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, 2003
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 (I.R.S. 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 reports), 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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ ] No [X]
The aggregate market value of the voting and non-voting common equity held
by non-affiliates, computed by reference to the closing price on the last
business day of the registrant's most recently completed second fiscal
quarter, was $1,822,159.
As of February 29, 2004, the registrant had 3,311,601 shares of $0.001 par
value Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement to be filed with the
Securities and Exchange Commission in connection with the Annual Meeting of
Stockholders to be held June 10, 2004 are incorporated by reference into
Part III, Items 10 through 14 hereof. Certain exhibits filed with this
registrant's prior registration statements and forms 10-K are incorporated
by reference into Part IV of this Report.
TABLE OF CONTENTS TO FORM 10-K
PART I
Page
----
ITEM 1. BUSINESS 3
ITEM 2. PROPERTIES 7
ITEM 3. LEGAL PROCEEDINGS 7
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 7
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS 7
ITEM 6. SELECTED FINANCIAL DATA 9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 9
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 19
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 19
ITEM 9A. CONTROLS AND PROCEDURES 19
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 19
ITEM 11. EXECUTIVE COMPENSATION 19
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS 20
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 20
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 20
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K 20
SIGNATURES 21
2
PART I
ITEM 1. BUSINESS
GENERAL
Farmstead Telephone Group, Inc. ("Farmstead", the "Company", "we", or
"our") was incorporated in Delaware in 1986. We are principally engaged as
a provider of new and used Avaya, Inc. ("Avaya") business
telecommunications parts, complete systems, and services. We provide used
"Classic Avaya(TM) " telecommunications equipment pursuant to an "Authorized
Remarketing Supplier Program" with Avaya, under which we are one of only
five companies nationwide so authorized. We also offer Avaya's full-line of
new telecommunications parts and complete systems as an Avaya-certified
"Gold Dealer". Our service revenues are under the aegis of our "2 Star"
Avaya Services Agreement. Our product offerings are primarily customer
premises-based private switching systems and peripheral products, including
voice messaging products. We also provide telecommunications equipment
installation, repair and refurbishing, short-term rental, inventory
management, and related value-added services. A portion of our revenues is
also derived from the sale of Avaya maintenance contracts. We sell our
products and services to large and mid-size, multi-location businesses, as
well as to small businesses, government agencies, and other equipment
resellers.
Effective February 1, 2001, we 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, we had a 50.1% ownership interest, and TriNET had a
49.9% ownership interest. Based in East Hartford, Connecticut, 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, we acquired TriNET's
49.9% ownership interest in InfiNet. During 2002, however, we changed our
business strategy concerning the use of InfiNet, downsizing its operating
activities by eliminating its entire workforce and fulfilling systems sales
orders directly through Farmstead, which acquired its own systems dealer
license in 2002. As a result, InfiNet has since been inactive.
Our revenue has declined significantly over the past three years.
Revenue for the years ended December 31, 2003, 2002 and 2001 was $14.68
million, $19.15 million and $33.34 million, respectively. The decline in
revenue is attributable primarily to the effect of general economic
conditions prevailing in the United States and resulting reduced business
spending on enterprise communications equipment. The decline in revenue has
also been the prime contributor to our net losses for the years ended
December 31, 2003, 2002 and 2001 of $709,000, $2,530,000 and $1,708,000,
respectively. Accordingly, we have tried to reduce our losses and return to
profitability through cost reductions and by broadening our product
offerings. Our current strategy is to become less dependent on parts sales,
and become more of a systems and applications solutions provider. We will
expand our product offerings beyond traditional voice communications
products by offering Internet Protocol, or IP, telephony products and
unified communications products including voice messaging. Because we
believe that business capital spending on enterprise communications
equipment will not significantly improve over the short-term, we expect to
have continued pressure on our ability to increase revenues over current
levels.
PRODUCTS
EQUIPMENT
---------
We sell a wide range of Avaya's traditional voice telephony parts and
systems, including Avaya's most advanced enterprise voice communications
system marketed under the DEFINITY(R) and MultiVantage product lines. These
server based product lines provide reliable voice communication and offer
integration with an enterprise's data networks. They support a wide variety
of voice and data applications such as call and customer contact centers,
messaging and interactive voice response. This product also facilitates the
ongoing transition at many enterprises from traditional voice telephony
systems to advanced systems that integrate voice and data traffic and
deploy increasingly sophisticated communications applications, including
"voice over internet protocol (VOIP)", popularized with Avaya's IP Office
product family. For smaller enterprises or small locations of larger ones,
we offer Avaya's, medium to small user voice communications products,
marketed under the MERLIN MAGIX(TM), SPIRIT(R) and PARTNER(R)
Communications Systems product families. We also offer Avaya voice
messaging and unified messaging products such as OCTEL(R) Messaging and
INTUITY(tm) AUDIX(R) Messaging, as well as the latest messaging release
called Modular Messaging.
