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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 June 30, 2003
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)
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 past 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 July 31, 2003, the registrant had 3,305,288 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
June 30, December 31,
(In thousands) 2003 2002
- -------------------------------------------------------------------------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 292 $ 994
Accounts receivable, net (Note 2) 2,637 1,869
Inventories, net (Note 3) 2,359 2,309
Other current assets 382 69
- ---------------------------------------------------------------------------
Total Current Assets 5,670 5,241
- ---------------------------------------------------------------------------
Property and equipment, net 330 394
Other assets 299 238
- ---------------------------------------------------------------------------
Total Assets $ 6,299 $ 5,873
===========================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,434 $ 1,111
Debt maturing within one year (Note 4) 365 -
Accrued expenses and other current liabilities
(Note 5) 347 385
- ---------------------------------------------------------------------------
Total Current Liabilities 2,146 1,496
- ---------------------------------------------------------------------------
Other liabilities 399 348
- ---------------------------------------------------------------------------
Total Liabilities 2,545 1,844
- ---------------------------------------------------------------------------
Commitments and contingencies (Note 9)
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; 3,305,288 and 3,298,958
shares issued and outstanding at June 30,
2003 and December 31, 2002, respectively 3 3
Additional paid-in capital 12,315 12,313
Accumulated deficit (8,564) (8,287)
- ---------------------------------------------------------------------------
Total Stockholders' Equity 3,754 4,029
- ---------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 6,299 $ 5,873
===========================================================================
See accompanying notes to consolidated financial statements.
2
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three For the Six
Months Ended Months Ended
June 30, June 30,
---------------- ----------------
(In thousands, except loss per share amounts) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------
Revenues:
Equipment $3,053 $4,207 $7,080 $ 9,877
Services and other revenue 758 557 1,170 914
- --------------------------------------------------------------------------------------------
Total revenues 3,811 4,764 8,250 10,791
Cost of Revenues:
Equipment 2,091 3,223 4,869 7,300
Services and other revenue 537 345 824 578
Other cost of revenues 208 441 446 852
- --------------------------------------------------------------------------------------------
Total cost of revenues 2,836 4,009 6,139 8,730
- --------------------------------------------------------------------------------------------
Gross profit 975 755 2,111 2,061
Selling, general and administrative expenses 1,094 1,417 2,369 3,077
- --------------------------------------------------------------------------------------------
Operating loss (119) (662) (258) (1,016)
Interest expense (8) (10) (10) (22)
Other income 1 19 3 90
- --------------------------------------------------------------------------------------------
Loss before income taxes (126) (653) (265) (948)
Provision for income taxes 6 7 12 13
- --------------------------------------------------------------------------------------------
Net loss $ (132) $ (660) $ (277) $ (961)
============================================================================================
Basic and diluted net loss per common share: $ (.04) $ (.20) $ (.08) $ (.29)
Weighted average common shares outstanding:
Basic 3,305 3,289 3,302 3,285
Diluted 3,334 3,304 3,319 3,297
============================================================================================
See accompanying notes to consolidated financial statements.
3
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months Ended June 30, 2003 and 2002
(In thousands) 2003 2002
- ----------------------------------------------------------------------------------
Cash flows from operating activities:
Net loss $ (277) $ (961)
Adjustments to reconcile net loss to net cash flows
used in operating activities:
Provision for (reversal of) doubtful accounts receivable 16 (51)
Provision for losses on inventories 15 45
Depreciation and amortization 88 115
Value of compensatory stock options issued - 17
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (784) 562
(Increase) decrease in inventories (65) 833
(Increase) decrease in other assets (374) 3
Increase (decrease) in accounts payable 323 (954)
Decrease in accrued expenses and other current
liabilities (38) (10)
Increase in other liabilities 51 44
- -----------------------------------------------------------------------------------
Net cash used in operating activities (1,045) (357)
- -----------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (24) (30)
Acquisition of InfiNet - (153)
- -----------------------------------------------------------------------------------
Net cash used in investing activities (24) (183)
- -----------------------------------------------------------------------------------
Cash flows from financing activities:
Borrowings under revolving credit line 365 345
Repayments of capital lease obligation - (37)
Issuance of common stock 2 10
Capital distribution to minority interest partner - (128)
- -----------------------------------------------------------------------------------
Net cash provided by financing activities 367 190
- -----------------------------------------------------------------------------------
Net decrease in cash and cash equivalents (702) (350)
Cash and cash equivalents at beginning of period 994 1,479
- -----------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 292 $ 1,129
===================================================================================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 7 $ 20
Income taxes 4 17
See accompanying notes to consolidated financial statements.
