UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
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 Identification No.)
incorporation or organization)
22 Prestige Park Circle, East Hartford, CT 06108-3728
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (860) 610-6000
Securities registered under Section 12(b) of the Act:
Title of each class Name of each Exchange on which registered
Common Stock, $.001 par value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 preceding 12 months (or for such shorter period that the
registrant was required to file such report), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of February 28, 2002, the aggregate market value of the Common Stock of
the registrant held by non-affiliates, based upon the last sale price of
the registrant's Common Stock on such date, was $2,254,568.
As of February 28, 2001, the registrant had 3,272,579 shares of its $0.001
par value Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's definitive proxy statement for the
Annual Meeting of Stockholders to be held on June 13, 2002 are incorporated
by reference in Items 10 through 13 of Part III of this Annual Report on
Form 10-K.
TABLE OF CONTENTS TO FORM 10-K
PART I
Page
----
Item 1. Business 3
Item 2. Properties 6
Item 3. Legal Proceedings 6
Item 4. Submission of Matters to a Vote of Security Holders 6
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 6
Item 6. Selected Financial Data 7
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation 7
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 12
Item 8. Financial Statements and Supplementary Data 12
Item 9. Changes in and Disagreements With Accountants
on Accounting and Financial Disclosure 12
PART III
Item 10. Directors and Executive Officers of the Registrant 13
Item 11. Executive Compensation 14
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters 14
Item 13. Certain Relationships and Related Transactions 14
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 14
2
PART I
Item 1. Business
General
Farmstead Telephone Group, Inc. ("Farmstead" or the "Company") was
incorporated in Delaware in 1986 and became publicly held in May 1987
following the completion of an initial public offering. The Company's main
offices are located at 22 Prestige Park Circle, East Hartford, CT 06108,
and its telephone number is (860) 610-6000. The Company is principally
engaged as an Authorized Remarketing Supplier of Classic Avaya(TM) and new
business communication products manufactured by Avaya Inc. ("Avaya"). These
products are primarily components of customer premises-based private
switching systems and peripheral telecommunications products, including
voice-processing systems. The Company also provides telecommunications
equipment installation, repair and refurbishing, rental, inventory
management, and related value-added services. Beginning January 2002, the
Company also became a "Diamond Dealer" for new Avaya business communication
products, authorized to sell complete telecommunication systems and
associated applications. The Company sells its products and services
throughout the U.S. to both large and small end-user businesses, government
agencies, and dealers.
Effective February 1, 2001, the Company entered into a joint venture
agreement with TriNET Business Trust ("TriNET"), forming a limited
liability corporation operating under the name of InfiNet Systems, LLC
("InfiNet"). Under the agreement, the Company has a 50.1% ownership
interest, and TriNET has a 49.9% ownership interest. Incorporated under
the laws of the State of Delaware, and with operations based in East
Hartford, CT, InfiNet was organized for the purpose of selling new Avaya
telecommunications systems primarily to customers within the State of
Connecticut and various counties in the State of New York. Effective
January 1, 2002, the Company acquired TriNET's 49.9% ownership interest in
InfiNet.
Product Offerings
Equipment
---------
The Company sells a wide range of Avaya product offerings, including
voice products branded as DEFINITY(R), MERLIN MAGIX(TM), SPIRIT(R) and
PARTNER(R) Communications Systems, voice messaging products such as
OCTEL(R) Messaging and INTUITY(TM) AUDIX(R) Messaging , and network support
products such as Avaya Cajun(R).
The Company predominantly conducts an aftermarket parts business,
selling both refurbished and new parts. Aftermarket parts include both
digital and analog telephone sets and circuit packs, and other system
accessories and related products such as headsets, consoles, speakerphones,
paging systems and voice processing system add-on parts. Through its
subsidiary InfiNet, the Company also sells complete systems. In January
2002, the Company also became an Avaya Diamond Dealer, authorized to sell
new telecommunications systems. This development will also allow the
Company to sell both new and used voice and data equipment, applications
and related services. Refurbished products are primarily sold under the
Classic Avaya(TM) label, pursuant to a licensing agreement with Avaya.
Equipment sales revenues accounted for approximately 93% of revenues
in both 2001 and 2000, and 92% in 1999.
Customer Services
-----------------
The Company is committed to respond to its customers' service or
project-oriented telecommunications needs. While each type of service is
not material to the Company's operations as a whole, the Company believes
these services help differentiate it from its competitors, as well as
contribute to longer-lasting customer relationships and incremental
equipment sales. Services include:
Installation services: The Company utilizes Avaya and other equipment
installation companies on a subcontract basis to install telecommunication
parts and systems, as well as equipment moves, adds and changes.
3
Repair and Refurbishing: The Company performs fee-based repair and
refurbishing services for its customers through its in-house facilities and
use of subcontract repair shops. The in-house work includes cleaning,
buffing and minor repairs. The Company outsources major repairs of printed
circuit boards.
Equipment Rentals: The Company rents out equipment on a month-to-
month basis, servicing those customers that have temporary, short-term
equipment needs.
Other Services: The Company's technical staff currently provide
system engineering and configuration, and technical "hot line" telephone
support services.
The Company's combined service revenues accounted for 7% of revenues
in 2001, 7% in 2000 and 8% in 1999. No individual service category
accounted for more than 5% of revenues from continuing operations.
Relationship with Avaya Inc./Lucent Technologies
Lucent Technologies ("Lucent") was formed in 1995 from the systems
and technology units that were formerly a part of AT&T Corp., including the
research and development capabilities of Bell Laboratories. In April 1996,
Lucent completed the initial public offering of its common stock and on
September 30, 1996, became independent of AT&T when AT&T distributed to its
shareholders all of its Lucent shares.
On September 30, 2000, Lucent completed the spin-off of its
Enterprise Networks Group business segment (essentially its PBX business,
and within which market segment the Company participates), as well as its
SYSTIMAX(R) cabling and LAN-based data businesses to Lucent shareholders,
forming a separate company named Avaya Inc. ("Avaya") that focuses directly
and independently on the enterprise networking market. Avaya is a leading
provider of telecommunications products in the U.S. The Company's
contractual relationships with Lucent are being continued with Avaya.
Since 1985, AT&T, Lucent, and now Avaya, have provided support to the
aftermarket by offering installation and maintenance services for its
products purchased by end-users through equipment resellers. Equipment
resellers such as the Company may also, with various restrictions, utilize
Avaya documentation, technical information and software. Avaya also
generally provides up to a one-year warranty on its products. Maintenance
of Avaya equipment sold by the Company is generally provided by Avaya. The
Company utilizes either Avaya, authorized Avaya subcontractors, or the
Company's own network of subcontract installers throughout the United
States to handle its customers's equipment installation needs.
The Company operates in an Avaya-sponsored Authorized Remarketing
Supplier ("ARS") aftermarket program as an ARS Dealer (the "ARS
Agreement"), selling Classic Avaya(TM) products to end-users nationwide.
The ARS Agreement expires December 31, 2003. Classic Avaya(TM) products are
defined as used Avaya PBX system and key system parts that have been
refurbished by the Company under Avaya quality standards. The Company is
currently one of four appointed ARS Dealers, none of whom has been granted
an exclusive territory. The ARS Agreement also allows the Company to sell
certain new Avaya PBX products and voice processing products to end-users,
including government agencies. In February 1999, as a condition of its
initial agreement with Lucent to become an ARS Dealer, the Company's new
key system distributor agreement was terminated, and its associated dealer
base was transferred to another Lucent distributor. Prior to the ARS
Agreement, the Company was an "Authorized Distributor of Selected Lucent -
Remanufactured Products" since 1991. In January 2000, the Company's direct
supplier relationship with Lucent was assigned to Catalyst Telecom, a
Lucent (and now Avaya) distributor, from whom the Company now purchases its
new telecommunications products. In January, 2002, the Company
additionally became a Diamond Dealer, authorized by Avaya to sell voice and
data systems and applications.
The Company believes that its relationship with Avaya is satisfactory
and has no indication that Avaya has any intention of terminating its ARS
Agreement, or any other agreement, with the Company. The Company could be
materially adversely affected should Avaya decide to terminate its
agreements.
4
Marketing and Customers
The Company markets its product offerings nationally through a direct
sales staff, which includes salespersons located throughout the Eastern
Seaboard, Texas and California. In February 2002, the Company opened a
sales office in New York City. The Company also sells Avaya products
through a call center operation started up in 1999. The Company's
customers range from large, multi-location corporations, to small
companies, and to equipment wholesalers, dealers, and government agencies
and municipalities. End-user customers accounted for approximately 86% of
the Company's revenues in 2001, 91% in 2000 and 96% in 1999, while sales to
dealers and other resellers accounted for approximately 14%, 9% and 4% of
revenues during the same respective periods. During the years ended
December 31, 2001 and 2000, no single customer accounted for more than 10%
of revenues. One customer, Lucent Technologies Inc., accounted for
approximately 15% of the Company's revenues during the year ended December
31, 1999. The Company's business is not considered seasonal.
Competition
The Company operates in a highly competitive marketplace. Telephone
equipment product competitors currently include Avaya and other new
equipment manufacturers such as Nortel Networks Corporation, other new
equipment distributors, as well as other equipment resellers. In the sale
of Classic Avaya(TM) products, the Company competes with the other Avaya-
designated ARS Dealers. The Company believes that key competitive factors
in its market are timeliness of delivery, service support, price and
product reliability. The Company also considers its working relationships
with its customers to be an important and integral competitive factor. The
Company anticipates intensified competition from larger companies having
substantially greater technical, financial and marketing resources, as well
as larger customer bases and name recognition. As the industry further
develops voice and data convergence products, the Company anticipates that
it will encounter a broader variety of competitors, including new entrants
from related computer and communication industries.
Suppliers
Lucent, and since October 1, 2000 Avaya, have historically been the
Company's largest suppliers of new telecommunication products and, until
1999, was one of its largest suppliers of refurbished products. In January
2000, the Company's direct supplier relationship with Lucent was assigned
to Catalyst Telecom ("Catalyst"), a former Lucent, and now an Avaya
distributor, from whom the Company has since purchased its new
telecommunications products. The Company acquires used equipment from a
variety of sources, depending upon price and availability at the time of
purchase. These sources include other secondary market equipment dealers,
leasing companies and end-users. The equipment so acquired may be in a
refurbished state and ready for resale, or it may be purchased "as-is",
requiring repair and/or refurbishing prior to its resale. The Company is
dependent upon its relationships and agreements with Catalyst and Avaya for
the provision of new equipment for resale. The Company is not otherwise
dependent upon any other single supplier for used equipment. The Company
believes that the availability of used equipment in the marketplace is
presently sufficient to allow the Company to meet its customers' used
equipment delivery requirements. See also "Relationship with Avaya
Inc./Lucent Technologies."