3
Equipment sales consist of both sales of complete systems and
software applications, and sales of new and refurbished parts (commonly
referred to as "aftermarket" sales). Refurbished products are primarily
sold under the Classic Avaya(TM) label pursuant to a licensing agreement
with Avaya. Aftermarket parts primarily consist of telephone sets and
circuit packs, and other system accessories such as headsets, consoles,
speakerphones and paging systems. Equipment sales revenues accounted for
approximately 88%, 90% and 93% of total revenues in 2003, 2002 and 2001,
respectively.
SERVICES AND OTHER REVENUE
--------------------------
We are committed to respond to our customers' service or project-
oriented telecommunications needs, and believe these services help
differentiate us from our competitors, as well as contribute to longer-
lasting customer relationships and incremental equipment sales. Services
include:
Installation Services: We use Avaya and, to a lesser degree, other
equipment installation companies on a subcontract basis to install
telecommunication parts and systems nation-wide, as well as to perform
equipment moves, adds and changes.
Repair and Refurbishing: We perform fee-based telecommunications
equipment repair and refurbishing services. Until 2003, these services were
provided through a combination of our in-house refurbishing center and the
use of subcontract repair shops. The in-house work primarily consisted of
cleaning, buffing and minor repairs, while major repairs of equipment,
including repair of circuit boards, was outsourced. By the end of 2003, we
had outsourced all equipment repair and refurbishing services to outside
repair shops.
Equipment Rentals: We provide rentals of equipment on a month-to-
month basis, servicing those customers that have temporary, short-term
equipment needs.
Other Services: Our technical staff currently provides system
engineering and configuration, project management, and technical "hot line"
telephone support services.
Other Revenue: A portion of our revenues is derived from the sale of
Avaya communications equipment maintenance contracts. In these transactions
we act as a sales agent of Avaya, and the service obligations are borne
entirely by Avaya.
Our combined service and other revenues accounted for 12%, 10% and 7%
of total revenues in 2003, 2002 and 2001, respectively. The largest
individual component, installation services, accounted for 9%, 8% and 6% of
total revenues in 2003, 2002 and 2001, respectively.
RELATIONSHIP WITH AVAYA INC.
Avaya is one of the leading providers of communications products in
the United States. Avaya provides support to the telecommunications
equipment aftermarket by offering installation and maintenance services for
its products purchased by end-users through equipment resellers. Equipment
resellers like us 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. Avaya generally
provides maintenance of Avaya equipment sold by us.
Our relationship with Avaya is on three main fronts. First, we are a
part of Avaya's 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, 2004;
however it shall automatically renew for an additional one-year term unless
written notice is given by either party of its intent not to renew thirty
days in advance of the termination date. Classic Avaya(TM) products are
defined as used Avaya PBX system and key system parts that have been
refurbished under Avaya quality standards, and sold with a Classic Avaya
label. We are currently one of only five appointed ARS Dealers, none of
whom has been granted an exclusive territory. The ARS Agreement also allows
us to sell certain new Avaya PBX products and voice processing products to
end-users, including government agencies. Second, we are an Avaya-certified
Gold Dealer, authorized to sell new voice and data systems and
applications. And third, Farmstead is a "2 Star" Services partner selling
Avaya installation, maintenance, and moves, adds and changes (MAC)
products.
4
Under the ARS Agreement with Avaya, we are required to pay fees to
Avaya based upon a percentage (currently 6.5%) of the sales price of
Classic Avaya(TM) products sold by us. We also required to pay fees to
Avaya based upon a percentage (currently 15%) of the sales price of Classic
Avaya(TM) products sold through the Company's call center. The Company
recorded in cost of revenues approximately $323,000, $507,000 and $1,341,000
of fee expense in 2003, 2002 and 2001, respectively.
We believe that our relationship with Avaya is satisfactory. Avaya is
currently considering replacing the ARS program with a successor program
which would allow the ARS companies, as well as non-ARS companies, to
purchase refurbished "Classic Avaya" equipment directly from Avaya. We
cannot predict whether the ARS program will continue throughout 2004 or
what the terms and conditions of any successor program might be or how it
might impact us. We believe that should the ARS program not be renewed, it
will not have a material adverse impact on our ability to sell refurbished
equipment.
MARKETING AND CUSTOMERS
We market our product offerings nationally through a direct sales
staff, which includes salespersons located along the Eastern seaboard, and
other areas of the country. Since 1999, we have also marketed Avaya
products through a call center operation. Our customers range from large
and mid-sized, multi-location corporations, to small companies, and to
equipment wholesalers, dealers, and government agencies and municipalities.