4
FARMSTEAD TELEPHONE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 and InfiNet Systems, LLC (both are
inactive). The accompanying consolidated financial statements as of and
for the three and six months ended June 30, 2003 and 2002 have been
prepared in accordance with accounting principles generally accepted in the
United States of America and the rules and regulations of the Securities
and Exchange Commission for interim financial statements. In the Company's
opinion, the unaudited interim consolidated financial statements and
accompanying notes reflect all adjustments, consisting of normal and
recurring adjustments, that 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 to be
experienced for the entire fiscal year. Certain prior year amounts on the
Consolidated Statements of Cash Flows have been reclassified to conform to
the current interim period presentation. 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, 2002
2. ACCOUNTS RECEIVABLE, NET
Accounts receivable, net consist of the following (in thousands):
June 30, December 31,
2003 2002
- ----------------------------------------------------------------------
Trade accounts receivable $2,438 $1,892
Other receivables 250 24
- ------------------------------------------------------------------
2,688 1,916
Less: allowance for doubtful accounts (51) (47)
- ------------------------------------------------------------------
Accounts receivable, net $2,637 $1,869
==================================================================
Other receivables consist of commissions, rebates and other dealer
incentives due from Avaya, Inc., and are recorded in the consolidated
financial statements when earned.
3. INVENTORIES, NET
Inventories are stated at the lower of cost or market, and are valued
on an average cost basis. Inventories, net consist of the following (in
thousands):
June 30, December 31,
2003 2002
- --------------------------------------------------------------------------------
Finished goods and spare parts $2,176 $2,362
Work in process (a) 496 456
Rental equipment 77 53
- ----------------------------------------------------------------------------
2,749 2,871
Less: reserves for excess and obsolete inventories (390) (562)
- ----------------------------------------------------------------------------
Inventories, net $2,359 $2,309
============================================================================
(a) Work in process inventories consist of used equipment requiring
repair or refurbishing.
4. DEBT MATURING WITHIN ONE YEAR
On February 19, 2003 the Company entered into a one-year, $1.5
million revolving loan agreement (the "BACC Agreement") with Business
Alliance Capital Corporation ("BACC"), replacing the Wachovia Loan
Agreement. Under the terms of the BACC Agreement, borrowings are advanced
at 75% of eligible accounts receivable, as defined (primarily receivables
that are less than 90 days old and, in the case of system sales, the
receivable does not become "eligible" until the system has been installed),
and at 25% of the value of eligible inventory, as defined (primarily
inventory that was purchased pursuant to a firm customer order), provided
that the amount advanced against eligible inventory shall not exceed
$200,000 or 30% of all outstanding advances under the BACC Agreement.
