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 September 30, 2002
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File Number: 0-15938
Farmstead Telephone Group, Inc.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-1205743
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
22 Prestige Park Circle
East Hartford, CT 06108
(Address of principal executive offices) (Zip Code)
(860) 610-6000
(Registrant's telephone number, including area code)
-----------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities
Exchange Act of 1934 during the proceeding 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]
As of October 31, 2002, the registrant had 3,298,958 shares of its
$0.001 par value Common Stock outstanding.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
(In thousands) 2002 2001
------------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 936 $ 1,479
Accounts receivable, less allowance for doubtful accounts 2,627 3,133
Inventories 3,044 4,427
Deferred taxes and other current assets 208 189
------------------------
Total Current Assets 6,815 9,228
------------------------
Property and equipment, net 404 505
Deferred income taxes 364 364
Goodwill (Notes 4 and 5) 101 -
Other assets 232 245
------------------------
Total Assets $ 7,916 $10,342
========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,767 $ 2,794
Debt maturing within one year (Note 2) 238 37
Accrued expenses and other current liabilities (Note 3) 275 567
------------------------
Total Current Liabilities 2,280 3,398
------------------------
Other liabilities 326 260
------------------------
Total Liabilities 2,606 3,658
------------------------
Minority Interest in Subsidiary (Note 5) - 153
Stockholders' Equity:
Preferred stock, $0.001 par value; 2,000,000 shares authorized;
no shares issued and outstanding - -
Common stock, $0.001 par value; 30,000,000 shares authorized;
3,298,958 and 3,272,579 shares issued and outstanding at
September 30, 2002 and December 31, 2001, respectively 3 3
Additional paid-in capital 12,309 12,285
Accumulated deficit (7,002) (5,757)
------------------------
Total Stockholders' Equity 5,310 6,531
------------------------
Total Liabilities and Stockholders' Equity $ 7,916 $10,342
========================
See accompanying notes to consolidated financial statements.
2
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three For the Nine
Months Ended Months Ended
September 30, September 30,
----------------- -------------------
(In thousands, except loss per share amounts) 2002 2001 2002 2001
---- ---- ---- ----
Revenues $4,766 $8,762 $15,557 $26,072
Cost of revenues 3,701 6,773 12,431 20,327
-----------------------------------------
Gross profit 1,065 1,989 3,126 5,745
Selling, general and administrative expenses 1,352 1,770 4,429 6,221
-----------------------------------------
Operating income (loss) (287) 219 (1,303) (476)
Interest expense (2) (41) (24) (124)
Other income 4 9 94 31
-----------------------------------------
Income (loss) before income taxes and minority interest
in income of subsidiary (285) 187 (1,233) (569)
Provision (benefit) for income taxes (1) 9 12 31
-----------------------------------------
Income (loss) before minority interest in income of
subsidiary (284) 178 (1,245) (600)
Minority interest in income of subsidiary - 168 - 369
-----------------------------------------
Net income (loss) $ (284) $ 10 $(1,245) $ (969)
=========================================
Basic and diluted net loss per common share: $ (.09) $ - $ (.38) $ (.30)
Weighted average common shares outstanding:
Basic 3,290 3,273 3,285 3,273
Diluted 3,290 3,273 3,286 3,285
=========================================
See accompanying notes to consolidated financial statements.
3
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended September 30, 2002 and 2001
(In thousands) 2002 2001
-------- --------
Cash flows from operating activities:
Net loss $(1,245) $ (969)
Adjustments to reconcile net loss to net cash flows
(used in) provided by operating activities:
Depreciation and amortization 161 194
Minority interest in income of subsidiary - 369
Value of compensatory stock options issued 11 26
Changes in operating assets and liabilities:
Decrease in accounts receivable 506 1,959
Decrease in inventories 1,383 1,123
(Increase) decrease in other assets (7) 15
Decrease in accounts payable (1,027) (687)
Decrease in accrued expenses
and other current liabilities (292) (911)
Increase in other liabilities 66 59
--------------------
Net cash (used in) provided by operating activities (444) 1,178
--------------------
Cash flows from investing activities:
Purchases of property and equipment (60) (92)
Acquisition of InfiNet (153) -
--------------------
Net cash used in investing activities (213) (92)
--------------------
Cash flows from financing activities:
Borrowings under revolving credit line 238 937
Repayments of capital lease obligation (37) (77)
Issuance of common stock 13 -
Capital (distribution to) contribution from minority
interest partner (100) 25
--------------------
Net cash provided by financing activities 114 885
--------------------
Net (decrease) increase in cash and cash equivalents (543) 1,971
Cash and cash equivalents at beginning of period 1,479 374
--------------------
Cash and cash equivalents at end of period $ 936 $ 2,345
====================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 23 $ 125
Income taxes 17 94
See accompanying notes to consolidated financial statements.