End-user customers accounted for approximately 91%, 83% and 86% of our
total revenues in 2003, 2002 and 2001, respectively, while sales to dealers
and other resellers accounted for approximately 9%, 17% and 14% of revenues
during the same respective periods. We have thousands of customers and,
during the years ended December 31, 2003, 2002 and 2001, no single customer
accounted for more than 10% of revenues. We do not consider our business to
be seasonal.
COMPETITION
We operate in a highly competitive marketplace. Over the years, our
marketplace has become subject to more rapid technological change as
communications systems have been evolving from stand-alone voice systems to
more highly integrated, software-driven systems. Since we principally sell
Avaya products, our competitive position in the marketplace is highly
dependent upon Avaya's ability to continue to be a market leader in the
product lines that we sell. Our competitors principally include Avaya and
other new equipment manufacturers that similarly compete against Avaya
products, including Nortel Networks Corporation, Siemens
Aktiengesellschaft, Alcatel S.A. and NEC Corporation along with their local
and regional dealers, and other Avaya business partners. In the sale of
Classic Avaya(TM) products, we compete with the other Avaya-designated ARS
Dealers. We believe that key competitive factors in our market are price,
timeliness of delivery, service and product quality and reliability. Due to
the reduction in business capital spending on telecommunications products,
which has developed in the U.S. over the past few years, competitive
pressures have intensified. We also anticipate 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 converged products, we
anticipate encountering a broader variety of competitors, including new
entrants from related computer and communication industries.
SUPPLIERS
Our agreement with Avaya requires us to purchase new equipment from a
designated "master distributor", and accordingly we have used Catalyst
Telecom ("Catalyst") as our primary supplier over the last several years.
The performance of this distributor in meeting our product and delivery
demands has been satisfactory to date. Should there be an adverse change in
Catalyst's performance, we would have the ability to contract with another
"master distributor" to supply us with new Avaya telecommunications
equipment.
We acquire 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. We are not dependent upon any single supplier for used
equipment. The Company believes that the availability of used equipment in
the marketplace is presently sufficient to enable the Company to meet its
customers' used equipment delivery requirements.
5
PATENTS, LICENSES AND TRADEMARKS
No patent is considered material to our continuing operations.
Pursuant to agreements in effect with Avaya, we may utilize, during the
term of these agreements, certain Avaya designated trademarks, insignia and
symbols in our advertising and promotion of Avaya products. We operate
under a license agreement with Avaya, in which we were 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, we are required to pay fees to Avaya based
upon a percentage of the sales price of Classic Avaya(TM) products that we
sell. For more information on these fees, refer to the above section
"Relationship With Avaya Inc." The license agreement expires December 31,
2004; however it shall automatically renew for an additional one-year term
unless written notice is given by either party of its intent not to renew
thirty days in advance of the termination date.
RESEARCH AND DEVELOPMENT
We did not incur any research and development expenses during the
three years ended December 31, 2003, and research and development
activities are not material to our business.
BACKLOG
The backlog of unshipped orders believed to be firm was approximately
$397,000 at December 31, 2003, compared to $1,010,000 at December 31, 2002.
We expect this entire backlog to ship and be recognized as revenue during
the current fiscal year.
EMPLOYEES
At December 31, 2003, we had 60 full-time employees. Our employees
are not represented by any organized labor union and are not covered by any
collective bargaining agreements.
WEBSITE ACCESS TO SEC FILINGS
We maintain an Internet website at www.farmstead.com . We make
available free of charge through our Internet website our annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange Act as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the SEC.
EXECUTIVE OFFICERS OF THE REGISTRANT
First
Became An
Executive
Name Age (1) Officer in Position(s) Held
--------------------- ------- ---------- --------------------------------------------------
George J. Taylor, Jr. 61 1984 Chairman of the Board, President, Chief Executive
Officer
Michael R. Johnson 57 2001 Executive Vice President
Robert G. LaVigne 52 1988 Executive Vice President, Chief Financial Officer,
Secretary, Treasurer
As of January 1, 2004.
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. 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
6
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 and Treasurer since 1988. Vice
President - Finance & Administration from 1988 until July 1997. Director of
the Company from 1988 to 2001. 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.
ITEM 2. PROPERTIES
As of December 31, 2003, we occupied two buildings in East Hartford,
CT, aggregating 49,897 square feet of office and warehouse space under
lease contracts expiring December 31, 2004. The leases contain two, three-
year renewal options. We also lease 1,700 square feet of office space in
New York, NY under a non-cancelable lease expiring March 31, 2005. This
lease contains one, two-year renewal option.