Patents, Licenses and Trademarks
No patent or trademark is considered material to the Company's
continuing operations. Pursuant to agreements in effect with Avaya, the
Company may utilize, during the term of these agreements, certain Avaya
designated trademarks, insignia and symbols in the Company's advertising
and promotion of Avaya products. The Company operates under a license
agreement with Avaya, in which the Company was granted a non-exclusive
license to use the Classic Avaya TM trademark in connection with the
refurbishing, marketing and sale of Avaya products sold under the ARS
Agreement. Under this agreement, the Company is obligated to pay Avaya a
fee, which has ranged from 10% to 6.5% (6.5% effective October 1, 2001)
of the sales price, on Classic Avaya products sold by the Company. The
license agreement and ARS Agreement expire December 31, 2003.
Research and Development
The Company did not incur any research and development expenses
during the three years ended December 31, 2001, and research and
development activities are not material to the Company's business.
5
Backlog
The backlog of unshipped orders believed to be firm was approximately
$1,732,000 at December 31, 2001 and $1,556,000 at December 31, 2000.
Employees
At December 31, 2001, the Company had 91 full-time employees, and 1
part-time employee. The Company's employees are not represented by any
organized labor union and are not covered by any collective bargaining
agreements.
Item 2. Properties
At December 31, 2001, the Company operated two facilities under long-
term lease agreements, occupying in excess of 49,000 square feet of
warehouse and office space in East Hartford, CT. The lease agreements
expire December 31, 2004. The Company believes that its facilities are
adequate for its present needs and suitable for their intended uses. If
new or additional space is required, the Company believes that adequate
facilities are available at competitive prices in the immediate areas of
its current operations.
Item 3. Legal Proceedings
From time to time the Company is involved in legal proceedings
arising in the ordinary course of business. The Company believes there is
no litigation pending that could have, individually or in the aggregate, a
material adverse effect on its financial position, results of operations or
cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders in the fourth
quarter of the fiscal year covered by this report.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's securities are traded on the American Stock Exchange,
under the following symbols: Common Stock - "FTG"; Warrants issued in the
Company's 1987 initial public offering ("IPO Warrants") - "FTG.WS";
Redeemable Class A Common Stock Purchase Warrants - "FTG.WS.A"; Redeemable
Class B Common Stock Purchase Warrants - "FTG.WS.B". The following sets
forth the range of quarterly high and low sales prices for these
securities, for the two years ended December 31, 2001:
Common Stock: IPO Warrants:
2001 2000 2001 2000
--------------- -------------- ------------- ------------
Quarter Ended High Low High Low High Low High Low
------------- ---- --- ---- --- ---- --- ---- ---
March 31 $ 2.13 $1.13 $2.13 $1.13 $.25 $.25 $.50 $.25
June 30 2.00 1.02 1.69 1.00 .40 .10 .38 .25
September 30 1.35 .65 1.50 1.00 .40 .10 .38 .25
December 31 .85 .56 1.81 1.06 .20 .05 .13 .13
6
Class A Warrants: Class B Warrants:
2001 2000 2001 2000
----------------- ------------ ----------------- ------------
Quarter Ended High Low High Low High Low High Low
------------- ---- --- ---- --- ---- --- ---- ---
March 31 $.33 $.06 $.56 $.13 $.25 $.07 $.56 $.13
June 30 .06 .02 .31 .13 .06 .02 .31 .13
September 30 .20 .02 .13 .06 .04 .01 .31 .06
December 31 .04 .01 .38 .13 .04 .01 .50 .06
There were 3,272,579 common shares outstanding at December 31, 2001
and 2000. There were 183,579 IPO Warrants, 1,137,923 Class A Warrants and
1,137,923 Class B Warrants outstanding at December 31, 2001 and 2000. As
of December 31, 2001 there were 522 holders of record of the common stock
representing approximately 2,800 beneficial stockholders, based upon the
number of proxy materials distributed in connection with the 2001 Annual
Meeting of Stockholders. The Company has paid no dividends and does not
expect to pay dividends in the foreseeable future as it intends to retain
earnings to finance the growth of its operations. Pursuant to a revolving
credit agreement with First Union National Bank, the Company is prohibited
from declaring or paying any dividends or making any other distribution on
any of the shares of its capital stock, without the prior consent of the
lender.
Item 6. Selected Financial Data
(In thousands, except per share amounts) Years ended December 31
-----------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(1) (2)
Revenues $33,339 $42,786 $32,871 $27,738 $20,559
Income (loss) from continuing operations (1,708) 1,753 57 780 (600)
Income (loss) from continuing operations
per common share:
Basic and diluted (.52) .54 .02 .23 (.18)
Total Assets 10,342 15,494 15,657 13,498 10,829
Long term debt - 1,726 4,578 1,916 1,997
Stockholders' equity 6,531 8,202 6,417 6,344 5,769
Dividends paid - - - - -
-----------------------------------------------------------------------------------------------
--------------------
Loss from continuing operations includes charges of $444 from losses
of unconsolidated subsidiaries and the write-off of the Company's
investments in, and accounts receivable from, these subsidiaries.
Total assets included $560 of net assets of discontinued operations.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis should be read in conjunction
with the financial statements and notes thereto contained in Item 8 of this
Report.
Results of Operations
Year Ended December 31, 2001 Compared With Year Ended December 31, 2000
Net Loss
Net loss for the year ended December 31, 2001 was $1,708,000 on
revenues of $33,339,000, compared to net income of $1,753,000 on revenues
of $42,786,000 for the year ended December 31, 2000. The current year net
loss included $1,443,000 in inventory valuation charges, of which
$1,050,000 was recorded in the fourth quarter, and $104,000 in employee
termination costs in connection with workforce reductions during 2001. The
current year net loss included $128,000 of income attributable to the
Company's 50.1 % ownership interest in the net income of InfiNet. See the
notes to consolidated financial statements contained elsewhere herein, for
further information on InfiNet.
7
These results reflect the recessionary market conditions which
prevailed in 2001 in the US economy in general, and in particular, the
technology sector. As a part of these conditions, the Company experienced
a reduction in capital spending by its customers. In response to these
conditions, the Company immediately began taking measures to reduce its
operating costs and to improve its operating efficiences. The Company is
not able to predict the timing of improvements in market conditions;
however management remains cautiously optimistic about the year 2002 taken
as a whole.
Revenues
Year Ended
December 31,
(In thousands) 2001 2000
----------------------------------------------------
End-user equipment sales $26,362 $36,172
Equipment sales to resellers 4,519 3,817
Services 2,458 2,797
----------------------------------------------------
Consolidated revenues $33,339 $42,786
====================================================
Revenues for the year ended December 31, 2001 were $33,339,000, a
decrease of $9,447,000 or 22% from the comparable 2000 period. End-user
equipment sales revenues in 2001 decreased by $9,810,000 or 27% from the
comparable 2000 period, while equipment sales to resellers increased by
$702,000 or 18% from the comparable 2000 period. Service revenues
decreased by $339,000 or 12% from the comparable 2000 period. End-user
equipment sales revenues accounted for 79% of revenues in 2001 (85% in
2000), while equipment sales to resellers accounted for 14% of revenues in
2001 (9% in 2000) and service revenues accounted for 7% of revenues in 2001
(6% in 2000). The operations of InfiNet during 2001 generated $4,228,000
in equipment sales and installation revenues, net of intercompany sales to
the Company.
The decrease in end-user equipment sales revenues was primarily a
reflection of economic conditions and the reduction in capital spending for
telecommunications products, and, to a lesser extent, the result of a
reduction in the Company's sales force due to turnover in the first quarter
of 2001. Incremental sales of systems generated by InfiNet helped offset
the slowdown in parts sales. The increase in equipment sales to resellers
reflected the Company's efforts to more aggressively develop this sales
channel, both as a means to increase overall Company sales and
profitability, and to create an additional outlet to sell off excess
inventory in situations of shifting end user product demand. The decrease
in service revenues was primarily due to lower equipment repair revenues as
a result of the termination of an unprofitable equipment repair and
refurbishing contract with Lucent Technologies in 2000. Installation
revenues, a component of service revenues, increased by 18% due to the
operations of InfiNet.
The Company expects that its future sales revenues will improve in
all of its current sales channels when capital spending for
telecommunication products improve, although no assurances can be given.
Cost of Revenues and Gross Profit
Total cost of revenues for the year ended December 31, 2001 were
26,681,000, a decrease of $6,035,000 or 18% from the comparable 2000
period. The gross profit for the year ended December 31, 2001 was
$6,658,000, a decrease of $3,412,000 or 34% from the comparable 2000
period. As a percentage of revenue, the gross profit margin was 20% for
2001, as compared to 24% for 2000. Approximately 2 percentage points of the
decrease in the gross profit margin from the prior year was attributable to
inventory valuation charges necessitated by economic conditions and
resulting slowdown in capital spending for telecommunications products,
significant price reductions implemented by Avaya during the fourth quarter
on certain products, and changes in the Company's inventory stocking
requirements. The remaining 2 percentage point decrease in gross profit
margin from the prior year was attributable to several factors including:
(i) the capital spending slowdown had the effect of increasing the supply
of equipment in the marketplace and of increasing competition, thereby
putting downward pressure on sales pricing in order to stimulate sales;
(ii) product sales mix, primarily a higher ratio of new equipment sales to
end-users than used equipment sales; (iii) sales promotional programs
enacted by the Company to sell-off certain overstocked inventory at
reduced, or below cost, sales prices, and (iv) lower margins from
subcontract installation services. These decreases were partly offset by
lower labor and overhead costs as a percentage of revenues.
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.