Interest is charged at the per annum rate of one and one-half percentage
points (1.5%) above the prime rate, but not less than 5.75%, subject to a
minimum interest charge based on a
5
minimum daily loan balance of $250,000 regardless of the actual loan
balance. Under the BACC Agreement, the Company is charged an annual
facility fee of 1% of the facility ($15,000) and a monthly service fee
equal to .25% of the average outstanding loan balance, subject to a minimum
daily loan balance of $250,000. As additional security to BACC, the
Company issued a $300,000 standby letter of credit in favor of BACC,
secured by cash, which can be drawn upon, up to the amount of the Company's
outstanding obligation to BACC, ninety days after an event of default (see
Note 9). The BACC Agreement restricts the Company from the payment of
dividends and limits capital expenditures during the term of the agreement
to $150,000, without the consent of BACC. The BACC Agreement contains no
specific financial covenants, however it defines certain circumstances
under which the agreement can be declared in default and subject to
termination, including among others if (i) there is a material adverse
change in the Company's business or financial condition; (ii) an insolvency
proceeding is commenced; (iii) the Company defaults on any of its material
agreements with third parties; (iv) the Company fails to comply with the
terms, representations and conditions of the BACC Agreement, and (v) there
are material liens or attachments levied against the Company's assets. In
the event the BACC Agreement is terminated prior to its expiration date,
the Company shall pay a fee in an amount equal to 5% of the advance limit
of $1.5 million if such termination occurs on or prior to August 19, 2003;
or 4% of the advance limit if such termination occurs thereafter.
As of June 30, 2003, outstanding borrowings under the BACC Agreement
were $365,000. The unused portion of the credit facility as of June 30,
2003 was $1,135,000, all of which was available under the Company's
borrowing formulas. The average and highest amounts borrowed during the
three months ended June 30, 2003 were approximately $270,000 and $530,000,
respectively. The average and highest amounts borrowed under all credit
facilities during the six months ended June 30, 2003 were approximately
$151,000 and $530,000. The Company was in compliance with the provisions
of its loan agreement as of June 30, 2003.
5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist of the
following (in thousands):
June 30, December 31,
2003 2002
- ----------------------------------------------------------------------------
Salaries, commissions and benefits $206 $241
License fees 19 24
Other 122 120
- -----------------------------------------------------------------------
Accrued expenses and other current liabilities $347 $385
=======================================================================
6. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
FASB INTERPRETATION NO. 45. In November 2002, the Financial
Accounting Standards Board issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the
existing disclosure requirements for most guarantees, including loan
guarantees such as standby letters of credit. It also requires that at the
time a company issues a guarantee, the company must recognize an initial
liability for the fair market value of the obligations it assumes under
that guarantee and must disclose that information in its interim and annual
financial statements. The initial recognition and measurement provisions of
FIN 45 apply on a prospective basis to guarantees issued or modified after
December 31, 2002. The Company adopted FIN 45 effective January 1, 2003.
The Company has no guarantees of the type contemplated by FIN 45 requiring
recognition of an initial liability on its books, however applicable
disclosures are reflected in Note 9 - Commitments and Contingencies.
7. STOCK OPTIONS
The Company applies the disclosure only provisions of Financial
Accounting Standards Board Statement ("SFAS") No. 123, "Accounting for
Stock-based Compensation" ("SFAS 123") and SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" ("SFAS 148") for
employee stock option awards. Had compensation cost for the Company's stock
option plan been determined in accordance with the fair value-based method
prescribed under SFAS 123, the Company's net loss and basic and diluted net
loss per share would have approximated the pro forma amounts indicated
below (dollars in thousands except per share amounts):
6
Three months ended Six months ended
June 30, June 30,
------------------ -------------------
2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------
Net loss, as reported $(132) $(660) $(277) $ (961)
Add: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax
effects (23) (45) (46) (89)
- --------------------------------------------------------------------------------------------------
Pro forma net loss $(155) $(705) $(323) $(1,050)
Pro forma net loss per share:
Basic and diluted $(.05) $(.21) $(.10) $ (.32)
==================================================================================================
The fair value of stock options used to compute pro forma net loss
and net loss per share disclosures was estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions: dividend yield of 0% for 2003 and 2002; expected volatility of
113% for 2003 and 2002; average risk-free interest rate of 2.78% for 2003
and 3.68% for 2002; and an expected option holding period of 5.6 years for
2003 and 2002.
