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, 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)
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 [ ]
As of July 31, 2002, the registrant had 3,288,610 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) 2002 2001
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(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 1,129 $ 1,479
Accounts receivable, less allowance
for doubtful accounts 2,622 3,133
Inventories 3,549 4,427
Deferred taxes and other current assets 175 189
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Total Current Assets 7,475 9,228
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Property and equipment, net 420 505
Deferred income taxes 364 364
Goodwill (Note 5) 128 -
Other assets 256 245
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Total Assets $ 8,643 $10,342
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,840 $ 2,794
Debt maturing within one year (Note 2) 345 37
Accrued expenses and other current
liabilities (Note 3) 557 567
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Total Current Liabilities 2,742 3,398
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Other liabilities 304 260
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Total Liabilities 3,046 3,658
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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;
3,288,610 and 3,272,579 shares
issued and outstanding at
June 30, 2002 and December 31, 2001,
respectively 3 3
Additional paid-in capital 12,312 12,285
Accumulated deficit (6,718) (5,757)
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Total Stockholders' Equity 5,597 6,531
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Total Liabilities and Stockholders' Equity $ 8,643 $10,342
===========================================================================
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) 2002 2001 2002 2001
-----------------------------------------------------------------------------------------------
Revenues $4,764 $ 8,016 $10,791 $17,310
Cost of revenues 4,009 6,685 8,730 13,554
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Gross profit 755 1,331 2,061 3,756
Selling, general and administrative expenses 1,417 2,320 3,077 4,451
-----------------------------------------------------------------------------------------------
Operating loss (662) (989) (1,016) (695)
Interest expense 10 42 22 83
Other income (19) (11) (90) (22)
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Loss before income taxes and minority
interest in income of subsidiary (653) (1,020) (948) (756)
Provision for income taxes 7 4 13 22
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Loss before minority interest in income
of subsidiary (660) (1,024) (961) (778)
Minority interest in income of subsidiary - 109 - 201
-----------------------------------------------------------------------------------------------
Net loss $ (660) $(1,133) $ (961) $ (979)
===============================================================================================
Basic and diluted net loss per common share: $ (.20) $ (.35) $ (.29) $ (.30)
Weighted average common shares outstanding:
Basic 3,289 3,273 3,285 3,273
Diluted 3,304 3,302 3,297 3,332
===============================================================================================
See accompanying notes to consolidated financial statements.
3
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended June 30, 2002 and 2001
(In thousands) 2002 2001
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Cash flows from operating activities:
Net loss $ (961) $ (979)
Adjustments to reconcile net loss to net cash flows
(used in) provided by operating activities:
Depreciation and amortization 115 130
Minority interest in income of subsidiary - 201
Value of compensatory stock options issued 17 25
Changes in operating assets and liabilities:
Decrease in accounts receivable 511 2,451
Decrease in inventories 878 222
Decrease (increase) in other assets 3 (33)
Decrease in accounts payable (954) (697)
Decrease in accrued expenses
and other current liabilities (10) (736)
Increase in other liabilities 44 39
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Net cash (used in) provided by operating activities (357) 623
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Cash flows from investing activities:
Purchases of property and equipment (30) (89)
Acquisition of InfiNet (153) -
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Net cash used in investing activities (183) (89)
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Cash flows from financing activities:
Borrowings (repayments) under revolving credit line 345 11
Repayments of capital lease obligation (37) (51)
Issuance of common stock 10 -
Capital contribution from (distribution to) minority
interest partner (128) 25
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Net cash provided by (used in) financing activities 190 (15)
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Net (decrease) increase in cash and cash equivalents (350) 519
Cash and cash equivalents at beginning of period 1,479 374
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Cash and cash equivalents at end of period $ 1,129 $ 893
====================================================================================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 20 $ 84
Income taxes 17 82
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
Outstanding borrowings under the Company's revolving credit facility
with Wachovia Bank, National Association (f/k/a First Union National Bank)
were $345,000 and $0 at June 30, 2002 and December 31, 2001, respectively.
As of June 30, 2002, the unused portion of the revolving credit facility was
approximately $3,655,000, of which approximately $2,200,000 was available
under various borrowing formulas. The average and highest amounts borrowed
during the three months ended June 30, 2002 were approximately $907,000 and
$1,531,000, respectively. The average and highest amounts borrowed during the
six months ended June 30, 2002 were approximately $913,000 and $1,531,000,
respectively.
As a result of the net loss for the three months ended March 31,
2002, the Company was not in compliance with its funds flow coverage ratio.