We are currently in the process of renegotiating our East Hartford,
CT building leases. Effective April 1, 2004, we expect to enter into an
agreement to terminate without penalty our existing lease on one of the
buildings containing 15,137 square feet of warehouse space. We also expect
to enter into a new lease agreement on the building containing our
principal offices and distribution center, replacing the existing lease.
Under the new agreement, we expect to lease approximately 25,000 square
feet for a period of ten years and nine months commencing April 1, 2004. We
will have the option to terminate this lease effective December 31, 2009,
and the lease will contain one five-year renewal option. If new or
additional space is required, we believe that adequate facilities are
available at competitive prices in the immediate areas of our current
operations.
ITEM 3. LEGAL PROCEEDINGS
From time to time we are involved in legal proceedings arising in the
ordinary course of business. There is no litigation pending that could
have, individually or in the aggregate, a material adverse effect on our
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
Our Common Stock is traded on the American Stock Exchange, under the
symbol "FTG". The following securities were traded on the American Stock
Exchange under the following symbols until June 30, 2002, at which time
they expired and were delisted: Warrants issued in our 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, 2003 (there was no trading in periods where no prices are indicated):
7
Common Stock IPO Warrants
----------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------- ------------ ------------
Quarter Ended High Low High Low High Low High Low
------------ ---- ---- ----- ---- ---- ---- ---- ----
March 31 $.35 $.21 $ .92 $.66 - - - -
June 30 .71 .26 1.14 .57 - - $.01 $.01
September 30 .85 .41 .79 .21 - - - -
December 31 .82 .57 .37 .21 - - - -
Class A Warrants Class B Warrants
----------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------- ------------ ------------
Quarter Ended High Low High Low High Low High Low
------------ ---- ---- ----- ---- ---- ---- ---- ----
March 31 - - - - - - $.04 $.04
June 30 - - $.02 $.01 - - .02 .02
September 30 - - - - - - - -
December 31 - - - - - - - -
There were 3,311,601 and 3,298,958 common shares outstanding at
December 31, 2003 and 2002, respectively. There were 183,579 IPO Warrants,
1,137,923 Class A Warrants and 1,137,923 Class B Warrants outstanding at
the time of their June 30, 2002 expiration. As of December 31, 2003 there
were 509 holders of record of the common stock representing approximately
2,400 beneficial stockholders, based upon the number of proxy materials
distributed in connection with our 2003 Annual Meeting of Stockholders. We
have paid no dividends and do not expect to pay dividends in the
foreseeable future as we intend to retain earnings to finance the growth of
our operations. Pursuant to a revolving credit agreement with Business
Alliance Capital Corporation, we are prohibited from declaring or paying
any dividends or making any other distribution on any of the shares of our
capital stock, without the prior consent of the lender.
EQUITY COMPENSATION PLAN INFORMATION
Securities authorized for issuance under equity compensation plans as
of December 31, 2003:
Number of securities
remaining available
Number of for future issuance
securities to be Weighted-average under equity
issued upon exercise price of compensation plans
exercise of outstanding (excluding securities
outstanding options, options, warrants reflected in column
warrants and rights and rights (a))
Plan Category (a) (b) (c)
---------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders 1,870,706 $1.73 1,137,500
Equity compensation plans
not approved by security
holders - - -
---------------------------------------------------------------------------------------------------
Total 1,870,706 $1.73 1,137,500
===================================================================================================
8
ITEM 6. SELECTED FINANCIAL DATA
(In thousands, except per share amounts) Years ended December 31
--------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
Revenues $14,680 $19,150 $33,339 $42,786 $32,871
Income (loss) from continuing operations (709) (2,530) (1,708) 1,753 57
Income (loss) from continuing operations
per common share:
Basic and diluted (.21) (.77) (.52) .54 .02
Total Assets 5,291 5,873 10,342 15,494 15,657
Long term debt - - - 1,726 4,578
Stockholders' equity 3,291 4,029 6,531 8,202 6,417
Dividends paid - - - - -
--------------------------------------------------------------------------------------------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Cautionary Statement Regarding Forward-Looking Statements
The discussions set forth below and elsewhere in this Annual Report
on Form 10-K contain certain statements, based on current expectations,
estimates, forecasts and projections about the industry in which we operate
and management's beliefs and assumptions, which are not historical facts
and are considered forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995 (the "Act"). Forward-
looking statements include, without limitation, any statement that may
predict, forecast, indicate, or imply future results, performance, or
achievements, and may contain the words "believe", "will be", "will
continue", "will likely result", "anticipates", "seeks to", "estimates",
"expects", "intends", "plans", "predicts", "projects", and similar words,
expressions or phrases of similar meaning. Our actual results could differ
materially from those projected in the forward-looking statements as a
result of certain risks, uncertainties and assumptions, which are difficult
to predict. Many of these risks and uncertainties are described under the
heading "Risk, Uncertainties and Other Factors That May Affect Future
Results" below. All forward-looking statements included in this document
are based upon information available to us on the date hereof. We undertake
no obligation to update publicly any forward-looking statements, whether as
a result of new information, future events or otherwise. In addition, other
written or oral statements made or incorporated by reference from time to
time by us or our representatives in this report, other reports, filings
with the Securities and Exchange Commission ("SEC"), press releases,
conferences, or otherwise may be forward-looking statements within the
meaning of the Act.
