted projects are made in
the period in which such losses are first subject to reasonable estimation. Historically, the majority of the Companys estimates to complete have been materially correct, but these estimates might not continue to be accurate.





The asset costs and estimated earnings in excess of billings on uncompleted projects represents revenues recognized in excess of amounts
billed. The liability billings in excess of costs and estimated earnings on uncompleted projects represents billings in excess of revenues recognized.





Included in accounts receivable on the consolidated balance sheets are reserves for doubtful accounts. Generally, before the Company does business with a new client, the Company reviews its
creditworthiness. Senior management reviews the accounts receivable on a monthly basis to determine if any receivables are potentially uncollectible. Based on the information available, the Company believes the reserve for doubtful accounts as of
November 1, 2002 is adequate.





Effective April 28, 2001, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets,
(SFAS No. 142), which establishes new accounting and reporting requirements for goodwill and other intangible assets. Under SFAS No. 142, all goodwill amortization ceased effective April 28, 2001. The Company identified reporting units
based on the current reporting structure, assigned all goodwill to the reporting units as well as other assets and liabilities, to the extent that they related to the reporting unit. As required by SFAS No. 142, subsequent impairment losses, if any
would be classified as an indirect expense on the Companys consolidated statements of income. The Company completed the first step of the transitional goodwill impairment test by comparing the fair value of each reporting unit to its carrying
value and determined that no impairment existed at the effective date of the implementation of the new standard. The Company also completed its annual goodwill impairment test as of May 3, 2002 and determined that no impairment existed as of that
date. Fair value of each reporting unit was measured using a valuation by an independent third party as of April 28, 2001 and May 3, 2002, which were based on the market multiples, comparable transactions and discounted cash flow methodologies.




24




---

##### Table of Contents

ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND


RESULTS OF OPERATIONScontinued





These valuations indicated an aggregate fair value of the reporting units
significantly in excess of the Companys market capitalization as of April 28, 2001 and May 3, 2002. The Company believes the market capitalization is not representative of the fair value of the Company because the Common Stock of the Company
is not actively traded.





Annually, the Company will obtain an independent valuation and perform a goodwill impairment test. At least
quarterly, management will evaluate to determine if an event has occurred that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company, if appropriate, will perform a goodwill impairment test
between the annual dates. Impairment adjustments recognized after adoption, if any, will be recognized as an operating expense.





Impairment indicators which may be considered include, but are not limited to, the following:





| |  | A significant adverse change in legal factors or in the business climate
|- |  | ------------------------------------------------------------------------

| |  | Unanticipated competition
|- |  | -------------------------

| |  | A significant decline in the operating performance
|- |  | --------------------------------------------------

| |  | Adverse action or assessment by a regulator
|- |  | -------------------------------------------




In the normal course of business, the Company is party to various claims and legal proceedings. The Company records a reserve for these matters when an adverse outcome is probable and the amount of the potential liability is
reasonable estimable. Although the ultimate outcome of these matters is currently not determinable, the Company does not believe that the resolution of these matters will have a material effect upon the financial condition, results of operations or
cash flows for an interim or annual period.





ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





The Company is exposed to market risk from
changes in interest rates affecting our credit arrangements, including a variable rate revolving credit arrangement and term loan agreement, which may adversely affect our results of operations and cash flows. The Company seeks to minimize interest
rate risk through our day-to-day operating and financing activities. The Company does not engage in speculative or derivative financial or trading activities.





A hypothetical 100 basis point adverse change (increase) in interest rates relating to the WBCC Loans and BOS Loan would have decreased pre-tax income for the six months ended November 1, 2002 by approximately $40,000.





Through the operations of GAIH and HLML, the Company is exposed to foreign currency exchange rate fluctuations primarily between United
States Dollar (USD) and Great Britain Pound (GBP) resulting from translation. Foreign exchange rates have limited impact on earnings and net assets of the Company since the majority of GAIH and HLML sales and assets and
liabilities are denominated in GBP. A 10% deviation (decrease) in conversion of GBP to USD would have decreased the Companys pretax income by approximately $50,000 and net assets by approximately $350,000.





The Company has no other material exposure to market risk sensitive instruments.




25




---

##### Table of Contents




ITEM 4. CONTROLS AND PROCEDURES





Based on their most recent evaluation, which was completed within 90 days of
the filing of this Form 10-Q, the Companys Chief Executive Officer and Chief Financial Officer believe the Companys disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) are effective. There were no
significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.




26




---

##### Table of Contents




PART II. OTHER INFORMATION





Item 2.    Changes in Securities and Use of Proceeds





The Companys Revolving Credit,
Term Loan, Capital Expenditure Loan, Guaranty and Security Agreement as amended, provides that the Company may not pay cash dividends on its common stock.





In August and September 2002, the Company issued an aggregate of 61,000 shares of Preferred Stock to 4 accredited investors in a private placement exempt under Section 4(2) of the Securities Act of 1933 and Rule 506 there
under for gross proceeds of $915,000. A sales agent for the Company was paid commissions of $54,900. The Company is using the proceeds for general corporate purposes. Shares of Preferred Stock are convertible at the option of the holder into shares
of Common Stock at a conversion ratio that is initially 3 to 1, based on an initial conversion price of $5. The shares of Preferred Stock must be converted into Common Stock on the initial ratio of 3 to 1 if the trading price of the Common Stock
exceeds $6.50 for twenty consecutive trading days. The original conversion price is subject to adjustment in the event of stock dividends, subdivisions or splits, company combinations or reclassifications, reorganizations, consolidations or mergers.