8. MAJOR CUSTOMERS AND CONCENTRATIONS OF CREDIT RISK
During the three and six months ended June 30, 2003, no customer
accounted for more than 10% of revenues. During the three and six months
ended June 30, 2002, one customer accounted for 19% and 12%, respectively,
of revenues. The Company extends credit to its customers in the normal
course of business. As of June 30, 2003, one customer accounted for 20% of
accounts receivable. As of December 31, 2002, one customer accounted for
11% of accounts receivable. Although the Company is subject to changes in
economic conditions which may impact its overall credit risk, the Company
sells to a wide variety of customers, and does not focus on any particular
industry sector. The Company establishes its allowance for doubtful
accounts based upon factors surrounding the credit risk of specific
customers, historical trends and experience, and other information
available to it. Management considers the Company's credit risk to be
satisfactorily diversified and believes that its $51,000 allowance for
doubtful accounts is adequate to absorb estimated losses as of June 30,
2003.
9. COMMITMENTS AND CONTINGENCIES
Letter of Credit. In connection with the Company's revolving credit
agreement with BACC, the Company issued a $300,000 irrevocable standby
letter of credit ("LC") in favor of BACC. The LC can be drawn upon by BACC
to satisfy any outstanding obligations under the Company's loan agreement
ninety days after an event of default. The LC is secured by cash, and
since this cash is restricted from use by the Company during the term of
the LC, it has been classified under other current assets in the
consolidated balance sheet at June 30, 2003.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The discussions set forth below and elsewhere in this Annual Report
on Form 10-Q contain certain statements, based on current expectations,
estimates, forecasts and projections about the industry in which we operate
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. Our 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, Uncertainties and Other Factors That May Affect Future
Results" below. All forward-looking statements included in this document
are based upon information available to us on the date hereof. We
undertake 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 us or our representatives in this report,
other reports, filings with the Securities and Exchange Commission, press
releases, conferences, or otherwise may be forward-looking statements
within the meaning of the Act.
7
RESULTS OF OPERATIONS
Overview. For the three months ended June 30, 2003, we recorded a
net loss of $132,000 or $.04 per share on revenues of $3,811,000. This
compares to a net loss of $660,000 or $.20 per share on revenues of
$4,764,000 for the three months ended June 30, 2002. For the six months
ended June 30, 2003, we recorded a net loss of $277,000 or $.08 per share
on revenues of $8,250,000. This compares to a net loss of $961,000 or $.29
per share on revenues of $10,791,000 recorded for the six months ended June
30, 2002. We believe that our operating results for 2003 reflect the
continuing soft market conditions for telecommunications products in the
United States. Although we are encouraged by an increase in sales
quotation activities, capital spending for telecommunications products
remains sluggish, and we are not able to predict when business capital
spending restraints will lessen. We have therefore remained in a somewhat
defensive posture, attempting to offset the financial impact of a reduced
revenue stream by reducing, more tightly controlling, and deferring where
possible, operating costs and expenses. Our overall strategy has been to
lower our breakeven point and return to profitability, through a
combination of operating expense reductions and product purchasing
initiatives to improve gross profit margins, and to conserve cash by better
managing assets, principally accounts receivable and inventories. During
2003, this strategy has enabled us to significantly reduce our losses
despite decreased revenues. Although second quarter revenues were 20%
lower than second quarter 2002, and 24% lower year-to-date, we managed to
reduce our comparative net losses by 80% and 71%, respectively. We
accomplished this through reducing our selling, general and administrative
expenses by 23% and by significantly increasing our profit margins from 16%
to 26% quarter-over-quarter, and from 19% to 26% year-over-year, through
personnel reductions, improved product buying and outsourcing equipment
repair operations. Additionally, while second quarter revenues were 14%
lower than first quarter 2003, our net loss was still 9% less.
During the remainder of 2003, our business focus will continue to
center on two main fronts - (1) strategies to increase sales volume by (i)
expanding our sales force so as to provide more coverage of existing and
potential customers located within the market areas which we serve; and
(ii) broadening our product offerings; and (2) continuing efforts to lower
our breakeven point by (i) focusing on gross margin improvements through
improved product purchasing and outsourcing where possible; and (ii)
bringing improved scalability to our business through reducing fixed
expenses where possible, so that our operating expenses are more variable
and can more quickly adjust to changes in sales volume. Should there be
continued softness in the market conditions in the telecommunications
equipment industry, however, we may experience continued decreases in
revenues and deterioration in operating results. Additional information on
major components of our operating performance for the three and six months
ended June 30, 2003 follows below.