Overview
For the year ended December 31, 2003, we reported a net loss of
$709,000 or $.21 per share on revenues of $14,680,000. This compares with a
net loss of $2,530,000 or $.77 per share on revenues of $19,150,000
recorded for the year ending December 31, 2002. The net loss for 2002
included (i) a $455,000 charge to fully reserve for all deferred tax
assets; (ii) $333,000 in inventory valuation charges and (iii) a $101,000
charge to write off all recorded goodwill arising from the acquisition of
InfiNet.
The 23% decline in sales revenues in 2003 was again a reflection of
the continued softness in corporate buying in the telecommunications
equipment sector. There have, however, been some signs of improvement in
our industry as evidenced by improved operating results from some of the
key manufacturers, and we are encouraged by an increase in sales quotation
activities. Our overall strategy has been to properly size our business in
relation to current revenue run-rates, while preserving our key technical
resources that are critical to maintaining and growing a systems and
services business. We have remained in a somewhat defensive posture,
attempting to offset the financial impact of a reduced revenue stream by
reducing, more tightly controlling, and deferring where possible, operating
costs and expenses. As a result, despite the year-over-year revenue
decline, we managed to reduce our comparative net loss by 72% (57%
excluding the 2002 charges noted above). We accomplished this through (i)
increasing our profit margins from 19% to 26% through new revenue
opportunities such as selling Avaya maintenance contracts, personnel
reductions, improved product buying and outsourcing equipment repair
operations; and (ii) reducing our selling, general and administrative
expenses by 21% year-over-year.
9
Having made substantial progress in reducing costs and increasing
profit margins, our primary business focus for the near term will center on
strategies to increase sales revenues. We believe that our return to
profitability will now be driven more so by increasing sales levels than
from further cost reductions. To that end, we have been hiring additional
experienced salespersons to provide more coverage of existing and potential
customers located within the market areas that we serve; broadening our
product offerings; and increasing the marketing of our products and
capabilities, including our on-line electronic ordering system. However,
should there be a continuation of operating losses, we will implement
further cost and infrastructure reduction measures as deemed necessary,
which may hinder the execution of our long-term growth plans. As further
described in the Liquidity and Capital Resources section below, our current
cash position and borrowing capacity could be a limiting factor to our
growth, particularly if operating losses continue or, if growth is
predominantly in the systems products since under our current loan
agreement, we are prohibited from borrowing against receivables generated
by systems sales until such time as the systems are installed. Under these
circumstances, we could deplete our cash, borrowing availability and/or
require a higher credit line. However, as of December 31, 2003, we had $3.1
million in working capital and no bank debt. Additional information on our
results of operations and financial condition for the year ended December
31, 2003 follows below.
Results of Operations
Year Ended December 31, 2003 Compared To 2002
Revenues
Year Ended December 31,
--------------------------------
(Dollars in thousands) 2003 % 2002 %
--------------------------------------------------------------------
End-user equipment sales $11,561 79 $14,116 74
Equipment sales to resellers 1,368 9 3,205 17
--------------------------------------------------------------------
Total equipment sales 12,929 88 17,321 91
--------------------------------------------------------------------
Services 1,520 10 1,799 9
Other revenue 231 2 30 -
--------------------------------------------------------------------
Total services and other revenue 1,751 12 1,829 9
--------------------------------------------------------------------
Consolidated revenues $14,680 100 $19,150 100
====================================================================
Equipment Sales. Total equipment sales for the year ended December
31, 2003 were $12,929,000, down $4,392,000 or 25% from the comparable 2002
period. The decrease consisted of a $2,555,000 or 18% decline in end-user
sales, and a $1,837,000 or 57% decline in equipment sales to resellers
("wholesale sales"). End-user sales consist of both parts sales (new and
refurbished), and systems sales (complete systems and system upgrades).
We attribute these sales declines in part to a continuing soft market
for telecommunications equipment and to the following: (1) the turnover of
sales personnel during the past year and the concurrent hiring and training
of new salespersons and; (2) increased competition for sales, which has
resulted in increased sales price discounting in order to capture business.
During 2003, we have continued a strategy of diversifying our product
offerings by marketing the sale of complete telecommunications systems to
our customer base. This is a growth strategy, designed to augment our long-
established aftermarket parts business that continues as our primary source
of revenues. Our goal is to balance our sales effort to sell systems, parts
and services. For the year ended December 31, 2003 system sales were
$3,127,000, up 18% from the prior year period.