In addition, due to continued losses, the Company was not in compliance
with its tangible net worth covenant at April 30, 2002, which required a
minimum $6 million tangible net worth, as defined, at all times. On May
10, 2002 the Company was granted a waiver of these covenant violations as
consideration for the following modifications to its loan agreement, which
became effective June 4, 2002: (i) the overall credit line was reduced from
$8 million to $4 million; (ii) the advance rate formula on inventory was
modified from 50% of eligible inventory with a cap of $2 million, to 50% of
eligible inventory with a revised cap equal to 50% of eligible accounts
receivable; (iii) the minimum amount of tangible net worth required was
reduced from $6 million to $5.5 million, excluding certain corporate
restructuring charges incurred by June 30, 2002 not to exceed $200,000;
(iv) the funds flow ratio covenant was eliminated for the remainder of the
term of the agreement (the loan agreement expires September 27, 2002) and
(v) the borrowing rate was increased from the average 30-day London Interbank
Offered Rate ("LIBOR") plus 250 basis points to LIBOR plus 300 basis points
(4.84% at June 30, 2002). As of June 30, 2002, the Company was in compliance
with its modified financial loan covenants. However, based upon operating
results for the month of July, the Company was not in compliance with the
minimum tangible net worth covenant as of the date of this filing, and will
be seeking a waiver from the lender.
Should the Company continue to be in default of its financial
covenants, the bank could elect to terminate the credit facility, which is
otherwise scheduled to expire in September 2002, or decide not to extend
the facility for another term. Should that happen, other sources of
working capital could be more expensive and possibly not obtainable until
the Company could demonstrate improved operating results. 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 for
such purpose.
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 as of June 30, 2002.
Note 3. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consisted of the
following (in thousands):
June 30, December 31,
2002 2001
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Salaries, commissions and benefits $367 $420
License fees 50 42
Other 140 105
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Accrued expenses and other current liabilities $557 $567
===========================================================================
5
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 $128,335 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 six months ended June
30, 2001 as if the acquisition had been completed as of the beginning of
those periods. The results of operations for the three and six months
ended June 30, 2002 include the effects of the acquisition from January 1,
2002.
Three months ended Six months ended
June 30, 2001 June 30, 2001
------------------------ ------------------------
(In thousands, except per share data) As Reported Pro forma As Reported Pro forma
------------------------------------------------------------------------------------------------
Revenue $ 8,016 $ 8,016 $17,310 $17,310
Loss before minority interest
in income of subsidiary (1,024) (1,024) (778) (778)
Minority interest in income of subsidiary 109 - 201 -
Net loss $(1,133) $(1,024) (979) (778)
Earnings per share: basic $ (.35) $ (.31) $ (.30) $ (.24)
diluted (.35) (.31) $ (.30) (.23)
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, is 1,300,000.
6
As of June 30, 2002 there were 8,000 options outstanding under the 2002
Plan, and 1,941,306 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.
In February 2002, the Company issued 16,031 shares of Common Stock
pursuant to the Company's 2001 Employee Stock Purchase Plan. Proceeds from
the issuance were $10,219.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Results of Operations
Net Loss
For the three months ended June 30, 2002, the Company reported a net
loss of $660,000 or $(.20) per share, on revenues of $4,764,000, as
compared to a net loss of $1,133,000 or $(.35) per share on revenues of
$8,016,000 for the comparable 2001 period. For the six months ended June
30, 2002, the Company reported a net loss of $961,000 or $(.29) per share,
on revenues of $10,791,000, as compared to a net loss of $979,000 or $(.30)
per share on revenues of $17,310,000 for the comparable 2001 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 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 components of the Company's operating performance for the
three and six months ended June 30, 2002 as compared to the comparable 2001
periods follows below.
Revenues
Three months Six Months
ended ended
June 30, June 30,
(In thousands) 2002 2001 2002 2001
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End-user equipment sales $3,054 $6,308 $ 7,856 $13,888
Equipment sales to resellers 1,155 1,174 2,039 2,264
Services 555 534 896 1,158
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Consolidated revenues $4,764 $8,016 $10,791 $17,310
===========================================================================
Revenues for the three months ended June 30, 2002 were $4,764,000, a
decrease of $3,252,000 or 41% from the comparable 2001 period. End-user
equipment sales revenues in 2002 decreased by $3,254,000 or 52% from the
comparable 2001 period, reflecting decreases in both parts and systems
sales revenues. Equipment sales to resellers ("wholesale sales") decreased
by $19,000 or 2% from the comparable 2001 period. Service revenues
increased by $21,000 or 4% from the comparable 2001 period, attributable to
higher installation and equipment refurbishing revenues. End-user equipment
sales revenues accounted for 64% of revenues in 2002 (79% in 2001),
equipment sales to resellers accounted for 24% of revenues in 2002 (15% in
2001) and service revenues accounted for 12% of revenues in 2002 (6% in
2001).