4
FARMSTEAD TELEPHONE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. Basis of Presentation
The consolidated financial statements presented herein consist of the
accounts of Farmstead Telephone Group, Inc. and its wholly-owned
subsidiaries, FTG Venture Corporation (inactive) and InfiNet Systems, LLC
(which became wholly-owned effective January 1, 2002; prior thereto the
Company owned a 50.1% interest. See Note 5). The interim consolidated
financial statements and notes presented herein are unaudited, however in
the opinion of management these statements reflect all adjustments,
consisting of adjustments that are of a normal recurring nature, which are
necessary for a fair statement of results for the interim periods
presented. The results of operations for the interim periods are not
necessarily indicative of the results for the entire fiscal year. This Form
10-Q should be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Annual Report on
Form 10-K for the year ended December 31, 2001.
Note 2. Debt Maturing Within One Year
Debt obligations maturing within one year consisted of the following
(in thousands):
September 30, December 31,
2002 2001
------------- ------------
Revolving credit agreement $238 $ -
Obligation under capital lease - 37
---------------------
Debt maturing within one year $238 $37
=====================
Revolving credit agreement
--------------------------
Outstanding borrowings under the Company's revolving credit facility
with Wachovia Bank, National Association (f/k/a First Union National Bank)
("Wachovia") were $238,000 and $0 at September 30, 2002 and December 31,
2001, respectively. As of September 30, 2002, the unused portion of the
revolving credit facility was $262,000, all of which was available under
existing borrowing formulas. The average and highest amounts borrowed
during the three months ended September 30, 2002 were approximately $22,000
and $238,000, respectively. The average and highest amounts borrowed during
the nine months ended September 30, 2002 were approximately $612,000 and
$1,531,000, respectively.
In Form 10-Q for the quarterly period ended June 30, 2002, filed with
the Securities and Exchange Commission on August 14, 2002, the Company
disclosed that it was not in compliance with the minimum tangible net worth
covenant required under its revolving credit facility with Wachovia. On
August 30, 2002, the Company was granted a covenant waiver by Wachovia
under the following conditions: (1) the $4 million line of credit was
reduced to a $1 million facility; (2) the borrowing rate was increased to
LIBOR plus 6% effective August 1, 2002; and (3) the minimum tangible net
worth covenant was revised from $5,500,000 to $5,150,000. In addition, the
Company agreed to pay a $5,000 fee, and reimburse the bank for legal fees
incurred in connection with documenting the waiver agreement.
On September 30, 2002, Wachovia and the Company agreed to an
extension of the credit facility until February 28, 2003, to allow the
Company time to procure external, replacement financing. As a condition of
the extension, the aggregate line of credit was reduced to $500,000, and
the minimum tangible net worth covenant was further revised from $5,150,000
to $4,750,000. In addition, the Company agreed to pay a $5,000 fee, and
reimburse the bank for legal fees incurred in connection with documenting
the extension agreement. Except for the tangible net worth covenant, there
are no other financial covenants during the extension period.
The Company is currently seeking a new commercial lender to provide a
replacement credit facility, and it is possible that it will not be
successful in obtaining a replacement credit facility until the Company
could demonstrate improved operating results. If the Company is unable to
obtain a replacement credit facility, it would be dependent upon currently
available cash and cash generated by operations to satisfy its working
capital requirements, which could adversely impact current operating levels
as well as future growth.
Obligation under capital lease
------------------------------
Debt maturing within one year at December 31, 2001 consisted of
remaining payments of $37,556 under a capital lease obligation, which was
fully repaid during 2002.
5
Note 3. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consisted of the
following (in thousands):
September 30, December 31,
2002 2001
------------- ------------
Salaries, commissions and benefits $226 $420
License fees 33 42
Other 16 105
----------------------
Accrued expenses and other current liabilities $275 $567
======================
Note 4. Recently Adopted Accounting Pronouncements
On January 1, 2002, the Company adopted Statement of Financial
Accounting Standards ("SFAS") Nos. 141 and 142, "Business Combinations" and
"Goodwill and Other Intangible Assets", respectively. SFAS 141 requires
all business combinations initiated after June 30, 2001 to be accounted for
using the purchase method. Under the provisions of SFAS 142, goodwill
recorded as a part of a business combination is no longer amortized, but
instead will be subject to at least an annual assessment for impairment by
applying a fair-value-based test. Also, SFAS 142 requires that in future
business combinations, all acquired intangible assets should be separately
stated on the balance sheet if the benefit of the intangible asset can be
sold, transferred, licensed, rented, or exchanged, regardless of the
acquirer's intent to do so. These intangible assets would then be
amortized over their useful lives, resulting in amortization expense. The
Company has applied the provisions of these new accounting pronouncements
in its accounting for the acquisition of its minority partner's ownership
interest in InfiNet, as discussed in Note 5.