8
Selling, General and Administrative ("SG&A") Expenses
SG&A expenses for the year ended December 31, 2001 were $8,119,000, a
decrease of $335,000 or 4% from the comparable 2000 period. SG&A expenses
were 24% of revenues in 2001 as compared to 20% of revenues in 2000. The
operations of InfiNet during 2001 generated $652,000 in SG&A expense,
consisting principally of employee and subcontracted technical support
compensation costs. Excluding InfiNet's 2001 SG&A, SG&A otherwise decreased
by $987,000 or 12% from the year 2000 level. The decrease in SG&A was
primarily attributable to a 12% reduction in compensation expenses (17%
excluding InfiNet) attributable to workforce reductions during the current
year, to lower sales commissions due to the reduced sales level, and to
reduced business travel expenses. The Company also incurred lower
depreciation expense and business consulting fees than the prior year
period. These decreases were partially offset by (i) incremental SG&A
expense associated with the operation of InfiNet as noted above, (ii)
increased bad debt expense; (iii) higher legal fees from the use of outside
counsel in day-to-day business and contract negotiation matters, as well as
incremental legal fees incurred during the first six months of the current
year in connection with amending the Company's By-laws and Certificate of
Incorporation, establishing an employee stock purchase plan which was
approved by stockholders at the June 14, 2001 annual meeting, and in
various other corporate governance matters; and (iv) increased insurance
costs. The Company also incurred $104,000 of employee termination expenses
during the second quarter of the current year in connection with its
workforce reductions.
Although no assurances can be given, the Company is continuing its
efforts to reduce SG&A expenses as a percent of revenues and currently
expects that its SG&A expenses will be lower in 2002 as a percent of
revenues, than in 2001.
Interest Expense, Other Income and Minority Interest
Interest expense for the year ended December 31, 2001 was $144,000,
as compared to $302,000 for the comparable 2000 period. The decrease in
interest expense was attributable to both lower average borrowings and
lower borrowing costs. During the year ended December 31, 2001, average
bank borrowings approximated $1.9 million at an average borrowing rate of
approximately 6.7%, compared with average bank borrowings of approximately
$2.7 million at an average borrowing rate of approximately 10.1% for the
comparable 2000 period.
Other income for the year ended December 31, 2001 and 2000 consisted
primarily of interest earned on invested cash. Minority interest of
$128,000 for the year ended December 31, 2001represents the 49.9% share of
the net income of InfiNet accruing to its minority partner.
(Benefit) Provision for Income Taxes
The Company recorded a tax provision of $17,000 in 2001, as compared
to a net tax benefit of $395,000 in 2000. Due to the Company's net loss
for 2001, the tax provision consisted of minimum required 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. During
2001, the deferred tax assets increased by $584,000, however the Company
increased its deferred tax valuation allowance by the same amount. This
increase was deemed prudent due to the net loss for 2001, and the
historical volatility of earnings.
Year Ended December 31, 2000 Compared With Year Ended December 31, 1999
Revenues
Revenues in 2000 were $42,786,000, an increase of $9,915,000 or 30%
as compared to revenues of $32,871,000 in 1999. Telecommunications
equipment sales revenues accounted for 93% of 2000 revenues as compared to
92% of 1999 revenues. Revenues from service operations accounted for 7% of
total revenues in 2000 as compared to 8% of total revenues in 1999. For
the year ended December 31, 2000, end-user equipment sales accounted for
73% of the revenue increase, while sales to other equipment resellers, and
service revenues, accounted for 24% and 3% of the revenue increase
respectively. End-user equipment revenue growth was primarily attributable
to the Company's expanding participation in Avaya's Business Partner
program, which includes the Company's designation as an Authorized
Remarketing Supplier of Classic Avaya(TM) equipment ("ARS"). This has led
to increased "partnering" with, and sales referrals from, Avaya Account
Managers and Account Executives, resulting in increased sales of both new
and used equipment. Revenues generated through the Company's Call Center
increased by 6% over the prior year, thereby contributing to the growth in
end-user equipment revenues.
9
Cost of Revenues and Gross Profit
Total cost of revenues in 2000 were $32,716,000, an increase of
$6,876,000 or 26.6%, as compared to $25,840,000 in 1999. The gross profit
in 2000 was $10,070,000, an increase of $3,039,000 or 43%, as compared to
$7,031,000 in 1999. As a percentage of revenue, the gross profit margin
increased from 21.4% in 1999 to 23.5% in 2000. The improvement in gross
profit margin was primarily attributable to product sales mix, particularly
a higher percentage of used equipment sales over new equipment sales, and
to favorable used equipment purchase costs. Lower labor and overhead costs
as a percent of revenues also contributed to the improved gross profit
margin.
Selling, General and Administrative ("SG&A") Expenses
SG&A expenses in 2000 were $8,454,000, an increase of $1,791,000 or
27%, as compared to $6,663,000 in 1999. The increase in SG&A expenses in
2000 was primarily attributable to higher sales and administrative
compensation, including higher sales commissions from increased sales
volume and profit margins. The Company also incurred increased costs
associated with consulting fees and expenses relating to business
performance improvement projects, higher insurance costs, and higher bad
debt and account collection expenses, while incurring lower levels of
depreciation, marketing and public relations expenses. As a percent of
revenues, SG&A expenses decreased from 20.3% in 1999 to 19.8% in 2000.
Interest Expense and Other Income
Interest expense in 2000 was $302,000, a decrease of $47,000 or 13%
as compared to $349,000 in 1999. The decrease in interest expense is
attributable to lower average borrowings under the Company's revolving
credit facilities, partially offset by higher borrowing costs during 2000
as compared to 1999. During 2000 average borrowings under all revolving
credit facilities were approximately $2,708,000 at an average borrowing
rate of 10.1%. This compares to average borrowings of $3,195,000 at an
average borrowing rate of 8.9% during 1999. Other income consists primarily
of interest earned on invested cash for both 2000 and 1999.
(Benefit) Provision for Income Taxes
The Company recorded a net tax benefit of $395,000 in 2000, as
compared to a net tax benefit of $2,000 in 1999. The net tax benefit in
2000 principally resulted from a $455,000 reduction in a deferred tax asset
valuation allowance. The valuation allowance was reduced by 50%, from a
full 100% reserve at December 31, 1999, as a result of positive earnings in
2000 and resulting partial utilization of net operating loss carryforwards.
Liquidity and Capital Resources
Working capital was $5,830,000 at December 31, 2001, a decrease of
$3,065,000 or 34% from $8,895,000 at December 31, 2000. The working
capital ratio was 2.7 to 1 at both December 31, 2001 and 2000.
Operating activities provided $3,001,000 during the year ended
December 31, 2001, primarily due to reductions in both accounts receivable
and inventories, partially offset by a decrease in accounts payable,
accrued expenses and other current liabilities. Decreases in the
aformentioned accounts was primarily as a result of lower sales levels,
improved turnover of accounts receivable, implementation of inventory
reduction strategies and inventory write-offs. Investing activities used
$130,000 in the purchase of property and equipment.
Financing activities used $1,766,000 during the year ended December
31, 2001, primarily from repayments of borrowings under the revolving
credit facility, and repayments of the capital lease obligation. On
September 27, 2000, the Company entered into a two-year, $8 million
revolving loan agreement (the "Loan Agreement") with First Union National
Bank ("FUNB"), replacing a $10 million revolving credit line with Deutsche
Financial Services Corporation. Under the terms of the FUNB Loan
Agreement, borrowings are advanced at 75% of eligible accounts receivable
(primarily receivables that are less than 90 days old), and at 50% of the
value of eligible inventory (inventory that was purchased new or
refurbished and ready for sale), provided that the amount advanced against
eligible inventory shall not exceed $2 million. The interest rate charged
the Company on outstanding borrowings is the LIBOR Market Index Rate plus
2.5% (4.37 % at December 31, 2001). The Company is also charged an
availability fee equal to .25% per annum on the unused portion of the
available credit line. The Loan Agreement restricts the Company from the
payment of dividends without the consent of FUNB, and requires the Company
to maintain a minimum tangible net worth of $6 million at all times. The
Loan Agreement also contains financial covenants requiring the Company to
maintain certain debt-to-equity and funds flow coverage ratios which are
measured on a quarterly basis. On December 19, 2001, the Loan Agreement
was modified to suspend the measurement date of the funds flow coverage
ratio until the first quarter ending March 31, 2002. As a result, the
Company was in compliance with its loan requirements at December 31, 2001.
As of December 31, 2001, the
10
Company did not have any outstanding borrowings under the $8 million
facility, and approximately $2,722,000 was available under various
borrowing formulas. The average and highest amounts borrowed during the
year ended December 31, 2001 were approximately $1,896,000 and $2,876,000,
respectively.
The Company is currently dependent upon its existing credit
agreements and accounts receivable collection experience to provide cash to
satisfy its working capital requirements. Material restrictive changes in
its credit agreements, an inability of the Company to comply with its loan
covenants, or a slowdown in the collection of accounts receivable, could
negatively impact the Company. The Company currently anticipates that it
will not be in compliance with its funds flow coverage ratio at March 31,
2002, and has started discussions with its bank on further amending its
covenants. The Company anticipates that it will be able to reach agreement
on a modification of its loan covenants, and that it will continue its
current credit facility on terms substantially similar to its current
terms. 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. There are currently no
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-K 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, 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.
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, nonexclusionary 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.
11
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risks which 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
the LIBOR Market Index Rate, which is a floating interest rate. Assuming
an average borrowing level of $1.9 million (which amount approximated the
average amount borrowed under the Company's revolving credit facility
during the year ended December 31, 2001), each 1 percentage point increase
in the LIBOR Market Index Rate would result in $19,000 of additional annual
interest charges. The Company does not currently use interest rate
derivative instruments to manage exposure to interest rate changes.
Item 8. Financial Statements and Supplementary Data
See Index to Financial Statements and Financial Statement Schedule in
Item 14.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On October 17, 2001, the Company dismissed Deloitte & Touche LLP
("Deloitte") as its independent accountant. Neither of Deloitte's reports
on the financial statements of the Company for the years ended December 31,
2000 and December 31, 1999 contained any adverse opinion or disclaimer of
opinion and neither was qualified or modified as to uncertainty, audit
scope or accounting principles. The decision to change accountants was
approved by the Audit Committee of the Board of Directors.
During the two fiscal years ended December 31, 2000 and the
subsequent interim period preceding Deloitte's dismissal, there have been
no disagreements between Deloitte and the Company on any matter of
accounting principles or practices, financial statement disclosure, or
auditing scope or procedure, which disagreements, if not resolved to the
satisfaction of Deloitte, would have caused it to make a reference to the
subject matter of the disagreement(s), in connection with its report.
During the two fiscal years ended December 31, 2000 and the subsequent
interim period preceding Deloitte's dismissal, no event occurred that is
required to be disclosed pursuant to paragraph (a)(1)(v) of Item 304 of
Regulation S-K.
On October 17, 2001, the Company retained DiSanto Bertoline &
Company, P.C. ("DiSanto Bertoline") as the Company's new independent
accountant to audit the Company's financial statements. Since December 31,
1998, the Company did not consult DiSanto Bertoline regarding any matter to
be disclosed pursuant to paragraph (a)(2) of Item 304 Regulation S-K.