Significant portions of our equipment sales revenues are derived from
"Business Partner" relationships with Avaya. For the past several years,
Avaya has been pursuing a strategy of more fully utilizing its dealer
channel as a revenue source. Through our relationships with various Avaya
sales personnel, we are often referred Classic Avaya parts business by
Avaya. Such referrals however, have been subject to fluctuation as Avaya's
direct sales business fluctuates.
Services and Other Revenue. For the year ended December 31, 2003,
service revenues were $1,520,000, down $279,000 or 16% from 2002, primarily
attributable to lower installation revenues. For the year ended December
31, 2003, other revenue was $231,000, up $201,000 from 2002. Other revenue
consisted primarily of commissions earned from selling Avaya maintenance
contracts. In these transactions we act as a sales agent of Avaya, and the
10
service obligations are borne entirely by Avaya. During 2003 we have
increased our focus on selling these contracts as part of our strategy to
develop new and profitable sources of revenue for the Company.
We continue to remain cautious about the near term levels of capital
spending for telecommunications products in the US. There have, however,
been some signs of improvement in our industry as evidenced by improved
operating results from some of the key manufacturers, and we are encouraged
by an increase in sales quotation activities. Revenue generation from all
product lines and sales channels is the primary focus of management, and
strategies being implemented include increasing the size and experience
level of our sales force, increased marketing of our on-line ordering
process, and other direct-marketing approaches.
Cost of Revenues and Gross Profit. Total cost of revenues for the
year ended December 31, 2003 was $10,794,000, down $4,733,000 or 30% from
the comparable 2002 period. The gross profit for the year ended December
31, 2003 was $3,886,000, up $263,000 or 7% from the comparable 2002 period.
As a percentage of revenue, the gross profit margin was 26% for 2003,
compared to 19% for the comparable 2002 period.
Our gross profit margins are dependent upon a variety of factors
including (1) product mix - gross margins can vary significantly among
parts sales, system sales and our various service offerings. The parts
business, for example, involves hundreds of parts that generate
significantly varying gross profit margins depending upon their
availability, competition, and demand conditions in the marketplace; (2)
customer mix - we sell parts to both end-users and to other equipment
resellers. In our partnering relationship with Avaya, certain customers
receive pre-negotiated discounts from Avaya which could lower our gross
margins as we do business with these customers; (3) the level and amount of
discounts and purchase rebates available to us from Avaya and its master
distributors and (4) the level of overhead costs in relation to sales
volume. Overhead costs consist primarily of product handling, purchasing,
and facility costs. The combined effect of all of these factors will result
in varying gross profit margins from period to period.
Gross Profit Margins on Equipment Sales. For the year ended December
31, 2003, the gross profit margin on equipment sales increased to 32% from
25% in 2002. This was primarily attributable to (i) increased margins on
both end-user and wholesale parts sales, due to product sales mix and lower
inventory purchase costs; (ii) increased purchase discounts and system
rebates from Avaya; and (iii) lower license fee expense.
Gross Profit Margins on Services and Other Revenue. For the year
ended December 31, 2003, the gross profit margin on services and other
revenue decreased to 35%, from 40% in 2002. The decrease was attributable
to the services component, which generated a 26% profit margin in 2003
compared to a 39% profit margin in 2002. This decrease was attributable to
installation service margins, which were 16% in 2003 compared to 33% in
2002, principally due to a loss incurred on a large system installation.
Excluding this particular installation, the profit margin would have been
24%. Other revenues consisted of commissions earned from selling Avaya
maintenance contracts, which generate a 100% profit margin.
Other Cost of Revenues: Other cost of revenues consists of product
handling, purchasing and facility costs and expenses. For the year ended
December 31, 2003, these expenses were $827,000, or 6% of equipment
revenues, compared to $1,408,000 or 8% of equipment revenues in 2002. As a
result of cost reduction initiatives, which included personnel reductions
of 50%, and increased outsourcing of equipment repair operations, other
cost of revenues were 41% lower in 2003 than 2002.
Selling, General and Administrative ("SG&A") Expenses. SG&A expenses
for the year ended December 31, 2003 were $4,561,000, down $1,192,000 or
21% from the comparable 2002 period. SG&A expenses for the year ended
December 31, 2003 were 31% of revenues, compared to 30% of revenues in
2002. In response to lower sales levels, we have been actively managing our
headcount and tightly controlling SG&A expenses. Approximately 56% of the
decrease in SG&A expenses was attributable to a reduction in compensation
expenses, resulting from an 11% reduction in the average number of
employees and lower sales commissions. We also experienced reductions in
travel, consulting, office, depreciation, and other employment related
expenses, offset by higher bad debt and property tax expenses. We expect to
continue the close monitoring of our expense levels going forward into
2004.