Note 5. Acquisition of InfiNet
In February 2002, the Company acquired, effective January 1, 2002,
TriNET Business Trust's ("TriNET") 49.9% ownership interest in InfiNet for
an aggregate cash purchase price of $153,334. Prior to the acquisition,
the Company had a 50.1% ownership interest in InfiNet. In December 2001,
TriNET notified the Company that it wanted to terminate its participation
in InfiNet. Although contractually not obligated to do so, the Company
offered to buy TriNET's share interest, and negotiated a purchase price
equal to one times TriNET's share of InfiNet's earnings for the ten months
ended December 31, 2001 plus $25,000. The Company acquired TriNET's
interest for several reasons including its trained workforce in systems
design and sales and the opportunity to further leverage InfiNet's customer
contacts with Farmstead's existing and future product offerings. The
acquisition has been accounted for as a purchase, under SFAS 141 as
described in Note 4. The $100,512 excess of the purchase price over the
fair value of the net assets acquired has been allocated to goodwill, in
accordance with SFAS 142 as described in Note 4, and will be subject to an
annual assessment for impairment.
The following pro forma information presents the Company's
consolidated results of operations for the three and nine months ended
September 30, 2001 as if the acquisition had been completed as of the
beginning of those periods. The results of operations for the three and
nine months ended September 30, 2002 include the effects of the acquisition
from January 1, 2002.
Three months ended Nine months ended
September 30, 2001 September 30, 2001
------------------------- -------------------------
(In thousands, except per share data) As Reported Pro forma As Reported Pro forma
----------- --------- ----------- ---------
Revenues $8,762 $8,762 $26,072 $26,072
Income (loss) before minority interest
in income of subsidiary 178 178 (600) (600)
Minority interest in income of
subsidiary 168 - 369 -
Net income (loss) 10 178 (969) (600)
Earnings per share: basic $ - $ .05 $ (.30) $ (.18)
diluted $ - $ .05 $ (.30) $ (.18)
6
Note 6. Stock Options
On April 3, 2002, the Board of Directors adopted the Farmstead
Telephone Group, Inc. 2002 Stock Option Plan (the "2002 Plan"), which was
approved by stockholders at the June 13, 2002 Annual Meeting of
Stockholders. The 2002 Plan replaces the 1992 Stock Option Plan that
terminated in May 2002. The 2002 Plan permits the granting of options to
employees, directors and consultants of the Company, which shall be either
incentive stock options ("ISOs") as defined under Section 422 of the
Internal Revenue Code, or non-qualified stock options ("NSOs"). ISOs may
be granted at no less than market value at the time of grant, with a
maximum term of ten years except, for a 10% or more stockholder, the
exercise price shall not be less than 110% of market value, with a maximum
term of five years. NSOs may be granted at no less than 50% of market
value at the time of granting, with a maximum term of 10 years. Any option
granted pursuant to this Plan which for any reason fails to qualify as an
ISO shall be deemed to have been granted as an option not qualified under
Section 422 of the Code. The maximum number of shares issuable under the
2002 Plan, which expires April 3, 2012, are 1,300,000. As of September
30, 2002 there were 38,000 options outstanding under the 2002 Plan, and
1,939,306 options outstanding under the 1992 Stock Option Plan.
Note 7. Stockholders' Equity
On June 30, 2002, the following securities expired: all 1,137,923 of
the Class A Redeemable Common Stock Purchase warrants; all 1,137,923 of the
Class B Redeemable Common Stock Purchase warrants; all 183,579 of the
Warrants issued in connection with the Company's 1987 initial public
offering; all 33,136 of the Underwriter Options issued in connection with
the Company's 1987 initial public offering; all 89,948 Representative
Warrants issued in 1996 to the Company's underwriter in connection with a
secondary offering of securities.
During the nine months ended September 30, 2002, the Company issued
26,379 shares of Common Stock pursuant to the Company's 2001 Employee Stock
Purchase Plan. Proceeds from the issuance were $13,479.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The discussions set forth in this Form 10-Q report contain certain
statements, based on current expectations, estimates, forecasts and
projections about the industry in which the Company operates and
management's beliefs and assumptions, which are not historical facts and
are considered forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 ("the Act"). Forward-looking
statements include, without limitation, any statement that may predict,
forecast, indicate, or imply future results, performance, or achievements,
and may contain the words "believe," "will be," "will continue," "will
likely result," "anticipates," "seeks to," "estimates," "expects,"
"intends," "plans," "predicts," "projects," and similar words, expressions
or phrases of similar meaning. The Company's actual results could differ
materially from those projected in the forward-looking statements as a
result of certain risks, uncertainties and assumptions, which are difficult
to predict. Many of these risks and uncertainties are described under the
heading "Risk Factors" below. All forward-looking statements included in
this document are based upon information available to the Company on the
date hereof. The Company undertakes no obligation to update publicly any
forward-looking statements, whether as a result of new information, future
events or otherwise. In addition, other written or oral statements made or
incorporated by reference from time to time by the Company or its
representatives in this report, other reports, filings with the Securities
and Exchange Commission ("SEC"), press releases, conferences, or otherwise
may be forward-looking statements within the meaning of the Act.