REVENUES
Three months ended Six months ended
June 30, June 30,
------------------ ------------------
(in thousands) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------
End-user equipment sales $2,661 $3,051 $6,283 $ 7,838
Equipment sales to resellers 392 1,156 797 2,039
- ------------------------------------------------------------------------------------
Total equipment sales 3,053 4,207 7,080 9,877
- ------------------------------------------------------------------------------------
Services 682 555 1,073 897
Other revenue 76 2 97 17
- ------------------------------------------------------------------------------------
Total services and other revenue 758 557 1,170 914
- ------------------------------------------------------------------------------------
Consolidated revenues $3,811 $4,764 $8,250 $10,791
====================================================================================
Equipment Sales
---------------
Total equipment sales for the three months ended June 30, 2003, were
$3,053,000, a decrease of $1,154,000 or 27% from the comparable 2002
period. The decrease consisted of a $390,000 or 13% decline in end-user
sales, and a $764,000 or 66% decline in equipment sales to resellers
("wholesale sales"). Total equipment sales for the six months ended June
30, 2003, were $7,080,000, a decrease of $2,797,000 or 28% from the
comparable 2002 period. The decrease consisted of a $1,555,000 or 20%
decline in end-user sales, and a $1,242,000 or 61% decline in wholesale
sales. End user sales consist of both parts sales (new and refurbished),
and of systems sales (complete systems and system upgrades).
We attribute these sales declines primarily to continuing softness in
the U.S. economy and its negative impact on capital spending for
telecommunications products. These conditions have also led to increased
competition and downward pressure on sales prices. Another factor affecting
our sales levels has been the transitioning of our sales force. During
2003, we have continued a strategy of diversifying our product offerings by
marketing the sale of complete telecommunications systems to our customer
base. This is a growth strategy, designed to augment our long-established
aftermarket parts business that continues as our primary source of
revenues. This strategy necessitated the hiring of sales, service and
technical design
8
personnel experienced in systems and applications design and sales. As a
result, we have increased our focus on selling new systems and system
upgrades, which while resulting in increased systems sales, coupled with
the turnover of certain experienced parts salespersons over the last two
years, has contributed to the reduction in aftermarket parts sales. For the
three months ended June 30, 2003, systems sales represented $613,000 of our
end-user equipment sales, an increase of 98% from the comparable 2002
period. For the six months ended June 30, 2003, system sales represented
$2,045,000 of our end-user equipment sales, an increase of 91%. We remain
committed to the continuing growth of our systems revenues and are
currently implementing strategies to increase revenues from parts sales,
including the implementation of on-line ordering processes and other
direct-marketing approaches. To date, orders received electronically from
customers through our on-line catalogs have not been significant. We are,
however, still in the early stages of marketing this process to our
customer base.
Services and other revenue
--------------------------
Services and other revenue for the three months ended June 30, 2003,
were $758,000, an increase of $201,000 or 36% from the comparable 2002
period. The increase consisted of a $174,000 increase in services and a
$74,000 increase in other revenue. Services and other revenue for the six
months ended June 30, 2003, were $1,170,000, an increase of $256,000 or 28%
from the comparable 2002 period. The increase consisted of a $176,000
increase in services and an $80,000 increase in other revenue. The
increase in services revenue for both current year periods was primarily
attributable to higher installation revenues as a result of the growth in
system sales. Other revenue consisted primarily of commissions earned from
selling Avaya maintenance contracts. In these transactions we act as a
sales agent of Avaya, and the service obligations are borne entirely by
Avaya. During 2003 we have increased our focus on selling these contracts
as part of our strategy to develop new sources of revenue for the Company.