12
PART III
Item 10. Directors and Executive Officers of the Registrant
Executive Officers of the Company
(Age as of January 1, 2002)
First
Became An
Executive
Name Age Officer in Position(s) Held
---- --- ---------- ----------------
George Taylor, Jr.* 59 1984 Chairman of the Board,
President, Chief
Executive Officer
Michael R. Johnson 55 2001 Executive Vice President
Robert G. LaVigne 50 1988 Executive Vice President, Chief Financial
Officer, Secretary, Treasurer
Robert L. Saelens 56 1997 Vice President - Marketing
--------------------
* Member of the Board of Directors.
George J. Taylor, Jr., Chairman of the Board of Directors and Chief
Executive Officer of the Company (including its predecessors) since 1984,
and President since 1989. Member of the Compensation Committee of the
Board of Directors (until February 24, 1998). President of Lease
Solutions, Inc. (formerly Farmstead Leasing, Inc.), a business products
and automobile leasing company, from 1981 to 1993. Vice President -
Marketing and Sales for National Telephone Company from 1977 to 1981.
Director of Beijing Antai Communication Equipment Company, Ltd. ("ATC").
Mr. Taylor was one of the founders of the National Association of
Telecommunication Dealers, has been a member of, or advisor to, its Board
of Directors since its inception in 1986, and for two years served as its
President and Chairman. Brother of Mr. Hugh M. Taylor, a Director of the
Company.
Michael R. Johnson, Executive Vice President since August, 2001. Sales
Vice President, Avaya Inc. from 2000 to 2001; Vice President - Global Accounts,
Lucent Technologies, from 1996 to 2000. From 1979 though 1996, Mr. Johnson
held various product management and sales management positions with AT&T
Corporation. While employed by Avaya, Lucent and AT&T, Mr. Johnson was
assigned sales management responsibilities covering many of their largest
commercial customers located in New York.
Robert G. LaVigne, Executive Vice President since July 1997. Chief
Financial Officer, Corporate Secretary, Treasurer and Director since 1988.
Vice President - Finance & Administration from 1988 until July 1997.
Controller of Economy Electric Supply, Inc., a distributor of electrical
supplies and fixtures, from 1985 to 1988. Corporate Controller of Hi-G,
Inc., a manufacturer of electronic and electromechanical components, from
1982 to 1985. Certified Public Accountant. Director of ATC.
Robert L. Saelens, Vice President - Marketing from June 1997 to May
2000, and since March 2001. Vice President - Sales and Marketing from May
2000 to March 2001. Director of Marketing from May 1996 through May 1997.
President of Saelens & Associates, a marketing consulting firm, from 1989
to 1997. President of Baker, Bateson & Saelens, Inc., a marketing
consulting firm, from 1982 to 1989. Prior thereto Mr. Saelens served for
ten years in the Creative and Strategic planning departments of the J.
Walter Thompson Corporation.
The other information required by Item 10 is included in the
Company's definitive proxy statement which will be filed pursuant to
regulation 14A on or before April 30, 2002. Such information is
incorporated herein by reference, pursuant to General Instruction G(3).
13
Item 11. Executive Compensation
The information required by Item 11 is included in the Company's
definitive proxy statement which will be filed pursuant to Regulation 14A
on or before April 30, 2002. Such information is incorporated herein by
reference, pursuant to General Instruction G(3).
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters
The information required by Item 12 is included in the Company's
definitive proxy statement which will be filed pursuant to Regulation 14A
on or before April 30, 2002. Such information is incorporated herein by
reference, pursuant to General Instruction G(3).
Item 13. Certain Relationships and Related Transactions
The information required by Item 13 is included in the Company's
definitive proxy statement which will be filed pursuant to Regulation 14A
on or before April 30, 2002. Such information is incorporated herein by
reference, pursuant to General Instruction G(3).
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Index to Financial Statements and Financial Statement Schedule
Page
----
Report of DiSanto Bertoline & Company, P.C 16
Report of Deloitte & Touche LLP 17
Consolidated Balance Sheets - December 31, 2001 and 2000 18
Consolidated Statements of Operations -
Years Ended December 31, 2001, 2000 and 1999 19
Consolidated Statements of Changes in Stockholders' Equity -
Years Ended December 31, 2001, 2000, and 1999 19
Consolidated Statements of Cash Flows -
Years Ended December 31, 2001, 2000, and 1999 20
Notes to Consolidated Financial Statements 21
Financial Statement Schedule:
Report of DiSanto Bertoline & Company, P.C 30
Report of Deloitte & Touche LLP 31
Schedule II - Valuation and Qualifying Accounts 32
(b) Exhibits: See Index to Exhibits on page 33.
(c) Reports on Form 8-K: On October 24, 2001, the Company filed Form 8-K
to report a change in independent accountants, as further described in Item
9 of this Form 10-K.
14
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on March
25, 2002.
FARMSTEAD TELEPHONE GROUP, INC.
By: /s/ George J. Taylor, Jr.
-------------------------
George J. Taylor, Jr.
Chairman of the Board, Chief
Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated as of March 25, 2002.
Signature Title(s)
--------- --------
/s/ George J. Taylor, Jr. Chairman of the Board, Chief Executive Officer
---------------------------- and President
George J. Taylor, Jr. (Principal Executive Officer)
/s/ Robert G. LaVigne Executive Vice President, Chief Financial
---------------------------- Officer, Secretary and Director
Robert G. LaVigne (Principal Financial and Accounting Officer)
/s/ Harold L. Hansen Director
----------------------------
Harold L. Hansen
/s/ Hugh M. Taylor Director
----------------------------
Hugh M. Taylor
/s/ Joseph J. Kelley Director
----------------------------
Joseph J. Kelley
/s/ Bruce S. Phillips Director
----------------------------
Bruce S. Phillips
15
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Farmstead Telephone Group, Inc.
We have audited the accompanying consolidated balance sheet of Farmstead
Telephone Group, Inc. and subsidiaries (the "Company") as of December 31,
2001, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for the year then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit in accordance with U.S. generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall consolidated financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Farmstead
Telephone Group, Inc. and subsidiaries as of December 31, 2001, and the
results of their operations and their cash flows for the year then ended in
conformity with U.S. generally accepted accounting principles.
DISANTO BERTOLINE & COMPANY, P.C.
Glastonbury, Connecticut
February 21, 2002
16
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Farmstead Telephone Group, Inc.
East Hartford, Connecticut
We have audited the accompanying consolidated balance sheet of Farmstead
Telephone Group, Inc. and subsidiary (the "Company") as of December 31,
2000, and the related consolidated statements of operations, changes in
stockholders' equity, and cash flows for each of the two years in the
period ended December 31, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Farmstead Telephone Group,
Inc. and subsidiary as of December 31, 2000, and the results of their
operations and their cash flows for each of the two years in the period
ended December 31, 2000 in conformity with accounting principles generally
accepted in the United States of America.
DELOITTE & TOUCHE LLP
Hartford, Connecticut
February 21, 2001
17
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2001 and 2000
(In thousands, except share amounts) 2001 2000
-------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,479 $ 374
Accounts receivable, less allowance for doubtful
accounts of $150 in 2001 and $244 in 2000 3,133 6,527
Inventories 4,427 7,181
Deferred income taxes (Note 11) 91 107
Other current assets 98 90
-------------------------------------------------------------------------------
Total Current Assets 9,228 14,279
-------------------------------------------------------------------------------
Property and equipment, net (Note 3) 505 632
Non-current deferred income taxes (Note 11) 364 348
Other assets 245 235
-------------------------------------------------------------------------------
Total Assets $10,342 $15,494
===============================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,794 $ 3,789
Debt maturing within one year (Note 5) 37 102
Accrued expenses and other current liabilities (Note 4) 567 1,493
-------------------------------------------------------------------------------
Total Current Liabilities 3,398 5,384
-------------------------------------------------------------------------------
Long-term debt (Note 5) - 1,726
Other liabilities (Note 10) 260 182
-------------------------------------------------------------------------------
Total Liabilities 3,658 7,292
-------------------------------------------------------------------------------
Minority Interest in Subsidiary (Note 6) 153 -
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; 3,272,579 shares issued and outstanding
in 2001 and 2000 3 3
Additional paid-in capital 12,285 12,248
Accumulated deficit (5,757) (4,049)
-------------------------------------------------------------------------------
Total Stockholders' Equity 6,531 8,202
-------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $10,342 $15,494
===============================================================================
See accompanying notes to consolidated financial statements.
18
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2001, 2000 and 1999
(In thousands, except per share amounts) 2001 2000 1999
-------------------------------------------------------------------------------------
Revenues $33,339 $42,786 $32,871
Cost of revenues 26,681 32,716 25,840
-------------------------------------------------------------------------------------
Gross profit 6,658 10,070 7,031
Selling, general and administrative expenses 8,119 8,454 6,663
-------------------------------------------------------------------------------------
Operating income (loss) (1,461) 1,616 368
Interest expense 144 302 349
Other income (42) (44) (36)
-------------------------------------------------------------------------------------
Income (loss) before income taxes and minority
interest in income of subsidiary (1,563) 1,358 55
Provision (benefit) for income taxes 17 (395) (2)
-------------------------------------------------------------------------------------
Income (loss) before minority interest in income
of subsidiary (1,580) 1,753 57
Minority interest in income of subsidiary 128 - -
-------------------------------------------------------------------------------------
Net income (loss) $(1,708) $ 1,753 $ 57
=====================================================================================
Basic and diluted net income (loss) per common share $ (.52) $ .54 $ .02
Weighted average common shares outstanding:
Basic weighted average common shares 3,272 3,272 3,272
Dilutive effect of stock options 11 3 2
-------------------------------------------------------------------------------------
Diluted weighted average common and
common equivalent shares 3,283 3,275 3,274
=====================================================================================
See accompanying notes to consolidated financial statements.
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2001, 2000 and 1999
Common Stock Additional Accum-
---------------- Paid-in ulated
(In thousands) Shares Amount Capital deficit Total
-----------------------------------------------------------------------------------------
Balance at December 31, 1998 3,264 $3 $12,200 $(5,859) $6,344
Stock options exercised 8 - 16 - 16
Net income - - - 57 57
-----------------------------------------------------------------------------------------
Balance at December 31, 1999 3,272 3 12,216 (5,802) 6,417
Compensatory stock options issued - - 32 - 32
Net income - - - 1,753 1,753
-----------------------------------------------------------------------------------------
Balance at December 31, 2000 3,272 3 12,248 (4,049) 8,202
Compensatory stock options issued - - 37 - 37
Net loss - - - (1,708) (1,708)
-----------------------------------------------------------------------------------------
Balance at December 31, 2001 3,272 $3 $12,285 $(5,757) $6,531
=========================================================================================
See accompanying notes to consolidated financial statements.