Results of Operations
For the three months ended September 30, 2002, the Company reported a
net loss of $284,000 or $(.09) per share, on revenues of $4,766,000, as
compared to net income of $10,000 or less than one-half cent per share on
revenues of $8,762,000 for the comparable 2001 period. For the nine months
ended September 30, 2002, the Company reported a net loss of $1,245,000 or
$(.38) per share, on revenues of $15,557,000, as compared to a net loss of
$969,000 or $(.30) per share on revenues of $26,072,000 for the comparable
2001 period. The net loss for the three and nine month periods ended
September 30, 2002 include a credit of $126,000 resulting from a one-time
reduction in license fees payable to Avaya for the current year to date
period.
Management believes that these declines reflect the significant
reduction in demand for telecommunications products in the U.S. which
commenced during the first quarter of 2001 and which is continuing in 2002.
Since the second quarter of 2001, the Company has attempted to offset the
financial impact of a reduced revenue stream by reducing and more tightly
controlling operating costs and expenses, which included workforce
reductions and pay reductions during 2001. These
7
efforts have continued into 2002, including an additional workforce
reduction in June of 14%, and, effective July 1, 2002, 20% pay reductions
for the Company's executive officers and 33% fee reductions for its outside
directors. However, should there be a further deterioration in the market
conditions in the telecommunications equipment industry, the Company may
experience continued decreases in revenues and deterioration in operating
results. Additional information on major components of the Company's
operating performance for the three and nine months ended September 30,
2002 as compared to the comparable 2001 periods follows below.
Revenues
Three months Nine Months
ended Ended
September 30, September 30,
----------------- -------------------
(In thousands) 2002 2001 2002 2001
---- ---- ---- ----
End-user equipment sales $3,810 $7,046 $11,666 $20,917
Equipment sales to resellers 578 879 2,617 3,143
Services 378 837 1,274 2,012
-----------------------------------------
Consolidated revenues $4,766 $8,762 $15,557 $26,072
=========================================
End-User Sales
--------------
During the three months ended September 30, 2002, end-user equipment
sales revenues, consisting of parts sales and systems sales, decreased by
$3,236,000 or 46% from the comparable 2001 period. During the nine months
ended September 30, 2002, end-user equipment sales revenues decreased by
$9,251,000 or 44% from the comparable 2001 period. The Company has
experienced significant declines in both its parts and systems sales
business during these periods. The Company attributes these sales declines
principally to the deteriorated market conditions in the US economy in
general, and in the telecommunications industry more specifically, which
has resulted in reduced capital spending by the Company's customers. This
in turn has lead to increased competition and downward pressure on sales
prices, particularly in the aftermarket parts business. During 2002, the
Company has continued a strategy of developing a systems sales business,
which it started in 2001 with the formation of InfiNet Systems LLC, and the
appointment as a systems dealer by Avaya in January 2002. This strategy has
necessitated the hiring of sales, service and technical design personnel
experienced in systems and applications design and sales. As a result, the
Company has increased its focus on selling new systems and system upgrades.
Additionally, due to turnover, the Company's sales force is now more
experienced in selling systems, which has contributed to the reduction in
parts sales. Management remains committed to the continuing growth of its
systems business and is currently implementing strategies to increase its
parts business, which will include the development of on-line ordering
processes and other marketing approaches.
Equipment sales to resellers ("Wholesale sales")
------------------------------------------------
During the three months ended September 30, 2002, wholesale sales
revenues decreased by $301,000 or 34% from the comparable 2001 period.
During the nine months ended September 30, 2002, wholesale sales revenues
decreased by $526,000 or 17% from the comparable 2001 period. The
decreases are attributable to the market conditions described above,
resulting in reduced buying by equipment wholesalers.
Services
--------
During the three months ended September 30, 2002, service revenues
decreased by $459,000 or 55% from the comparable 2001 period. During the
nine months ended September 30, 2002, service revenues decreased by
$738,000 or 37% from the comparable 2001 period. For the three-month
period, the decrease resulted entirely from lower installation revenues.
For the nine-month period, the decrease was attributable to both lower
installation revenues and lower equipment rentals. Installation revenues
are directly related to the systems sales business, and the decrease in
installation revenues has been approximately proportional to the decrease
in systems sales and upgrade revenues.
Management remains cautious about the telecommunications product
marketplace going forward. The Company still expects that its future sales
revenues will improve in all of its current sales channels when capital
spending for telecommunication products improves, although no assurances
can be given as to the timing of when this will occur.