7
Revenues for the six months ended June 30, 2002 were $10,791,000, a
decrease of $6,519,000 or 38% from the comparable 2001 period. End-user
equipment sales revenues in 2002 decreased by $6,032,000 or 43% from the
comparable 2001 period, reflecting decreases in both parts and systems
sales revenues. Equipment sales to resellers decreased by $225,000 or 10%
from the comparable 2001 period. Service revenues decreased by $262,000 or
23% from the comparable 2001 period, attributable to lower installation and
equipment rental revenues. End-user equipment sales revenues accounted for
73% of revenues in 2002 (80% in 2001), equipment sales to resellers
accounted for 19% of revenues in 2002 (13% in 2001) and service revenues
accounted for 8% of revenues in 2002 (7% in 2001).
As discussed above, the decrease in revenues during both the three
month and six month periods of 2002 was primarily attributable to continued
reduced demand in the U.S. for telecommunication products which the Company
started experiencing by the end of the first quarter of 2001, and to
increased competition in the marketplace, particularly in the aftermarket
parts business. These factors have contributed to downward pressure on sales
pricing in order to generate sales. Since the formation of InfiNet in 2001,
the Company's strategy has been to develop its systems and applications
product offerings to become a more significant part of its overall revenues.
This strategy has necessitated the hiring of sales, service and technical
design personnel experienced in systems and applications design and sales.
However, systems and application sales have not to date achieved the levels
expected by management, in large part due to current economic conditions
and reduced technology spending by customers. 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 June 30, 2002 was
$4,009,000, a decrease of $2,676,000 or 40% from the comparable 2001
period. The gross profit for the three months ended June 30, 2002 was
$755,000, a decrease of $576,000 or 43% from the comparable 2001 period.
As a percentage of revenue, the gross profit margin was 16% for 2002, as
compared to 17% for the comparable 2001 period.
Total cost of revenues for the six months ended June 30, 2002 was
$8,730,000, a decrease of $4,824,000 or 36% from the comparable 2001
period. The gross profit for the six months ended June 30, 2002 was
$2,061,000, a decrease of $1,695,000 or 45% from the comparable 2001
period. As a percentage of revenue, the gross profit margin was 19% for
2002, as compared to 22% for the comparable 2001 period.
For both the three and six months ended June 30, 2002, lower product
demand in connection with the decline in technology spending has resulted
in increased sales competition, and has put downward pressure on sales
pricing in order to generate sales, particularly in the Company's
aftermarket end-user and wholesale parts business. In addition, the
overall gross profit margin was negatively impacted by 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 June 30, 2002, represented 24% of revenues as compared to 15% of
revenues in the comparable prior year period. For the six months ended June
30, 2002, wholesale sales represented 19% of revenues as compared to 13% in
2001. In addition, the gross profit margin was negatively impacted by
higher labor and overhead costs as a percentage of revenues. As a partial
offset, the Company recorded improved gross profit margins on installation
services in both three and six 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.
Selling, General and Administrative ("SG&A") Expenses
SG&A expenses for the three months ended June 30, 2002 were
$1,417,000, a decrease of $903,000 or 39% from the comparable 2001 period.
SG&A expenses were 30% of revenues in 2002 as compared to 29% of revenues
in 2001. The decrease in SG&A expenses was primarily attributable to (i) a
$371,000 decrease in payroll expenses as a result of lower employment
levels than the prior year period, and lower commissions due to lower sales
levels; (ii) a $60,000 reduction in bad debt reserves due to better than
expected receivable collections, (iii) lower depreciation expense, and (iv)
Company efforts to reduce other operating expenses in response to its lower
sales levels, which has resulted in lower marketing, travel, legal,
consulting and other office and employment-related expenses. SG&A
expenses for the three months ended June 30, 2002 and 2001 included
approximately $7,000 and $104,000, respectively, of employee termination
expenses in connection with workforce reductions.