Interest Expense and Other Income. Interest expense for the year
ended December 31, 2003 was $28,000, compared to $24,000 for the comparable
2002 period. The increase in interest expense was attributable to higher
interest rates on borrowings as our credit facility moved from Wachovia
Bank to Business Alliance Capital Corporation. Other income for the year
ended December 31, 2003 was $7,000, consisting of interest earned on
11
invested cash, compared to $97,000 recorded in 2002. Other income in 2002
included $82,000, from the sale of common stock of Anthem, Inc., which we
received at no cost, as part of the conversion of Anthem Insurance
Companies, Inc. from a mutual insurance company to a stock insurance
company. The balance of other income for 2002 consisted primarily of
interest earned on invested cash.
Provision for Income Taxes. The provision for income taxes for the
year ended December 31, 2003 was $13,000, compared to $473,000 recorded in
2002. The provision for income taxes in 2003 consisted entirely of
estimated minimum state taxes. Tax expense in 2002 consisted of a provision
of $18,000 for estimated state taxes and a $455,000 charge to increase the
valuation allowance against our net deferred tax assets at December 31,
2002. We maintain a full valuation allowance against our net deferred tax
assets, which consist primarily of net operating loss and capital loss
carryforwards, and timing differences between the book and tax treatment of
inventory and other account valuations. Realization of these net deferred
tax assets is dependent upon our ability to generate future taxable income.
Year Ended December 31, 2002 Compared To 2001. For the year ended December
31, 2002, we reported a net loss of $2,530,000 or $.77 per share on
revenues of $19,150,000. This compares with a net loss of $1,708,000 or
$.52 per share on revenues of $33,339,000 recorded for the year ending
December 31, 2001. The net loss for 2002 included (i) a $455,000 charge to
fully reserve for all deferred tax assets; (ii) $333,000 in inventory
valuation charges and (iii) a $101,000 charge to write off all recorded
goodwill arising from the acquisition of InfiNet.
Revenues
Year Ended December 31,
--------------------------------
(Dollars in thousands) 2002 % 2001 %
----------------------------------------------------------------
End-user equipment sales $14,146 74 $26,362 79
Equipment sales to resellers 3,205 17 4,519 14
Services 1,799 9 2,458 7
----------------------------------------------------------------
Consolidated revenues $19,150 100 $33,339 100
================================================================
Equipment Sales. During the year ended December 31, 2002, end-user
equipment sales revenues, consisting of sales of both new and refurbished
parts and systems sales, decreased by $12,216,000 or 46% from the
comparable 2001 period. Additionally, equipment sales to resellers
("wholesale sales") decreased by $1,314,000 or 29% from the comparable 2001
period. Management attributes these sales declines primarily to the
deteriorated market conditions in the U.S. economy which has resulted in
reduced capital spending by businesses on telecommunications equipment.
These conditions have, in turn, led to increased competition and downward
pressure on sales prices. Another factor affecting sales levels has been
the transitioning of our sales force. During 2002, we continued a strategy
of developing a systems sales business, begun in 2001 with the formation of
InfiNet, and continuing with Farmstead's appointment as a systems dealer by
Avaya in January 2002. This is a growth strategy, designed to augment our
long-established aftermarket parts business that continues as our primary
source of revenues. This strategy necessitated the hiring of sales, service
and technical design personnel experienced in systems and applications
design and sales. As a result, we have increased our focus on selling new
systems and system upgrades, which coupled with the turnover of certain
experienced parts salespersons over the last two years, has contributed to
the reduction in aftermarket parts sales. Management remains committed to
the continuing growth of its systems business and is currently implementing
strategies to increase its parts business, which will include the
development of on-line ordering processes and other direct-marketing
approaches.
Significant portions of our sales revenues are derived from "Business
Partner" relationships with Avaya. For the past several years, Avaya has
been pursuing a strategy of more fully utilizing its dealer channel as a
revenue source. Through our relationships with various Avaya sales
personnel, we are often referred business by Avaya. Such referrals however,
have been subject to fluctuation as Avaya's direct sales business itself
fluctuates.
Services. During the year ended December 31, 2002, service revenues
decreased by $659,000 or 27% from the comparable 2001 period. The decrease
was primarily attributable to lower installation revenues and secondarily
to lower equipment rentals. Installation revenues are generated primarily
from the sale of systems and system upgrades which as noted above, have
been negatively affected by the market downturn.