Cost of Revenues and Gross Profit
Total cost of revenues for the three months ended September 30, 2002
was $3,701,000, a decrease of $3,072,000 or 45% from the comparable 2001
period. The gross profit for the three months ended September 30, 2002 was
$1,065,000, a decrease of $924,000 or 46% from the comparable 2001 period.
As a percentage of revenue, the gross profit margin was 22% for 2002, as
compared to 23% for the comparable 2001 period. The gross profit margin
for the three months ended
8
September 30, 2002 benefited from a one-time, Avaya license fee reduction
in the amount of $126,000. Excluding the fee reduction, the gross profit
margin would have been 20% for this period.
Total cost of revenues for the nine months ended September 30, 2002
was $12,431,000, a decrease of $7,896,000 or 39% from the comparable 2001
period. The gross profit for the nine months ended September 30, 2002 was
$3,126,000, a decrease of $2,619,000 or 46% from the comparable 2001
period. As a percentage of revenue, the gross profit margin was 20% for
2002, as compared to 22% for the comparable 2001 period. The gross profit
margin for the nine months ended September 30, 2002 benefited from a one-
time, license fee reduction in the amount of $120,000 negotiated with
Avaya. Excluding the fee reduction, the gross profit margin would have
been 19% for this period.
The Company's gross profit margins are dependent upon a variety of
factors including (1) product mix - gross margins can vary significantly
among parts sales, system sales and the Company's various service
offerings. The parts business, for example, involves hundreds of parts
which generate significantly varying gross profit margins depending upon
their availability, competition, and demand conditions in the marketplace;
(2) customer mix - the Company sells parts to both end-users and to other
equipment resellers. In addition, in its partnering relationship with
Avaya, certain customers receive pre-negotiated discounts from Avaya which
could lower the Company's gross margins as it does business with these
customers; and (3) the level and amount of discounts and purchase rebates
available to the Company from Avaya and its suppliers. The combined effect
of all of these factors will result in varying gross profit margins from
period to period.
The reduction in gross profit dollars during the three and nine
months ended September 30, 2002 was primarily attributable to lower sales
levels, for the reasons discussed above. The reduction in gross profit
margins during the three and nine months ended September 30, 2002 was
primarily attributable to (1) increased sales competition, and downward
pressure on sales pricing in the Company's end-user parts business; (2)
increased wholesale sales as a percent of total sales revenues. Wholesale
sales generate margins that are lower than end-user margins and, during the
three months ended September 30, 2002, represented 12% of revenues as
compared to 10% of revenues in the comparable prior year period. For the
nine months ended September 30, 2002, wholesale sales represented 17% of
revenues as compared to 12% in 2001; and (3) higher overhead costs as a
percent of revenues. As a partial offset, the Company recorded improved
gross profit margins on both systems sales and installation services in
both three and nine month periods of 2002, as compared with the comparable
prior year periods, and also benefited from reduced license fees.
The Company believes that there will continue to be pressure on gross
profit margins until market conditions and product demand in the
telecommunications industry improves. The Company may also experience
continued downward pressure on gross profit margins if systems sales become
a larger component of total revenues, and/or if the Company increases its
business with customers with pre-negotiated Avaya discounts.
Selling, General and Administrative ("SG&A") Expenses
SG&A expenses for the three months ended September 30, 2002 were
$1,352,000, a decrease of $418,000 or 24% from the comparable 2001 period.
SG&A expenses were 28% of revenues in 2002 as compared to 20% of revenues
in 2001. SG&A expenses for the nine months ended September 30, 2002 were
$4,429,000, a decrease of $1,792,000 or 29% from the comparable 2001
period. SG&A expenses were 28% of revenues in 2002 as compared to 24% of
revenues in 2001.
The decrease in SG&A expenses for the three months ended September
30, 2002 was primarily attributable to (i) a $189,000 (18%) decrease in
payroll expenses as a result of lower employment levels than the prior year
period (including a workforce reduction in June of 14%), lower sales
commissions due to lower sales levels, and management pay reductions
implemented during the current year quarter; (ii) cost-reduction
initiatives in response to lower sales levels, which has resulted in lower
marketing, legal, consulting and other office and employment-related
expenses; (iii) lower bad debt expenses attributable to lower sales volume
and better than expected receivable collections, and (iv) lower
depreciation expense.
The decrease in SG&A expenses for the nine months ended September 30,
2002 was primarily attributable to (i) a $797,000 (22%) decrease in payroll
expenses as a result of lower employment levels than the prior year period,
lower sales commissions due to lower sales levels, and management pay
reductions implemented during the current year; (ii) cost-reduction
initiatives in response to lower sales levels, which has resulted in
reduced marketing, travel, legal, consulting and other office and
employment-related expenses; (iii) lower bad debt expense resulting from a
$33,000 reserve reduction due to better than expected receivable
collections, a $15,234 bad debt recovery and lower sales volume and (iv)
lower depreciation expense.