19
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2001, 2000 and 1999
(In thousands) 2001 2000 1999
---------------------------------------------------------------------------------------
Operating Activities:
Net income (loss) $(1,708) $ 1,753 $ 57
Adjustments to reconcile net income (loss) to net
cash flows provided (used) by operating activities:
Provision for losses on inventories 1,443 947 155
Depreciation and amortization 257 305 358
Minority interest in income of subsidiary 128 - -
Deferred income taxes - (455) -
Value of compensatory stock options issued 37 32 -
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable 3,394 138 (1,715)
Decrease (increase) in inventories 1,311 (589) (844)
(Increase) decrease in other assets (18) (92) 25
(Decrease) increase in accounts payable (995) 1,338 1,009
(Decrease) increase in accrued expenses
and other liabilities (848) 728 311
---------------------------------------------------------------------------------------
Net cash provided (used) by operating activities 3,001 4,105 (644)
---------------------------------------------------------------------------------------
Investing Activities:
Purchases of property and equipment (130) (163) (282)
---------------------------------------------------------------------------------------
Net cash used in investing activities (130) (163) (282)
---------------------------------------------------------------------------------------
Financing Activities:
Repayments under inventory finance agreement - (1,175) (1,907)
(Repayments) borrowings under revolving credit lines (1,689) (2,750) 2,751
Repayments of capital lease obligation (102) (89) (78)
Capital contribution from minority interest partner 25 - -
Proceeds from exercise of stock options - - 16
---------------------------------------------------------------------------------------
Net cash (used) provided by financing activities (1,766) (4,014) 782
---------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 1,105 (72) (144)
Cash and cash equivalents at beginning of year 374 446 590
---------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 1,479 $ 374 $ 446
=======================================================================================
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 155 $ 302 $ 349
Income taxes 87 15 10
See accompanying notes to consolidated financial statements.
20
FARMSTEAD TELEPHONE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business Operations
Farmstead Telephone Group, Inc. ("Farmstead" or the "Company") is
principally engaged as a secondary market reseller, and Authorized
Remarketing Supplier of Classic Avaya(TM) and new Avaya Inc. ("Avaya")
business telecommunication products. Its products are primarily customer
premises-based private switching systems and peripheral products, including
voice processing systems. The Company also provides telecommunications
equipment repair and refurbishing, rental, inventory management, and
related value-added services. The Company sells its products and services
to both large and small end-user businesses, government agencies, and other
secondary market companies. During the years ended December 31, 2001 and
2000, no single customer accounted for more than 10% of revenues. One
customer, Lucent Technologies, Inc. accounted for 15% of the Company's
revenues during the year ended December 31, 1999.
Principles of Consolidation
The consolidated financial statements presented herein include the
accounts of the Company, its wholly- owned inactive subsidiary, FTG Venture
Corporation, and its 50.1% owned subsidiary, InfiNet Systems, LLC
("InfiNet").
Use of Estimates
The preparation of consolidated financial statements in conformity
with U.S. generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts and
disclosures in the consolidated financial statements. Actual results could
differ from those estimates. Estimates are used in accounting for
allowances for uncollectible receivables, inventory obsolescence,
depreciation, taxes and contingencies, among others. Estimates and
assumptions are reviewed periodically and the effects of revisions are
reflected in the consolidated financial statements in the period they are
determined to be necessary.
Revenue Recognition
Revenues are recognized when products are shipped or when services
are performed.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an
initial maturity of three months or less to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market, and are valued
on an average cost basis.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the
related assets, which range from three to ten years, except for leasehold
improvements, which are amortized over the shorter of 10 years or the
remaining lease term. Maintenance, repairs and minor renewals are charged
to operations as incurred.
Income Taxes
The Company provides for income taxes under the asset and liability
method, under which deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax basis. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.
Net Income (Loss) Per Share
Basic net income (loss) per common share was computed by dividing net
income (loss) (the numerator) by the weighted average number of common
shares outstanding (the denominator) during the period. Diluted net income
(loss) per common share was computed by increasing the denominator by the
weighted average number of
21
additional shares that could have been outstanding from securities
convertible into common stock, such as stock options and warrants, unless
their effect on net income (loss) per share is antidilutive. The following
table shows securities outstanding as of December 31 that could potentially
dilute basic earnings per common share in the future that were not included
in the computation of diluted earnings per common share because to do so
would have been antidilutive (in thousands):
2001 2000 1999
---------------------------------------------------------------------
Stock Options 1,875 1,948 1,790
Warrants 2,472 2,472 2,472
Underwriter Options and Warrants (Note 8) 339 339 339
---------------------------------------------------------------------
Total 4,686 4,759 4,601
=====================================================================
Segment Information
In the opinion of management, the Company operates in one industry
segment, which is the sale of telecommunications equipment.
Reclassification
Certain amounts in the prior year financial statements have been
reclassified to conform to the current year presentation.
2. CASH AND CASH EQUIVALENTS
Cash and cash equivalents at December 31, 2001 and 2000 includes an
investment in a money market fund consisting of high quality short term
instruments, principally U.S. Government and Agency issues and commercial
paper. The carrying amounts approximate their fair value at December 31,
2001 and 2000.
3. PROPERTY AND EQUIPMENT, NET
As of December 31, the components of property and equipment, net were
as follows (in thousands):
2001 2000
--------------------------------------------------------------------
Equipment $ 1,262 $ 1,161
Furniture and fixtures 76 76
Leasehold improvements 127 127
Leased equipment under capital lease 381 381
--------------------------------------------------------------------
1,846 1,745
Less accumulated depreciation and amortization (1,341) (1,113)
--------------------------------------------------------------------
Property and equipment, net $ 505 $ 632
====================================================================
Leased equipment under capital lease at December 31, 2001 and 2000
consisted principally of office furniture, equipment and computer
equipment. The accumulated amortization of the leased equipment was
$326,000 and $277,000 at December 31, 2001 and 2000, respectively.
Depreciation and amortization expense for the years ended December 31,
2001, 2000 and 1999 totaled $257,000, $305,000 and $358,000, respectively.
4. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
As of December 31, the components of accrued expenses and other
current liabilities were as follows (in thousands):
2001 2000
------------------------------------------------------------------
Salaries, commissions and benefits $420 $1,137
License fees payable to Avaya (Note 9) 42 210
Other 105 146
------------------------------------------------------------------
Accrued expenses and other current liabilities $567 $1,493
==================================================================
22
5. DEBT OBLIGATIONS
Debt Maturing Within One Year
-----------------------------
As of December 31, debt obligations consisted of the following (in
thousands):
2001 2000
------------------------------------------------------
Revolving credit agreement(a) $ - $1,689
Obligation under capital lease(b) 37 139
------------------------------------------------------
37 1,828
Less debt maturing within one year (37) (102)
------------------------------------------------------
Long-term debt $ - $1,726
------------------------------------------------------
(a) On June 14, 1999, the Company entered into a two-year, $10
million business financing agreement (the "Credit Agreement") with
Deutsche Financial Services Corporation ("DFS"), replacing a $6 million
revolving credit line with First Union National Bank ("FUNB") and a $4
million inventory credit line with Finova Capital Corporation. The Credit
Agreement contained the following credit sublimits: (i) a $10 million
accounts receivable-based credit line, (ii) a $10 million inventory
floorplan credit line to finance product purchased directly from Lucent
Technologies, Inc. ("Lucent") or an approved Lucent distributor, and (iii)
a $1.5 million supplemental inventory-based credit line. Borrowings under
the accounts receivable line were advanced at 80% of eligible receivables,
while borrowings under the supplemental inventory-based line were advanced
at 50% of the cost of eligible refurbished inventory, and between 50-100%
of the cost of new equipment purchased from Lucent, or an approved Lucent
distributor, through DFS's floorplan financing program. Borrowings were at
prime plus .50% (9.0% at December 31, 1999). Borrowings under the $10
million inventory floorplan credit line, which were $1,175,000 at December
31, 1999, were repayable, interest-free in either two or three equal
monthly installments. The facility called for a commitment fee of .09% of
the aggregate credit line. There were no compensating balance
requirements. The Credit Agreement restricted the Company from the payment
of dividends without the consent of DFS, and required the Company to
maintain a minimum tangible net worth of $5.75 million on and after
December 31, 1999. The Credit Agreement also contained covenants requiring
the Company to maintain certain debt-to-equity, interest coverage and
current asset ratios, and minimum profitability levels.
On September 27, 2000, the Company entered into a two-year, $8
million revolving loan agreement (the "Loan Agreement") with FUNB,
replacing the DFS credit facility. Under the terms of the FUNB Loan
Agreement, borrowings are advanced at 75% of eligible accounts receivable
(primarily receivables that are less than 90 days old), and at 50% of the
value of eligible inventory (inventory that was purchased new or
refurbished and ready for sale), provided that the amount advanced against
eligible inventory shall not exceed $2 million. The interest rate charged
the Company on outstanding borrowings is the LIBOR Market Index Rate plus
2.5% (4.37 % at December 31, 2001). The Company is also charged an
availability fee equal to .25% per annum on the unused portion of the
available credit line. Since it was the Company's intent to maintain this
credit facility for longer than one year, borrowings at December 31, 2000
were classified as long-term debt. The Loan Agreement restricts the
Company from the payment of dividends without the consent of FUNB, and
requires the Company to maintain a minimum tangible net worth of $6 million
at all times. The Loan Agreement also contains financial covenants
requiring the Company to maintain certain debt-to-equity and funds flow
coverage ratios. On December 19, 2001, the Loan Agreement was modified to
suspend the measurement date of the funds flow coverage ratio until the
first quarter ending March 31, 2002. As a result, the Company was in
compliance with its loan requirements at December 31, 2001. The Company
currently anticipates that it will not be in compliance with its funds flow
coverage ratio at March 31, 2002, and has started discussions with its bank
on further amending its covenants. The Company anticipates that it will be
able to reach agreement on a modification of its loan covenants, and that
it will continue its current credit facility on terms substantially similar
to its current terms. As of December 31, 2001, the Company did not have
any outstanding borrowings under the $8 million facility, and approximately
$2,722,000 was available under various borrowing formulas. The average and
highest amounts borrowed during the year ended December 31, 2001 were
approximately $1,896,000 and $2,876,000, respectively.