Significant portions of our sales revenues are derived from "Business
Partner" relationships with Avaya. For the past several years, Avaya has
been pursuing a strategy of more fully utilizing its dealer channel as a
revenue source. Through our relationships with various Avaya sales
personnel, we are often referred business by Avaya. Such referrals
however, have been subject to fluctuation as Avaya's direct sales business
itself fluctuates. We believe we are well positioned to benefit from our
Avaya relationships as capital spending for telecommunications products
improves.
We continue to remain cautious about the near term levels of capital
spending for telecommunications products in the US. We still expect that
our future sales revenues will improve in all of our current sales channels
when capital spending improves, although no assurances can be given as to
the timing of when this will occur. To combat this current environment, we
are looking to hire additional sales personnel in order to provide
increased coverage of our existing customer base. This will include a
larger inside-sales staff to focus on smaller-market opportunities.
COST OF REVENUES AND GROSS PROFIT. Total cost of revenues for the
three months ended June 30, 2003 was $2,836,000, a decrease of $1,173,000
or 29% from the comparable 2002 period. The gross profit for the three
months ended June 30, 2003 was $975,000, an increase of $220,000 or 29%
from the comparable 2002 period. As a percentage of revenue, the gross
profit margin was 26% for 2003, compared to 16% for the comparable 2002
period. Total cost of revenues for the six months ended June 30, 2003 was
$6,139,000, a decrease of $2,591,000 or 30% from the comparable 2002
period. The gross profit for the six months ended June 30, 2003 was
$2,111,000, an increase of $50,000 or 2% from the comparable 2002 period.
As a percentage of revenue, the gross profit margin was 26% for 2003, as
compared to 19% for the comparable 2002 period.
Our 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 our various service offerings. The parts
business, for example, involves hundreds of parts that generate
significantly varying gross profit margins depending upon their
availability, competition, and demand conditions in the marketplace; (2)
customer mix - we sell parts to both end-users and to other equipment
resellers. In our partnering relationship with Avaya, certain customers
receive pre-negotiated discounts from Avaya which could lower our gross
margins as we do business with these customers; (3) the level and amount of
discounts and purchase rebates available to us from Avaya and its master
distributors and (4) the level of overhead costs in relation to sales
volume. Overhead costs consist primarily of product handling, purchasing,
and facility costs. The combined effect of all of these factors will
result in varying gross profit margins from period to period.
Gross Margins on Equipment Sales. For the three months ended June
30, 2003, the gross profit margin on equipment sales increased to 32% from
23% in 2002. This was primarily attributable to increased margins on both
end-user and wholesale parts sales, largely due to lower inventory purchase
costs. For the six months ended June 30, 2003, the gross profit margin on
equipment sales increased to 31% from 26% in 2002. This was primarily
attributable to (i) increased margins on both end-user and wholesale parts
sales, largely due to lower inventory purchase costs; (ii) increased
purchase discounts and system rebates from Avaya; and (iii) lower license
fees paid to Avaya.
9
Gross Margins on Services and Other Revenue. For the three months
ended June 30, 2003, the gross profit margin on services and other revenue
was 29%, down from 38% in 2002. For the six months ended June 30, 2003, the
gross profit margin on services and other revenue was 30%, down from 37% in
2002. The current year quarter and six-month profit margins were adversely
impacted by a loss incurred on a large system installation. This reduced
the profit margin on installation revenues to 18% from 34% quarter-over-
quarter, and to 15% from 30% year-over-year.
Other Cost of Sales Expenses: Other cost of sales expenses consist of
product handling, purchasing and facility costs and expenses. For the
three months ended June 30, 2003, these expenses were $208,000, or 5% of
revenues, compared to $441,000 or 9% of revenues in the comparable prior
year period. For the six months ended June 30, 2003, these expenses were
$446,000, or 5% of revenues, compared to $852,000 or 8% of revenues in the
comparable prior year period. The expense reductions in each current year
period reflect cost reduction initiatives which included personnel
reductions of over 50%, and increased outsourcing of equipment repair.
We believe that there will continue to be pressure on gross profit
margins until market conditions and product demand in the
telecommunications industry improves, and we currently expect profit
margins for the balance of 2003 to remain at current levels.