The Company is continuing its efforts to further reduce SG&A
expenses, as necessitated by its lower current revenue levels, as one
measure in a strategy to return to profitability.
9
Interest Expense, Other Income and Minority Interest
Interest expense for the three months ended September 30, 2002 was
$1,521, as compared to $41,000 for the comparable 2001 period. Interest
expense for the nine months ended September 30, 2002 was $24,000, as
compared to $124,000 for the comparable 2001 period. The decrease in
interest expense in each period was attributable to both lower average
borrowings and lower borrowing costs. During the three months ended
September 30, 2002, average bank borrowings approximated $22,000 at an
average borrowing rate of approximately 4.9%, compared with average bank
borrowings of approximately $2,389,000 at an average borrowing rate of
approximately 6.1% for the comparable 2001 period. During the nine months
ended September 30, 2002, average bank borrowings approximated $612,000 at
an average borrowing rate of approximately 4.5%, compared with average bank
borrowings of approximately $2,173,000 at an average borrowing rate of
approximately 7% for the comparable 2001 period.
Other income for the three months ended September 30, 2002 and 2001
consisted of interest earned on invested cash. Other income for the nine
months ended September 30, 2002 included $81,727 representing the net
proceeds from the sale of common stock of Anthem, Inc. received by the
Company, at no cost, as part of the conversion of Anthem Insurance
Companies, Inc. from a mutual insurance company to a stock insurance
company, and interest earned on invested cash. Other income for the nine
months ended September 30, 2001 consisted primarily of interest earned on
invested cash.
Minority interest in income of subsidiary of $168,000 and $369,000
for the three and nine months ended September 30, 2001, respectively,
represented a provision for the 49.9% share of the net income of InfiNet
earned by TriNET. In February 2002, the Company acquired, effective
January 1, 2002, all of TriNET's ownership interest in InfiNet for an
aggregate cash purchase price of $153,334.
(Benefit) Provision for Income Taxes
The Company recorded a net tax benefit of $1,000 and a provision of
$9,000 for the three-month periods ended September 30, 2002 and 2001,
respectively, as compared to a provision of $12,000 and $31,000 in the
comparable nine-month periods. Due to the Company's net loss for both
current year periods, the tax provision consisted of estimated minimum
state income taxes. The Company's deferred tax assets consist primarily of
net operating loss and capital loss carryforwards, and timing differences
between the book and tax treatment of inventory and other asset valuations.
The increase in the deferred tax assets from December 31, 2001 have been
fully reserved for due to the Company's current year operating loss and its
history of earnings volatility.
Liquidity and Capital Resources
Working capital, defined as current assets less current liabilities,
was $4,535,000 at September 30, 2002, a decrease of $1,295,000 or 22% from
$5,830,000 at December 31, 2001. The working capital ratio was 3 to 1 at
September 30, 2002, compared with 2.7 to 1 at December 31, 2001.
Operating activities used $444,000 during the nine months ended
September 30, 2002, primarily due to the net loss and the reduction of
accounts payable, partly offset by cash generated from lower accounts
receivable and inventories. Decreases in these accounts were primarily
attributable to lower revenue levels, improved receivable collections and
efforts to reduce inventory levels and expenses.
Investing activities used $213,000 during the nine months ended
September 30, 2002, attributable to (i) the $153,334 purchase price for the
acquisition of TriNET's 49.9% ownership interest in InfiNet, and (ii)
$60,000 of purchased equipment.
Financing activities provided $114,000 during the nine months ended
September 30, 2002, principally from net borrowings of $238,000 under the
revolving credit facility. During this period the Company also received
$13,479 from 26,379 common shares issued to employees under the Company's
employee stock purchase plan, made $37,000 in capital lease payments to
fully pay-off a lease obligation, and made a $100,000 capital distribution
to TriNET out of the accumulated earnings of InfiNet.
In Form 10-Q for the quarterly period ended June 30, 2002, filed with
the SEC on August 14, 2002, the Company disclosed that it was not in
compliance with the minimum tangible net worth covenant required under its
revolving credit facility with Wachovia. On August 30, 2002, the Company
was granted a covenant waiver by Wachovia under the following conditions:
(1) the $4 million line of credit was reduced to a $1 million facility; (2)
the borrowing rate was increased to LIBOR plus 6% effective August 1, 2002;
and (3) the minimum tangible net worth covenant was revised from $5,500,000
to $5,150,000. In addition, the Company agreed to pay a $5,000 fee, and
reimburse the bank for legal fees incurred in connection with documenting
the waiver agreement.
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On September 30, 2002, Wachovia and the Company agreed to an
extension of the credit facility until February 28, 2003, to allow the
Company time to procure external, replacement financing. As a condition of
the extension, the aggregate line of credit was reduced to $500,000, and
the minimum tangible net worth covenant was further revised from $5,150,000
to $4,750,000. In addition, the Company agreed to pay a $5,000 fee, and
reimburse the bank for legal fees incurred in connection with documenting
the extension agreement. Except for the tangible net worth covenant, there
are no other financial covenants during the extension period.