(b) In May 1997, the Company entered into a five year, noncancelable
lease agreement to finance $419,000 of office furniture, equipment and
computer equipment acquired in connection with the Company's facility
relocation. Monthly lease payments are $9,589, with a $1.00 purchase
option at the end of the lease. The effective interest rate
23
on the capitalized lease obligation is 13.29%. As of December 31, 2001,
the future minimum annual lease payments, all payable in 2002, total
$37,556, of which amount $1,015 represents interest.
The carrying values of the Company's borrowings approximated their
fair values at December 31, 2001 and 2000.
6. FORMATION AND ACQUISITION OF INFINET SYSTEMS, LLC
Effective February 1, 2001, the Company entered into a joint venture
agreement with TriNet Business Trust ("TriNET"), forming a limited
liability corporation operating under the name of InfiNet Systems, LLC
("InfiNet"). Under the agreement, the Company had a 50.1% ownership
interest, and TriNET had a 49.9% ownership interest. With operations based
in East Hartford, CT, InfiNet is an Avaya dealer, authorized to sell new
Avaya telecommunications systems primarily to customers within the State of
Connecticut and various counties in the State of New York. InfiNet was
initially funded by an aggregate capital contribution of $50,000. InfiNet
recorded revenues, net of intercompany sales to the Company, of $4,666,000
and net income of $256,000 from its inception to December 31, 2001.
InfiNet's total assets at December 31, 2001 were $1,150,000. Since the
Company owns greater than a 50% interest in, and exercises significant
control over, InfiNet, the financial statements of InfiNet have been
consolidated herein. All intercompany balances and transactions have been
eliminated.
In February, 2002, the Company acquired, effective January 1, 2002,
TriNET's 49.9% ownership interest in InfiNet for an aggregate cash purchase
price of $153,334. The acquisition will be accounted for as a purchase in
fiscal 2002.
7. STOCK OPTIONS
The Company's 1992 Stock Option Plan ("1992 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. The maximum number of shares issuable under the 1992 Plan, which
expires May 1, 2002, was originally 3,500,000. During 2001, in connection
with the adoption of an Employee Stock Purchase Plan, the Company reduced
the number of shares issuable under the 1992 Plan to 3,250,000. Options
currently granted expire on various dates through 2011. A summary of stock
option transactions for each of the three years in the period ended
December 31, 2001 is as follows:
Weighted
Average
Number Exercise Exercise
of Shares Price Range Price
--------------------------------------------------------------------------
Outstanding at December 31, 1998 1,761,429 $1.19 - 11.80 $2.04
Granted 92,017 1.12 - 2.56 1.89
Exercised (8,000) 2.00 2.00
Canceled or expired (53,100) 1.19 - 6.70 2.42
--------------------------------------------------------------------------
Outstanding at December 31, 1999 1,792,346 $1.12 - 11.80 $2.02
Granted 366,900 1.19 - 2.00 1.42
Exercised - - -
Canceled or expired (208,210) 1.12 - 2.69 1.92
--------------------------------------------------------------------------
Outstanding at December 31, 2000 1,951,036 $1.12 - 11.80 $1.92
Granted 379,300 .68 - 2.04 1.53
Exercised - - -
Canceled or expired (455,530) 1.12 - 3.12 1.65
--------------------------------------------------------------------------
Outstanding at December 31, 2001 1,874,806 $ .68 - 1.80 $1.91
==========================================================================
As of December 31, 2001:
Exercisable 1,398,806 $1.12 - 11.80 $1.99
Available for future grant 1,363,236
24
The following summarizes information about stock options outstanding
and exercisable as of December 31, 2001:
Options Outstanding Options Exercisable
------------------------------------------------------- -----------------------------
Weighted Avg.
Range of Number Remaining Weighted Avg. Number Weighted Avg.
Exercise Prices Outstanding Contractual Life (Yrs) Exercise Price Exercisable Exercise Price
--------------- ----------- ---------------------- -------------- ----------- --------------
$ .68 - 1.00 6,000 9.8 $ .75 - $ -
$1.01 - 1.50 319,400 7.7 1.29 172,650 1.44
$1.51 - 2.00 1,464,556 6.0 1.96 1,192,806 1.97
$2.01 - 5.00 70,500 7.7 2.39 19,000 3.30
$5.01 - 11.80 14,350 2.4 8.55 14,350 8.55
-----------------------------------------------------------------------------------------------------------
Total 1,874,806 6.4 $1.91 1,398,806 $1.99
===========================================================================================================
The Company applies Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its stock option plans. Accordingly, compensation cost for
stock options is recorded as the excess, if any, of the market price of the
Company's common stock at the date of grant over the exercise price of the
option. Had compensation cost for the Company's stock option plans been
determined in accordance with the methodology prescribed under Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", the Company's net income (loss) and basic and diluted net
income (loss) per share would have approximated the pro forma amounts shown
below for each of the years ended December 31 (in thousands except per
share amounts):
2001 2000 1999
--------------------- --------------------- ---------------------
As As As
Reported Pro forma Reported Pro forma Reported Pro forma
-------- --------- -------- --------- -------- ---------
Net income (loss) $(1,708) $(1,958) $1,753 $1,380 $57 $(262)
Basic net income (loss) per share (.52) (.60) .54 .42 .02 (.08)
Diluted net income (loss) per share (.52) (.60) .54 .42 .02 (.08)
=======================================================================
The fair value of stock options used to compute pro forma net income
(loss) and net income (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 2001,
2000, and 1999; expected volatility of 115% for 2001, 117% for 2000, and
194% for 1999; risk-free interest rate of 4.3% for 2001, 5.7% for 2000, and
5.5% for 1999; and an expected option holding period of 5 years for 2001,
2000, and 1999. The weighted average fair value of options granted during
2001, 2000, and 1999 was $1.24, $1.17, and $1.59, respectively.
8. STOCKHOLDERS' EQUITY
As of December 31, 2001, the following securities were outstanding:
(a) 33,136 Underwriter Options, exercisable at $7.50 per unit, each
unit consisting of one share of common stock, and one warrant to purchase
1.07 shares of common stock at $4.67. These options, and the underlying
warrants, expire June 30, 2002. The Underwriter Options were issued in
connection with the Company's 1987 initial public offering.
(b) 183,579 warrants issued in connection with the Company's 1987
initial public offering, exercisable at $4.67 per share, and entitling the
holder to purchase 1.07 shares of common stock. The warrants expire June
30, 2002. The warrants are redeemable at the option of the Company at $.05
per warrant, provided the average of the last reported sales price for ten
consecutive business days, ending five days before notice of the redemption
is given, of the common stock exceeds $11.25 per share.
(c) 1,137,923 Redeemable Class A Common Stock Purchase Warrants
("Class A Warrant"), and 1,137,923 Redeemable Class B Common Stock Purchase
Warrants ("Class B Warrant"), each exercisable at $2.00 per share, and
entitling the holder to purchase one share of common stock. These warrants
expire June 30, 2002. The warrants
25
are redeemable at the option of the Company at $.10 per warrant, provided
the average of the last reported sales price for twenty consecutive
business days, ending five days before notice of the redemption is given,
of the common stock exceeds $2.90 per share.
(d) 89,948 Representative Warrants to purchase 89,948 units at an
exercise price of $2.90 per unit. Each unit consists of one share of
common stock, one Class A Warrant and one Class B Warrant. The
Representative Warrants were issued in 1996 to the Company's underwriter in
connection with a secondary offering of securities, and they expire June
30, 2002.
9. LEASES AND OTHER COMMITMENTS AND CONTINGENCIES
The Company leases 49,897 square feet of office and warehouse space
under non-cancelable leases expiring December 31, 2004. The leases contain
two, three-year renewal options. As of December 31, 2001, future minimum
annual rental payments were as follows: $255,945 for 2002, $257,104 for
2003 and $257,104 for 2004. Rent expense, which included short-term rentals
of warehouse space in 2000 and 1999, was $250,146 in 2001, $277,624 in 2000
and $225,229 in 1999.
Effective January 1, 1998, the Company entered into a ten-year
employment agreement with the Chief Executive Officer ("CEO"). The
agreement provides for five years of full-time employment (the "Active
Period"), and five years of limited employment (the "Limited Period"). The
Limited Period commences January 1, 2003. The CEO's annual base salary was
set at $300,000 for calendar years 2000 through 2002. During the Limited
Period, the CEO will be paid an annual amount equal to one-third of the
base salary rate in effect at the commencement of the Limited Period, as
consideration for up to fifty days of active service per year. The
agreement provides that the CEO will be eligible for an annual bonus of up
to 50% of base salary during the term of the agreement, and $1,500,000 in
life insurance for the benefit of the CEO's named designee. The agreement
also provides severance pay for the CEO during the term should the Company
terminate the agreement without cause, or in the event of a change in
control of the Company, as defined. During the Active Period, severance
pay will equal three times (i) the amount of the then-current base pay,
plus (ii) the average bonus paid during the three most recent calendar
years. During the Limited Period, severance pay will equal the total
amount that would have been due for the time remaining in the Limited
Period. The CEO was also granted an option in January 1998 to purchase up
to 500,000 shares of common stock at the fair market value on the date of
grant.
The aforementioned agreement was amended effective August 1, 2001 to
reduce the CEO's annual base salary to $200,000 from August 1, 2001 through
December 31, 2002 (the CEO's base salary had previously been reduced to
$285,000 in April, 2001) and to increase the amount of base salary payable
to the CEO during the initial year of the Limited Period by the total
amount of the salary reductions imposed during calendar years 2001 and
2002. The amendment also fixed the CEO's base salary at $300,000 for the
purpose of computing compensation entitlements during the Limited Period,
and to provide that severance otherwise payable to the CEO under the
agreement would not be diminished by the salary reductions.
In October 1998, the Company entered into a license agreement with
Lucent, under which the Company was granted a non-exclusive license to use
the Classic Lucent TM trademark in connection with the refurbishing,
marketing and sale of Lucent products sold under the ARS Agreement. In
October 2000, the license agreement was transferred to Avaya and, on
February 2, 2001 both the ARS and license agreements were extended to
December 31, 2003. Under the license agreement, the Company is required to
pay Avaya license fees based upon the sales price of Classic Avaya products
sold by the Company. Over the period of the license agreement, said fees
have ranged from 10% to 6.5% (6.5% effective October 1, 2001). The Company
recorded in cost of revenues approximately $1,341,000, $2,097,000 and
$1,530,000 of fee expense in 2001, 2000 and 1999, respectively.