SELLING, GENERAL AND ADMINISTRATIVE ("SG&A") EXPENSES. SG&A expenses
for the three months ended June 30, 2003 were $1,094,000, a decrease of
$323,00 or 23% from the comparable 2002 period. SG&A expenses for the six
months ended June 30, 2003 were $2,369,000, a decrease of $708,000 or 23%
from the comparable 2002 period. SG&A expenses for the three months ended
June 30, 2003 were 29% of revenues, compared to 30% of revenues in 2002,
and for the six months ended June 30, 2003 and 2002 they were 29% of
revenues. In response to lower sales levels, we have been more tightly
controlling expenses, and deferring them where possible. We have also
reduced our SG&A headcount by 14% from a year ago. As a result of this
reduced headcount, coupled with lower sales commissions due to lower sales
levels, compensation expense was $201,000 (21%) lower for the current year
quarter, and $393,000 (21%) lower for the current year six month period,
than their respective prior year periods. In addition, we incurred lower
marketing, consulting, office and other employment related expenses than in
the prior year period as a result of cost-reduction initiatives, and
recorded lower depreciation expense. We will continue to monitor SG&A
expenses and where possible, make certain expenses more variable in
relation to sales volume.
INTEREST EXPENSE AND OTHER INCOME. Interest expense for the three
months ended June 30, 2003 was $8,000, compared to $10,000 for the
comparable 2002 period. Interest expense for the six months ended June 30,
2003 was $10,000, compared to $22,000 for the comparable 2002 period. The
decrease in interest expense was attributable to lower average borrowings.
Other income for the three and six months ended June 30, 2003 was $1,000
and $3,000, respectively, compared with $19,000 and $90,000 recorded for
the respective three and six months ended June 30, 2002. Other income for
the three and six months ended June 30, 2002 included $17,000 and $82,000,
respectively, representing the fair value of common stock of Anthem, Inc.,
which we received at no cost, as part of the conversion of Anthem Insurance
Companies, Inc. from a mutual insurance company to a stock insurance
company. The balance of other income for all periods presented consisted
primarily of interest earned on invested cash.
PROVISION FOR INCOME TAXES. The provision for income taxes for the
three and six months ended June 30, 2003 was $6,000 and $12,000,
respectively, compared to $7,000 and $13,000 for the respective prior year
periods. The provision for income taxes consisted of estimated minimum
state taxes in each period. We maintain a full valuation allowance against
our net deferred tax assets, which 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. Realization of
these net deferred tax assets is dependent upon our ability to generate
future taxable income.
LIQUIDITY AND CAPITAL RESOURCES
Working capital, defined as current assets less current liabilities,
was $3,524,000 at June 30, 2003, compared to $3,745,000 at December 31,
2002. The working capital ratio was 2.6 to 1 at June 30, 2003, compared to
3.5 to 1 at December 31, 2002.
Operating activities used $1,045,000 during the six months ended June
30, 2003. Net cash used by operating activities consisted of a net loss of
$277,000 adjusted for non-cash items of $119,000, and net cash used by
changes in operating assets and liabilities of $887,000. Net cash used by
changes in operating assets and liabilities was primarily attributable to
an increase in accounts receivable and inventories, partly offset by an
increase in accounts payable, and the $300,000 reclassification of
restricted cash (Note 9) to other current assets.
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Investing activities used $24,000 during the six months ended June
30, 2003 to fund capital expenditures.
Financing activities generated $367,000 during the six months ended
June 30, 2003, primarily attributable to working capital borrowings under
our revolving credit facility with BACC. As of June 30, 2003, outstanding
borrowings with BACC were $365,000. The unused portion of the revolving
credit facility as of June 30, 2003 was $1,135,000, all of which was
available to borrow. The average and highest amounts borrowed during the
six months ended June 30, 2003 were approximately $151,000 and $530,000,
respectively. We were in compliance with the provisions of our loan
agreement as of June 30, 2003.