Item 4.    Submission of Matters to a Vote of Security Holders





The Company held its
Annual Meeting of Stockholders on September 18, 2002 for the purposes of electing two directors, approving an amendment to the 1998 Stock Option Plan, and approving an amendment to the Employee Stock Purchase Plan. Proxies were solicited pursuant to
Regulation 14A of the Securities Exchange Act of 1934 and there was no solicitation in opposition to managements solicitations.





Proposal 1:





Election of directors for term indicated:





Name

Year of Annual Meeting of Stockholders that Term
Expires

Shares Voted For

Shares WithheldJoseph M. Harris

2005

1,808,594

248,951Vernon B. Brannon

2005

1,808,594

248,951





The following directors terms of office continued after the meeting: Shannon LeRoy, L.
Fred Pounds, V. Reitzel Snider, Marvin E. Brown, and Jerry D. Craft.





Proposal 2:





Amendment of the HLM Design, Inc. Employee Stock Purchase Plan was approved with the following vote:





Shares Voted For

Shares Voted Against

Shares Abstaining

Broker Non-Votes1,732,924

322,711

1,910

0




27




---

##### Table of Contents




PART II.    OTHER INFORMATIONCONTINUED





Item 4.    Submission of Matters to a Vote of Security Holderscontinued





Proposal 3:





Ratification of selection of the firm of Deloitte & Touche
LLP as the independent public accountants for fiscal year ending May 2, 2003:





Shares Voted For

Shares Voted Against

Shares Abstaining1,898,377

157,309

1,859





Item 6.    Exhibits and Reports on Form 8-K





| | (a) |  | The exhibits filed as part of this Form 10-Q are:
| | --- |  | -------------------------------------------------







Exhibit No. Description10.29.4

Fourth Amendment dated as of September 10, 2002 to Revolving Credit, Term Loan, Capital Expenditure Loan, Guaranty and Security Agreement (filed with Form
10-Q dated August 2, 2002).10.29.5

Fifth Amendment dated as of December 11, 2002 to Revolving Credit, Term Loan, Capital Expenditure Loan, Guaranty and Security Agreement.10.35.1

Letter from Bank of Scotland dated September 18, 2002 regarding Term Loan dated February 15, 2002 between G.A. Design International (Holdings) Limited and
Bank of Scotland (filed with Form 10-Q dated August 2, 2002).10.35.2

Letter from Bank of Scotland dated December 13, 2002 regarding Term Loan between G.A. Design International (Holdings) Limited and Bank of
Scotland.99.1

Certifications of Principal Executive Officer and Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act.





| | (b) |  | Reports on Form 8-K
| | --- |  | -------------------




None.




28




---

##### Table of Contents




Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.





HLM DESIGN, INC. (Registrant)


Date:

December 16, 2002



By:

/s/    JOSEPH M. HARRISJoseph M. Harris President,
Chairman and Director





Date:

December 16, 2002



By:

/s/    VERNON B. BRANNONVernon B. Brannon Senior Vice
President, Chief Operating Officer and Chief Financial Officer




29




---

##### Table of Contents

Certification of Chief Executive Officer


Pursuant to Section 302


of the Sarbanes-Oxley Act of 2002





I, Joseph M. Harris, certify that:





1. I have reviewed this quarterly report on Form 10-Q of HLM Design, Inc.
and Subsidiaries and Affiliates (the issuer or registrant);





2. Based on my knowledge,
this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect
to the period covered by this quarterly report; and





3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of issuer, as of, and for, the periods presented in this quarterly report.





4. The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:





a) Designed
such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this
quarterly report is being prepared;





b) Evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and





c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;





5. The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent function):





a) all significant
deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material
weaknesses in internal controls; and





b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls.





6. The registrants other
certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.





Date:        December 16, 2002



/S/ JOSEPH M. HARRISJoseph M. Harris President & Chief
Executive Officer










30




---

##### Table of Contents

Certification of Chief Financial Officer


Pursuant to Section 302


of the Sarbanes-Oxley Act of 2002





I, Vernon B. Brannon, certify that:





1. I have reviewed this quarterly report on Form 10-Q of HLM Design, Inc.
and Subsidiaries and Affiliates (the issuer or registrant);





2. Based on my knowledge,
this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect
to the period covered by this quarterly report; and





3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of issuer, as of, and for, the periods presented in this quarterly report.





4. The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:





a) Designed
such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this
quarterly report is being prepared;





b) Evaluated the effectiveness of the registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and





c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;





5. The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee
of registrants board of directors (or persons performing the equivalent function):





a) all significant
deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material
weaknesses in internal controls; and





b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls.





6. The registrants other
certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.





Date:        December 16, 2002



/S/ VERNON B. BRANNONVernon B. Brannon Senior Vice President, Chief Operating Officer and Chief Financial Officer




31