10. EMPLOYEE BENEFIT PLANS
The Company maintains a Supplemental Executive Retirement Plan
("SERP") for the benefit of its CEO. The SERP is a "target" benefit plan,
structured to provide the CEO with an annual retirement benefit, payable
over 15 years beginning at age 65, in an amount equal to one-third of the
CEO's average final three-year salary, however in no event less than
$100,000 per year. The SERP is being funded through a Company-owned life
insurance policy which has a projected $50,000 annual premium for ten
years. The cash surrender value of this policy was $140,340 and $128,078
at December 31, 2001 and 2000, respectively. The Company used the
Projected Unit Credit Method
26
and a 7% interest rate in determining the amount of benefit obligation
expense to accrue each year. The following table shows the changes in the
benefit obligation in each of the two years ended December 31 (in
thousands):
2001 2000
-------------------------------------------------------
Benefit obligation at beginning of year $182 $113
Service cost 61 57
Interest cost 17 12
-------------------------------------------------------
Benefit obligation at end of year $260 $182
=======================================================
The Company provides a split dollar life insurance program for
certain of its officers as a means of providing a life insurance benefit
and a future retirement benefit. Under this program, the Company may make
discretionary contributions of up to 10% of each participant's annual
compensation, and such contributions amounted to $49,506 in 2001, $71,167
in 2000 and $67,660 in 1999. The Company recognized expense of $34,231 in
2001, $45,849 in 2000 and $26,928 in 1999. The accumulated value of each
participant's account vests with the participant over a ten year period,
based on years of service, with each participant 100% vested upon the later
of attainment of age 65 or the completion of five years of service with the
Company.
Employee Stock Purchase Plan ("ESPP")
-------------------------------------
In September, 2001, the Company established an ESPP, following
stockholder approval, under which an initial 250,000 shares of common stock
could be sold to employees. Beginning in 2003, an annual increase of the
lesser of (i) 100,000 shares of common stock, (ii) 2% of the Company's
issued and outstanding capital stock on January 1 of such year, and (iii)
an amount determined by the Company's board of directors, can be added to
the ESPP. The ESPP covers all employees working more than 20 hours per
week, excluding employees owning 5% or more of the combined voting power of
all classes of shares of the Company or its subsidiary corporations. The
ESPP provides for six-month "offering periods" beginning September 14,
2001, with a final offering period beginning March 1, 2011, and during such
periods employees can participate through payroll deductions of up to 10%
of their earnings. At the end of each offering period, initially February
28, 2002, the participating employees will be able to purchase stock at a
15% discount to the market price of Company stock at either the beginning
or end of the offering period, whichever is lower. Shares purchased
through the ESPP cannot exceed $25,000 in fair market value per person per
calendar year. The shares purchased are allocated to an account
established for each participant at a brokerage firm. As of December 31,
2001, employees had contributed $18,475 into the plan. The shares issuable
pursuant to the ESPP were registered on Form S-8 (No. 333-69290) dated
September 11, 2001.
11. INCOME TAXES
The following table provides a summary of the current and deferred
components of the (benefit) provision for federal and state income taxes
attributable to earnings before income taxes for the three years ended
December 31 (in thousands):
2001 2000 1999
--------------------------------------------------------------
Federal income tax expense:
Current $ - $ 37 $ -
Deferred - (406) -
State income tax expense
Current 17 23 (2)
Deferred - (49) -
--------------------------------------------------------------
Provision (benefit) for income taxes $17 $(395) $(2)
==============================================================
Differences between the tax (benefit) expense reflected in the
financial statements and the amounts calculated at the federal statutory
income tax rate of 34% for the three years ended December 31 are as follows
(in thousands):
27
2001 2000 1999
----------------------------------------------------------------------------
Income tax provision (benefit) at statutory rate $(581) $ 458 $ 19
Increase (reduction) in income taxes
resulting from:
State and local income taxes, net of federal
income tax benefit (11) (66) 12
Non-deductible life insurance 25 24 33
Non-deductible meals and entertainment 19 26 20
Utilization of net operating loss - (690) (125)
Change in valuation allowance 565 (148) 38
Other - 1 1
----------------------------------------------------------------------------
Provision (benefit) for income taxes $ 17 $(395) $ (2)
============================================================================
The tax effects of temporary differences that give rise to
significant portions of deferred tax assets and liabilities at December 31,
2001 and 2000 are as follows (dollars in thousands):
2001 2000
-------------------------------------------------------------------
Deferred tax assets:
Allowance for doubtful accounts $ 60 $ 98
Inventory capitalization and allowances 552 380
Accrued vacation 57 84
Other 103 73
Net operating loss and capital loss carryforwards 722 275
-------------------------------------------------------------------
Total gross deferred tax assets 1,494 910
Less: valuation allowance (1,039) (455)
-------------------------------------------------------------------
Net deferred tax assets $ 455 $455
===================================================================
The Company has federal net operating loss carryforwards of
approximately $1,900,000 which expire through 2021. A full valuation
allowance of the entire net deferred tax asset was warranted for 1999 due
to the Company's history of cumulative operating losses. In 2000, the
valuation allowance was reduced to approximately $455,000 as a result of
positive earnings in 2000 and partial utilization of the Company's net
operating loss carryforwards. In 2001, the valuation allowance was
increased by an amount which fully offsets the increase in the Company's
deferred tax assets as of December 31, 2001. Management believes that the
present valuation allowance is prudent due to the historical volatility of
earnings.
12. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data for 2001 and 2000 is as follows
(in thousands except earnings (loss) per share):
Quarter
---------------------------------------------------------------------------------------------
2001 First Second Third Fourth
---------------------------------------------------------------------------------------------
Net Sales $9,294 $8,016 $8,762 $7,267
Gross Profit 2,425 1,331 1,989 913
Net income (loss) 154 (1,133) 10 (739)
Basic and diluted earnings (loss) per common share .05 (.35) - (.52)
Weighted average common shares outstanding - Basic 3,272 3,272 3,272 3,272
Weighted average common shares outstanding - Diluted 3,357 3,302 3,272 3,272
=============================================================================================
28
Quarter
-----------------------------------------------------------------------------------------------
2000 First Second Third Fourth
-----------------------------------------------------------------------------------------------
Net Sales $9,449 $11,125 $11,068 $11,144
Gross Profit 1,952 2,141 2,921 3,056
Net income 23 179 607 944
Basic and diluted earnings per common share .01 .05 .19 .29
Weighted average common shares outstanding - Basic 3,276 3,273 3,273 3,273
Weighted average common shares outstanding - Diluted 3,276 3,274 3,274 3,274
===============================================================================================
13. RELATED PARTY TRANSACTIONS
During the years ended December 31, 2001 and 2000, and continuing
into 2002, the Company has engaged PFS Venture Group LLC ("PFS") to assist
the Company with its strategic reorganization initiatives. PFS is in the
business of providing consulting services to small to mid-size companies.
PFS is owned by Mr. Bruce S. Phillips who, in June 2001, became a director
of the Company. Under the terms of the current agreement, PFS receives a
monthly fee of $7,000 plus a monthly stock option grant to purchase 3,500
shares of common stock at an exercise price of $1.50 per share. The
current agreement is on a month-to-month basis, and can be terminated upon
three-month's notice. The Company expensed $121,000 in 2001 and $97,000 in
2000 under this agreement.
29
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Farmstead Telephone Group, Inc.
We have audited the consolidated financial statements of Farmstead
Telephone Group, Inc. and subsidiaries (the "Company") as of December 31,
2001, and for the year then ended, and have issued our report thereon dated
February 21, 2002; such consolidated financial statements and report are
included elsewhere in this Form 10-K. Our audit also includes the
financial statement schedule of Farmstead Telephone Group, Inc. and
subsidiaries, listed in Item 14. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to
express an opinion based on our audit. In our opinion, such financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
DISANTO BERTOLINE & COMPANY, P.C.
Glastonbury, Connecticut
February 21, 2002
30
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Farmstead Telephone Group, Inc.
East Hartford, Connecticut
We have audited the consolidated financial statements of Farmstead
Telephone Group, Inc. and subsidiary (the "Company") as of December 31,
2000 , and for each of the two years in the period ended December 31, 2000,
and have issued our report thereon dated February 21, 2001; such report is
included elsewhere in this Form 10-K. Our audits also included the
financial statement schedule of Farmstead Telephone Group, Inc. for each of
the two years in the period ended December 31, 2000, listed in Item 14.
This financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our
audits. In our opinion, such financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents
fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Hartford , Connecticut
February 21, 2001
31
SCHEDULE II: VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
Column C- Additions
------------------------
Column B- (1) (2) Column E-
Balance at Charged to Charged to Balance at
beginning of costs and other Column D- End of
Column A- Description period expenses accounts Deductions* period
--------------------- ------------ ---------- ---------- ----------- ----------
Allowance for doubtful accounts:
Year ended December 31, 2001 $244 $ 104 $198 $ 150
Year ended December 31, 2000 266 92 114 244
Year ended December 31, 1999 287 23 44 266
Inventory valuation reserves:
Year ended December 31, 2001 935 1,443 996 1,382
Year ended December 31, 2000 128 947 140 935
Year ended December 31, 1999 57 155 84 128
--------------------
* Represents write-offs of inventories and uncollectible accounts
receivable.
32
INDEX TO EXHIBITS
The following documents are filed as Exhibits to this report on Form
10-K or incorporated by reference herein. Any document incorporated by
reference is identified by a parenthetical referencing the SEC filing which
included such document.