We are dependent upon generating positive cash flow from operations
and upon our revolving credit facility to provide cash to satisfy working
capital requirements. No assurances can be given that we will have
sufficient cash resources to finance future growth. Historically, our
working capital borrowings have increased during periods of revenue growth.
This is because our cash receipts cycle is longer than our cash
disbursements cycle. As our revenues from systems sales increases, as
management expects, the cash receipts cycle may lengthen, unless we can
consistently negotiate progress payments under our systems sales contracts.
Under the current lending agreement, we are prohibited from borrowing
against receivables generated by systems sales until the systems are
installed. Under these circumstances, we could run out of availability
and/or require a higher credit line. In order to obtain additional
financing, we may first need to demonstrate improved operating performance.
Since 2002, we have been engaged in a project to develop an e-
business platform, designed to enable our customers to transact business
with us electronically. As of June 30, 2003, we have incurred cumulative
expenditures of $85,000, and currently estimate that we could spend an
additional $40,000 on this project during the balance of 2003 in order to
complete the implementation of our on-line product catalogs, and
integration of the related on-line ordering processes with our computer
systems. There are currently no other material capital expenditures
planned.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion contained in the "Critical Accounting Policies and
Estimates" section of our Annual Report on Form 10-K for the year ended
December 31, 2002 is still considered current and is hereby incorporated
into this Quarterly Report on Form 10-Q.
RISKS, UNCERTAINTIES AND OTHER FACTORS THAT MAY AFFECT FUTURE RESULTS
The discussion included in the "Risks, Uncertainties and Other
Factors That May Affect Future Results" section included in our Annual
Report on Form 10-K for the year ended December 31, 2002 is still
considered current and applicable, and is hereby incorporated into this
Quarterly Report on Form 10-Q.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risks that have the potential to affect our earnings and cash
flows result primarily from changes in interest rates. Our 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 our results of operations or cash
flow.
We are also exposed to market risk from changes in the interest rate
related to our revolving credit facility, which is based upon the prime
rate charged by a designated bank. Assuming an average borrowing level of
$250,000 (which amount represented the assumed minimum loan balance for
purposes of interest charges under the BACC credit facility) each 1
percentage point increase in the bank's prime rate would result in $2,500
of additional annual interest charges. Under current policies, we do 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 on Form 10-Q. Based on such
evaluation, such officers have concluded that our disclosure controls and
procedures are effective in alerting them on a timely basis to material
information relating to our Company required to be included in our reports
filed or submitted under the Exchange Act.
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(b) Changes in Internal Controls. There were no significant changes
in our internal controls or in other factors that could significantly
affect such controls subsequent to the date of their most recent
evaluation.
PART II. OTHER INFORMATION.
ITEMS 1, 2, 3 and 5 have been omitted because there is nothing to
report or they are inapplicable.
Item 4. Submission of Matters to a Vote of Security Holders:
The proposals voted upon at the Company's Annual Meeting of
Stockholders, held June 12, 2003, along with the voting results, were as
follows:
(1) Election of Directors: All nominees were elected: The results
of the balloting were as follows:
Votes Votes
Nominees For Withheld
-------------------------------------------------------
George J. Taylor, Jr. 3,117,809 89,417
Harold L. Hanson 3,117,809 89,417
Hugh M Taylor 3,117,909 89,317
Joseph J. Kelley 3,117,809 89,417
Ronald P. Pettirossi 3,117,709 89,517
(2) Ratification of the appointment of Carlin, Charron & Rosen LLP
as independent auditors of the Company for the year ending
December 31, 2003: The proposal was approved with 3,139,323
votes for, 64,962 votes against, and 2,941 abstentions.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) Exhibits:
The following documents are filed as Exhibits to this Quarterly
Report on Form 10-Q:
31.1 Certification of the Chief Executive Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer, 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: August 12, 2003 /s/ George J. Taylor, Jr.
----------------------------------------
George J. Taylor, Jr.
Chief Executive Officer, President
Dated: August 12, 2003 /s/ Robert G. LaVigne
----------------------------------------
Robert G. LaVigne
Executive Vice President, Chief
Financial Officer
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