SG&A expenses for the six months ended June 30, 2002 were $3,077,000,
a decrease of $1,374,000 or 31% from the comparable 2001 period. SG&A
expenses were 29% of revenues in 2002 as compared to 26% of revenues in
2001. The
8
decrease in SG&A expenses was primarily attributable to (i) a $672,000
decrease in payroll expenses as a result of lower employment levels than
the prior year period, and lower commissions due to lower sales levels;
(ii) a $51,234 credit to bad debt expense resulting from a $36,000 reserve
reduction due to better than expected receivable collections, and a $15,234
bad debt recovery; (iii) lower depreciation expense, and (iv) Company efforts
to reduce other operating expenses in response to its lower sales levels,
which have resulted in lower marketing, travel, legal, consulting and other
office and employment-related expenses. SG&A expenses for the six months
ended June 30, 2002 and 2001 included approximately $7,000 and $104,000,
respectively, of employee termination expenses in connection with workforce
reductions.
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. Effective July 1, 2002,
the Company reduced the base compensation of its executive officers by 20%,
and reduced the compensation of its outside directors by 33 % as a part of
its cost-cutting strategy.
Interest Expense, Other Income and Minority Interest
Interest expense for the three months ended June 30, 2002 was
$10,000, as compared to $42,000 for the comparable 2001 period. Interest
expense for the six months ended June 30, 2002 was $22,000, as compared to
$83,000 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 June 30, 2002, average bank
borrowings approximated $907,000 at an average borrowing rate of
approximately 4.5%, compared with average bank borrowings of approximately
$2,265,000 at an average borrowing rate of approximately 6.9% for the
comparable 2001 period. During the six months ended June 30, 2002, average
bank borrowings approximated $913,000 at an average borrowing rate of
approximately 4.5%, compared with average bank borrowings of approximately
$2,063,000 at an average borrowing rate of approximately 7.5% for the
comparable 2001 period.
Other income for the three and six months ended June 30, 2002
included (i) $16,727 and $81,727, respectively, 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 (ii) interest earned on invested cash. Other income for the
three and six months ended June 30, 2001 consisted primarily of interest
earned on invested cash.
Minority interest in income of subsidiary of $109,000 and $201,000
for the three and six months ended June 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 tax provision of $7,000 and $13,000 for the
three and six months ended June 30, 2002, respectively, as compared to
$4,000 and $22,000 in the comparable period of 2001. 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 was $4,733,000 at June 30, 2002, a decrease of
$1,097,000 or 19% from $5,830,000 at December 31, 2001. The working
capital ratio was 2.7 to 1 at June 30, 2002, and at December 31, 2001.
Operating activities used $357,000 during the six months ended June
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 and efforts to reduce inventory levels and expenses.
Investing activities used $183,000 during the six months ended June
30, 2002, attributable to (i) the $153,334 purchase price for the
acquisition of TriNET's 49.9% ownership interest in InfiNet, and (ii) $30,000
of purchased equipment.
Financing activities provided $190,000 during the six months ended
June 30, 2002, from net borrowings of $345,000 under the revolving credit
facility and $10,219 from 16,031 common shares issued to employees under the
Company's employee stock purchase plan, less $37,000 in capital lease
payments and a $128,000 capital distribution to TriNET.
9
Outstanding borrowings under the Company's revolving credit facility
with Wachovia Bank, National Association (f/k/a First Union National Bank)
were $345,000 at June 30, 2002, compared with $0 at December 31, 2001. As of
June 30, 2002, the unused portion of the credit facility was $3,655,000, of
which approximately $2,200,000 was available under various borrowing
formulas. The average and highest amounts borrowed during the six months
ended June 30, 2002 were approximately $913,000 and $1,531,000, respectively,
as compared to approximately $2,063,000 and $2,876,000, respectively, during
the six months ended June 30, 2001.
As a result of the net loss for the three months ended March 31,
2002, the Company was not in compliance with its funds flow coverage ratio.
In addition, due to continued losses, the Company was not in compliance
with its tangible net worth covenant at April 30, 2002, which required a
minimum $6 million tangible net worth, as defined, at all times. On May
10, 2002 the Company was granted a waiver of these covenant violations as
consideration for the following modifications to be made to its loan
agreement: (i) the overall credit line was reduced from $8 million to $4
million; (ii) the advance rate formula on inventory was modified from 50%
of eligible inventory with a cap of $2 million, to 50% of eligible
inventory with a revised cap equal to 50% of eligible accounts receivable;
(iii) the minimum amount of tangible net worth required was reduced from $6
million to $5.5 million, excluding certain corporate restructuring charges
incurred by June 30, 2002 not to exceed $200,000; (iv) the funds flow ratio
covenant was eliminated for the remainder of the term of the agreement (the
loan agreement expires September 27, 2002) and (v) the borrowing rate was
increased from the average 30-day London Interbank Offered Rate ("LIBOR")
plus 250 basis points to LIBOR plus 300 basis points (4.84% at June 30,
2002). In consideration of the covenant waiver, the Company was charged
$5,000. As of June 30, 2002, the Company was in compliance with its
modified financial loan covenants. However, based upon operating results for
the month of July, the Company was not in compliance with the minimum
tangible net worth covenant as of the date of this filing, and will be
seeking a waiver from the lender.