3(a) Certificate of Incorporation [Exhibit 3(a) to the S-18
Registration Statement of the Company's securities declared
effective on April 13, 1987 (File No. 3-9556B)]
3(b) Certificate of Amendment of Certificate of Incorporation
[Exhibit 3(a) to Amendment No. 2 to SB-2 Registration
Statement dated July 22, 1996 (Registration No. 333-5103)]
3(c) Certificate of Amendment of Certificate of Incorporation of
Farmstead Telephone Group, Inc., dated July 10, 1991 [Exhibit
10.12 to the Annual Report on Form 10-K for the year ended
December 31, 1991]
3(d) Amended and Restated By-Laws [Exhibit 3(d) to the Annual
Report on Form 10-K for the year ended December 31, 2000]
3(e) Certificate of Amendment of Certificate of Incorporation of
Farmstead Telephone Group, Inc. dated July 9, 2001 [Exhibit
3(e) to the Quarterly Report on Form 10-Q for the quarter
ended June 30, 2001]
4(a) Form of Unit Warrant [ Exhibit 4(a) to the S-18 Registration
Statement of the Company's securities declared effective on
April 13, 1987 (File No. 3-9556B)]
4(b) Amended Form of Underwriter's Option [ Exhibit 4(b) to the
S-18 Registration Statement of the Company's securities
declared effective on April 13, 1987 (File No. 3-9556B)]
4(c) Resolutions adopted by Unanimous Written Consent of the
Company's Board Of Directors dated as of July 9, 1992
amending terms of Warrants and Underwriter's Options [Exhibit
4(a) to the Form S-3 Registration Statement of the Company's
securities declared effective on October 29, 1992
(Registration No. 33-50432)]
4(d) Amended 1992 Stock Option Plan [Exhibit to the Proxy
Statement on Schedule 14A filed April 14, 1998 (File No.
001-12155)]
4(e) Form of Underwriter's Warrant Agreement (including Form of
Underwriter's Warrant) [Exhibit 4.2 to the SB-2 Registration
Statement dated June 3, 1996 (Registration No. 333-5103)]
4(f) Form of Warrant Certificate [Exhibit 4.1 to Amendment No. 2
to SB-2 Registration Statement dated July 22, 1996
(Registration No. 333-5103)]
4(g) Form of Warrant Agreement [Exhibit 4.3 to Amendment No. 2 to
SB-2 Registration Statement dated July 22, 1996 (Registration
No. 333-5103)]
4(h) Form of Unit Certificate [Exhibit 4.4 to Amendment No. 2 to
SB-2 Registration Statement dated July 22, 1996 (Registration
No. 333-5103)]
4(i) Resolutions adopted by the Company's Board of Directors June
18, 1998, amending terms of Warrants and Underwriter's
Options [Exhibit 4(I) to the Annual Report on Form 10-KSB for
the year ended December 31, 1998]
4(j) Resolutions adopted by the Company's Board of Directors July
19, 2001, amending terms of warrants and Underwriter's
Options. [Exhibit 4(j) to the Quarterly Report on Form 10-Q
for the quarter ended June 30, 2001]
10(a) Commercial Revolving Loan and Security Agreement dated June
5, 1995, between Farmstead Telephone Group, Inc. and
Affiliated Business Credit Corporation [Exhibit 10.2 to the
Quarterly Report on Form 10-QSB for the quarter ended June
30, 1995]
10(b) Letter agreement dated March 11, 1996, amending the
Commercial Revolving Loan and Security Agreement dated June
5, 1995 between Farmstead Telephone Group, Inc. and
Affiliated Business Credit Corporation [Exhibit 10.1 to the
Annual Report on Form 10-KSB for the year ended December 31,
1995]
10(c) Form of Underwriter's Consulting Agreement [ Exhibit 10.1 to
the SB-2 Registration Statement dated June 3, 1996
(Registration No. 333-5103)]
10(d) Letter of Agreement dated June 3, 1996 between Farmstead
Telephone Group, Inc. and Lucent Technologies, Inc. [Exhibit
10.2 to Amendment No. 1 to SB-2 Registration Statement dated
July 22, 1996 (Registration No. 333-5103)]
10(e) Agreement of Lease By and between Tolland Enterprises and
Farmstead Telephone Group, Inc., dated November 5, 1996
[Exhibit 10.1 to the Quarterly Report on Form 10-QSB for the
quarter ended September 30, 1996]
33
10(f) Letter agreement dated as of May 30, 1997 by and among
Farmstead Telephone Group, Inc. (the "Borrower"), Farmstead
Asset Management Services, LLC (the "Guarantor") and First
Union Bank of Connecticut (successor-in-interest to
Affiliated Business Credit Corporation) (the "Lender"),
amending the Commercial Revolving Loan and Security Agreement
dated June 5, 1995, as amended, between Borrower and Lender
[Exhibit 10.1 to the Quarterly Report on Form 10-QSB for the
quarter ended June 30, 1997]
10(g) Third Amended and Restated Revolving Promissory Note, dated
June 6, 1997, in the amount of $3,500,000 [Exhibit 10.2 to
the Quarterly Report on Form 10-QSB for the quarter ended
June 30, 1997]
10(h) Agreement for Wholesale Financing, dated June 6, 1997, and
related letter agreement dated June 3, 1997 [Exhibit 10.3 to
the Quarterly Report on Form 10-QSB for the quarter ended
June 30, 1997]
10(i) Letter agreement dated as of December 1, 1997 by and among
Farmstead Telephone Group, Inc. (the "Borrower"), Farmstead
Asset Management Services, LLC (the "Guarantor") and First
Union National Bank (successor-in-interest to Affiliated
Business Credit Corporation), amending the Commercial
Revolving Loan and Security Agreement dated June 5, 1995, and
as amended May 30, 1997 [Exhibit 10.4 to the Annual Report
on Form 10-KSB for the year ended December 31, 1997]
10(j) Employment Agreement dated as of January 1, 1998 between
Farmstead Telephone Group, Inc. and George J. Taylor, Jr.
[Exhibit 10.5 to the Annual Report on Form 10-KSB for the
year ended December 31, 1997]
10(k) Supplemental Executive Retirement Plan, effective as of
January 1, 1998 [Exhibit 10.6 to the Annual Report on Form
10-KSB for the year ended December 31, 1997]
10(l) ARS Dealer Agreement Between Lucent Technologies and
Farmstead Telephone Group, Inc. For Business Communications
Systems [Exhibit 10(s) to the Annual Report on Form 10-KSB
for the year ended December 31, 1998]
10(m) ARS License Agreement Between Lucent Technologies and
Farmstead Telephone Group, Inc. For Authorized Remarketing
Supplier Program [Exhibit 10(t) to the Annual Report on Form
10-KSB for the year ended December 31, 1998]
10(n) Letter agreement dated as of August 24, 1998 between
Farmstead Telephone Group, Inc. and First Union National
Bank, amending the Commercial Revolving Loan and Security
Agreement dated June 5, 1995, as amended [Exhibit 10(u) to
the Annual Report on Form 10-KSB for the year ended December
31, 1998]
10(o) Letter agreement dated as of September 29, 1998 between
Farmstead Telephone Group, Inc. and First Union National
Bank, amending the Commercial Revolving Loan and Security
Agreement dated June 5, 1995, as amended [Exhibit 10(v) to
the Annual Report on Form 10-KSB for the year ended December
31, 1998]
10(p) Letter agreement dated as of October 15, 1998 between
Farmstead Telephone Group, Inc. and First Union National
Bank, amending the Commercial Revolving Loan and Security
Agreement dated June 5, 1995, as amended [Exhibit 10(w) to
the Annual Report on Form 10-KSB for the year ended December
31, 1998]
10(q) Letter agreement dated as of January 1, 1999 between
Farmstead Telephone Group, Inc. and First Union National
Bank, amending the Commercial Revolving Loan and Security
Agreement dated June 5, 1995, as amended [Exhibit 10(x) to
the Annual Report on Form 10-KSB for the year ended December
31, 1998]
10(r) Finova Capital Corporation letter agreement dated October 5,
1998 [Exhibit 10(y) to the Annual Report on Form 10-KSB for
the year ended December 31, 1998]
10(s) Finova Capital Corporation letter agreement dated February 4,
1999 [Exhibit 10(z) to the Annual Report on Form 10-KSB for
the year ended December 31, 1998]
10(t) Finova Capital Corporation letter agreement dated March 24,
1999 [Exhibit 10(aa) to the Quarterly Report on Form 10-QSB
for the quarter ended March 31, 1999]
10(u) Business Financing Agreement, dated June 14, 1999, between
Deutsche Financial Services Corporation and Farmstead
Telephone Group, Inc. [Exhibit 10(bb) to the Quarterly Report
on Form 10-QSB for the quarter ended June 30, 1999]
10(v) Rider #1 to Lease Dated November 5, 1996 By and Between
Tolland Enterprises ("Landlord") and Farmstead Telephone
Group, Inc. ("Tenant"), attached as of May 27, 1999 [Exhibit
10(cc) to the Annual Report on Form 10-K for the year ended
December 31, 1999]
34
10(w) First Amendment of Lease, dated June 30, 1999, By and Between
Tolland Enterprises ("Landlord") and Farmstead Telephone
Group, Inc. ("Tenant") [Exhibit 10(dd) to the Annual Report
on Form 10-K for the year ended December 31, 1999]
10(x) Loan Agreement, dated September 27, 2000 between First Union
National Bank and Farmstead Telephone Group, Inc. [Exhibit
10(ee) to the Quarterly Report on Form 10-Q for the quarter
ended September 30, 2000]
10(y) Promissory Note, dated September 27, 2000 between First Union
National Bank and Farmstead Telephone Group, Inc. [Exhibit
10(ff) to the Quarterly Report on Form 10-Q for the quarter
ended September 30, 2000]
10(z) Employment Agreement dated as of January 1, 2000 between
Farmstead Telephone Group, Inc. and Robert G. LaVigne
[Exhibit 10(ee) to the Annual Report on Form 10-K for the
year ended December 31, 2000]
10(aa) Amendment to Lucent ARS License Agreement Between Lucent
Technologies Inc. and Farmstead Telephone Group, Inc., dated
February 2, 2001. [Exhibit 10(ff) to the Annual Report on
Form 10-K for the year ended December 31, 2000]
10(bb) Amendment to Lucent ARS Dealer Agreement Between Lucent
Technologies Inc. and Farmstead Telephone Group, Inc., dated
February 2, 2001. [Exhibit 10(gg) to the Annual Report on
Form 10-K for the year ended December 31, 2000]
10(cc) Farmstead Telephone Group, Inc. Employee Stock Purchase Plan
[Appendix B to the to the Proxy Statement on Schedule 14A
filed April 13, 2001 for the 2001 Annual Meeting of
Stockholders]
10(dd) Limited Liability Company Agreement of InfiNet Systems LLC,
effective February 1, 2001
10(ee) First Modification to Loan Agreement, entered into December
19, 2001
10(ff) Restated First Addendum To That Certain Employment Agreement
Between Farmstead Telephone Group, Inc. and George J. Taylor,
Jr., effective August 1, 2001.
16 Letter re change in certifying accountants [Exhibit 16 to
Form 8-K dated October 23, 2001]
21 Subsidiaries
23(a) Consent of DiSanto Bertoline & Company, P.C.
23(b) Consent of Deloitte & Touche LLP
35