Outstanding borrowings under the Company's revolving credit facility
with Wachovia Bank, National Association (f/k/a First Union National Bank)
("Wachovia") were $238,000 and $0 at September 30, 2002 and December 31,
2001, respectively. As of September 30, 2002, the unused portion of the
revolving credit facility was $262,000, all of which was available under
existing borrowing formulas. The average and highest amounts borrowed
during the three months ended September 30, 2002 were approximately $22,000
and $238,000, respectively. The average and highest amounts borrowed during
the nine months ended September 30, 2002 were approximately $612,000 and
$1,531,000, respectively.
The Company is dependent upon its operating cash flow and credit
facility to provide cash to satisfy its working capital requirements. The
Company is currently seeking a new commercial lender to provide a
replacement credit facility, and it is possible that it will not be
successful in obtaining a replacement credit facility until the Company
could demonstrate improved operating results. In addition, the Company's
borrowing costs on a replacement facility could be significantly higher
than its current borrowing costs. If the Company should default on its
financial covenant, the bank could elect to terminate the credit facility
prior to its February 28, 2003 maturity date. No assurances can be given
that the Company will have sufficient cash resources to finance future
growth, and it may become necessary to seek additional financing sources
for such purpose.
During 2002, the Company has been engaged in a project to develop an
e-business platform, designed to enable its customers to transact business
with the Company electronically, at an estimated cost of $150,000-$250,000
to be incurred as various independent phases of the project are performed
during 2002 and 2003. There are currently no other material capital
expenditures planned.
Risk Factors
The Company's prospects are subject to certain uncertainties and
risks. These risks and uncertainties are detailed from time to time in
reports filed by the Company with the SEC, including Forms 8-K, 10-Q, and
10-K, and include, among other factors, the following principal risks:
Economic Conditions in the U.S. Management remains cautious about
the telecommunications product marketplace going forward, and cannot
predict whether the level of capital spending for the Company's products
will improve in the near term. The Company has worked to offset the
financial impact of a reduced revenue stream by reducing and more tightly
controlling operating costs and expenses. However, should the Company
experience continued decreases in revenues, profit margins and further
deterioration in operating results, it is likely that the Company would
implement further cuts in its operating expenses, which could prevent the
Company from maintaining its current array of product offerings and
technical resources needed for future growth.
Credit Facility and Working Capital. The Company is currently seeking
a new commercial lender to provide a replacement credit facility, and it is
possible that it will not be successful in obtaining a replacement credit
facility until the Company could demonstrate improved operating results.
If the Company is unable to obtain a replacement credit facility, it would
be dependent upon currently available cash and cash generated by operations
to satisfy its working capital requirements, which could adversely impact
current operating levels as well as future growth. No assurances can be
given that the Company will have sufficient cash resources to finance
future growth, and it may become necessary to seek additional financing
sources for such purpose.
Relationship with Avaya. The Company principally sells Avaya
telecommunications products through various Dealer agreements with Avaya.
The Company is dependent upon the quality of current Avaya products as well
as Avaya's continued development of new products in order to compete. The
Company's current sales levels could be adversely impacted should market
demand for these Avaya products significantly decline. The Company's parts
and systems sales levels would also be adversely impacted if its Avaya
dealer and license agreements were terminated. In addition, the Company
receives substantial rebates and other cash incentives from Avaya, based
upon volume levels of certain product purchases, which are material to the
Company's operating results and which help reduce product purchase costs,
market development and marketing expenses. These incentive programs are
subject to change annually, and no assurances can be given that they would
not be altered so as to adversely impact the Company's profit margins or
operating expenses.
11
In addition, the Company is also subject to other risks including
competitive factors and pricing pressures, changes in product mix, product
demand, risk of dependence on third party suppliers, the ability of the
Company to sustain, manage or forecast its growth and inventories,
performance and reliability of products, customer service, adverse
publicity, business disruptions; changes in business strategy or
development plans, turnover of key employees, and other risk factors
detailed in this report, described from time to time in the Company's other
SEC filings, or discussed in the Company's press releases.
The risks included here are not exhaustive. Other sections of this
report may include additional factors, which could adversely affect the
Company's business and financial performance. Moreover, the Company
operates in a very competitive and rapidly changing environment. New risk
factors emerge from time to time and it is not possible for management to
predict all such risk factors, nor can it assess the impact of all such
risk factors on its business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from
those contained in any forward-looking statements. Given these risks and
uncertainties, investors should not place undue reliance on forward-looking
statements as a prediction of actual results.