The Company is currently dependent upon its existing credit agreement
and operating cash flow to provide cash to satisfy its working capital
requirements. Should the Company continue to default on its financial
covenants, the bank could elect to terminate the credit facility, which is
otherwise scheduled to expire in September 2002, or decide not to extend
the facility for another term. Should that happen, other sources of
working capital could be more expensive and possibly not obtainable until
the Company could demonstrate improved operating results. 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 for
such purpose.
The Company is currently 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.
There are currently no other material commitments for capital expenditures.
Safe Harbor Forward-Looking Statements
The Company's prospects are subject to certain uncertainties and
risks. 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. The risks and uncertainties are detailed from time to time in
reports filed by the Company with the Securities and Exchange Commission
("SEC"), including Forms 8-K, 10-Q, and 10-K, and include, among other
factors, general economic conditions and growth in the telecommunications
industry, 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; increased costs of freight and
transportation to meet delivery deadlines, changes in business strategy or
development plans, turnover of key employees, the ability of the Company to
obtain necessary financing, 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. 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, press releases, conferences, or
otherwise are forward-looking statements within the meaning of the Act.
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.
10
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
$907,000 (which amount represented the average amount borrowed under the
revolving credit facility during the three months ended June 30, 2002),
each 1 percentage point increase in the bank's lending rate would result in
$9,070 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.
PART II. OTHER INFORMATION
Items 1, 3 and 5 have been omitted because there is nothing to report
or they are inapplicable.
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 4. Submission of Matters to a Vote of Security Holders:
The proposals voted upon at the Company's Annual Meeting of
Stockholders, held June 13, 2002, 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. 3,001,663 141,266
Harold L. Hanson 3,000,963 141,966
Hugh M Taylor 3,001,413 141,516
Joseph J. Kelley 3,001,263 141,666
Bruce S. Phillips* 3,001,663 141,266
* Mr. Phillips died in August 2002.
11
(2) Ratification of the appointment of DiSanto Bertoline & Company,
P.C. as independent auditors of the Company for the year ending
December 31, 2002: The proposal was approved with 2,812,150
votes for, 320,643 votes against, and 10,136 abstentions.
(3) Approval of the 2002 Stock Option Plan: The proposal was
approved with 656,369 votes for, 527,488 votes against, 49,658
abstentions and 1,909,414 shares not voted.
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) Avaya, Inc. Reseller Agreement, effective May 31, 2002.
10(b) First Amended and Restated Promissory Note, dated June
4, 2002, between Farmstead Telephone Group, Inc. and
Wachovia Bank, National Association (f/k/a First Union
National Bank).
10(c) Second Modification to Loan Agreement, dated June 4,
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) Section 906 Certification of George J. Taylor, Jr., CEO
99(b) Section 906 Certification of Robert G. LaVigne, CFO
(b) Reports on Form 8-K:
On April 4, 2002, the Company filed Form 8-K to report the
following: "On August 13, 2001, Farmstead Telephone Group, Inc.
("Company") erroneously reported in Part II, Item 2 and Part
II, Item 4 of its quarterly report on Form 10-Q that Proposal
No. 2 presented to stockholders at the Company's Annual Meeting
held June 14, 2001 had been approved. Proposal No. 2 sought
certain amendments to the Company's Certificate of
Incorporation. The Company was just recently advised by its
outside securities counsel that, upon their re-examination of
Delaware Law, although the proposal received votes of a
majority of stockholders present in person or represented by
proxy at the Annual Meeting, it did not receive votes of a
majority of the shares of common stock outstanding as required
by Delaware Law. As a result thereof, Proposal No. 2 was not
approved by the stockholders and any attempted amendment is
null and void."
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, 2002 /s/ George J. Taylor, Jr.
-----------------------------------
George J. Taylor, Jr.
Chief Executive Officer, President
Dated: August 12, 2002 /s/ Robert G. LaVigne
-----------------------------------
Robert G. LaVigne
Executive Vice President, Chief
Financial Officer
12