Investors should also be aware that while the Company does, from time
to time, communicate with securities analysts, it is against the Company's
policy to disclose to them any material information unless such information
shall have been previously or is simultaneously disclosed in a manner
intended to provide broad, non-exclusionary distribution of the information
to the public. Accordingly, shareholders should not assume that the Company
agrees with any statement or report issued by any analyst irrespective of
the content of the statement or report. Furthermore, the Company has a
policy against issuing or confirming financial forecasts or projections
issued by others. Thus, to the extent that reports issued by securities
analysts contain any projections, forecasts or opinions, such reports are
not the responsibility of the Company.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Market risks that have the potential to affect the Company's earnings
and cash flows result primarily from changes in interest rates. The
Company's cash equivalents, which consist of an investment in a money
market fund consisting of high quality short term instruments, principally
US government and agency issues and commercial paper, are subject to
fluctuating interest rates. A 10 percent change in such current interest
rates would not have a material effect on the Company's results of
operations or cash flow.
The Company is also exposed to market risk from changes in the
interest rate related to its revolving credit facility, which is based upon
a 30-day average LIBOR rate. Assuming an average borrowing level of
$612,000 (which amount represented the average amount borrowed under the
revolving credit facility during the nine months ended September 30, 2002),
each 1 percentage point increase in the bank's lending rate would result in
$6,120 of additional annual interest charges. Under its current policies,
the Company does not use interest rate derivative instruments to manage
exposure to interest rate changes.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. Our Chief Executive
Officer and Chief Financial Officer have evaluated the effectiveness of our
disclosure controls and procedures (as such term is defined in Rules 13a-
14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended
(the "Exchange Act") as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"). Based on such evaluation,
such officers have concluded that, as of the Evaluation Date, our
disclosure controls and procedures are effective in alerting them on a
timely basis to material information relating to our company (including our
consolidated subsidiaries) required to be included in our reports filed or
submitted under the Exchange Act.
(b) Changes in Internal Controls. Since the Evaluation Date, there have
not been any significant changes in our internal controls or in other
factors that could significantly affect such controls.
PART II. OTHER INFORMATION
Items 1, 3, 4 and 5 have been omitted because there is nothing to report or
they are inapplicable.
12
Item 2. Changes in Securities and Use of Proceeds
On June 30, 2002, the following securities expired: all 1,137,923 of
the Class A Redeemable Common Stock Purchase warrants; all 1,137,923 of the
Class B Redeemable Common Stock Purchase warrants; all 183,579 of the
Warrants issued in connection with the Company's 1987 initial public
offering; all 33,136 of the Underwriter Options issued in connection with
the Company's 1987 initial public offering; all 89,948 Representative
Warrants issued in 1996 to the Company's underwriter in connection with a
secondary offering of securities.
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits:
The following documents are filed as Exhibits to this report on
Form 10-Q or incorporated by reference herein. Any document
incorporated by reference is identified by a parenthetical
reference to the SEC filing which included such document.
10(a) Third Modification to Loan Agreement, dated September
23, 2002 between Farmstead Telephone Group, Inc. and
Wachovia Bank, National Association (f/k/a First Union
National Bank).
10(b) Modification Number One To Promissory Note, dated
October 9, 2002 between Farmstead Telephone Group, Inc.
and Wachovia Bank, National Association.
10(c) Fourth Modification to Loan Agreement, dated October 9,
2002 between Farmstead Telephone Group, Inc. and
Wachovia Bank, National Association (f/k/a First Union
National Bank).
21 Subsidiaries [Exhibit 21 to the Quarterly Report on
Form 10-Q for the quarter ended March 31, 2002].
99(a) Certification of George J. Taylor, Jr., CEO, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99(b) Certification of Robert G. LaVigne, CFO, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K: No reports on Form 8-K were filed during
the quarter for which this report is filed.
SIGNATURES
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.
FARMSTEAD TELEPHONE GROUP, INC.
Dated: November 8, 2002 /s/ George J. Taylor, Jr.
------------------------------------
George J. Taylor, Jr.
Chief Executive Officer, President
Dated: November 8, 2002 /s/ Robert G. LaVigne
------------------------------------
Robert G. LaVigne
Executive Vice President, Chief
Financial Officer
13
CERTIFICATIONS
I, George J. Taylor, Jr., Chief Executive Officer and President, certify
that:
1. I have reviewed this quarterly report on Form 10-Q of Farmstead
Telephone Group, Inc. ("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;
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 the Registrant 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; and
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: November 8, 2002
/s/ George J. Taylor, Jr.
- -------------------------
George J. Taylor, Jr.
Chief Executive Officer, President
I, Robert G. LaVigne, Executive Vice President and Chief Financial Officer,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Farmstead
Telephone Group, Inc. ("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;
14
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 the Registrant 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; and
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: November 8, 2002
/s/ Robert G. LaVigne
- ---------------------
Robert G. LaVigne
Executive Vice President, Chief Financial Officer
15