Cost of Revenues and Gross Profit. Total cost of revenues for the
year ended December 31, 2002 was $15,527,000, a decrease of $11,154,000 or
42% from the comparable 2001 period. The gross profit for the year ended
December 31, 2002 was $3,623,000, a decrease of $3,035,000 or 46% from the
comparable 2001 period. As a percentage of revenue, the gross profit margin
was 19% for 2002, as compared to 20% for the comparable 2001
12
period. These recorded gross profit margins were negatively affected by
inventory valuation charges of $333,000 in 2002, and $1,443,000 in 2001
necessitated by industry market conditions. Excluding these adjustments,
the gross profit margin in each year would have been 20% for 2002 and 24%
for 2001.
Our gross profit margins are dependent upon a variety of factors
including (1) product mix - gross margins can vary significantly among
parts sales, system sales and our various service offerings. The parts
business, for example, involves hundreds of parts that generate
significantly varying gross profit margins depending upon their
availability, competition, and demand conditions in the marketplace; (2)
customer mix - we sell parts to both end-users and to other equipment
resellers. In our partnering relationship with Avaya, certain customers
receive pre-negotiated discounts from Avaya which could lower our gross
margins as we do business with these customers; (3) the level and amount of
discounts and purchase rebates available to us from Avaya and its master
distributors and (4) the level of overhead costs in relation to sales
volume. Overhead costs consist primarily of materials handling, purchasing,
and facility costs. The combined effect of all of these factors will result
in varying gross profit margins from period to period.
The reduction in gross profit dollars during the year ended December
31, 2002 was primarily attributable to lower sales levels, for the reasons
discussed above. The gross profit margin for 2002, excluding the effect of
the inventory valuation charges noted above, was affected by (1) increased
sales competition, and downward pressure on sales pricing in our
aftermarket end-user parts sales channel; (2) increased wholesale sales as
a percent of total sales revenues. Wholesale sales generate margins that
are lower than end-user margins and for 2002 were 17% of revenue compared
with 14% in 2001; and (3) overhead costs, consisting principally of higher
overhead costs as a percent of revenues. As a partial offset, we recorded
improved gross profit margins on both systems sales and installation
services in 2002, as compared with the comparable prior year periods, and
also benefited from license fee reductions implemented by Avaya during
2002.
Selling, General and Administrative ("SG&A") Expenses. SG&A expenses
for the year ended December 31, 2002 were $5,753,000, a decrease of
$2,366,000 or 29% from the comparable 2001 period. SG&A expenses were 30%
of revenues in 2002 as compared to 24% of revenues in 2001. Of the total
decrease in SG&A, $909,000 was attributable to the downsizing of the
operations of InfiNet. This was the result of the acquisition by Farmstead
of its own systems dealer license in January 2002, and a change in strategy
concerning the business use of InfiNet. As a result, InfiNet was inactive
for most of 2002. The remaining $1,457,000 decrease in SG&A expenses was
attributable to the operations of Farmstead and included (i) an $880,000
(20%) reduction in payroll expenses as a result of lower employment levels
than the prior year period, lower sales commissions due to lower sales
levels, and management and director pay reductions; (ii) cost-reduction
initiatives in response to lower sales levels, which has resulted in
reduced marketing, travel, legal, consulting and other office and
employment-related expenses; (iii) $201,000 in reduced bad debt expense
resulting from a $33,000 reserve reduction due to better than expected
receivable collections, a $15,234 bad debt recovery and lower sales volume
and (iv) lower depreciation expense. In connection with the downsizing of
InfiNet, we wrote off $101,000 of goodwill associated with its acquisition.
Interest Expense, Other Income and Minority Interest. Interest
expense for the year ended December 31, 2002 was $24,000, compared with
$144,000 for the comparable 2001 period. The decrease in interest expense
was attributable to both lower average borrowings and lower borrowing
costs.
Other income for the year ended December 31, 2002 was $97,000,
compared with $42,000 for 2001. Other income for 2002 included $81,727
representing the net proceeds from the sale of common stock of Anthem,
Inc., which we received at no cost, as part of the conversion of Anthem
Insurance Companies, Inc. from a mutual insurance company to a stock
insurance company, with the balance consisting primarily of interest earned
on invested cash. Other income for the year ended December 31, 2001
consisted primarily of interest earned on invested cash.
Minority interest in income of subsidiary of $128,000 for the year
ended December 31, 2001, represented the 49.9% share of the net income of
InfiNet earned by TriNET. Effective January 1, 2002, we acquired all of
TriNET's ownership interest in InfiNet for an aggregate cash purchase price
of $153,334.
Provision for Income Taxes. We recorded tax expense of $473,000 for
the year ended December 31, 2002, compared with tax expense of $17,000 for
2001. Tax expense in 2002 consisted of a provision for estimated minimum
state taxes of $18,000 and a $455,000 charge to increase the valuation
allowance against the Company's net deferred tax assets at December 31,
2002. Our net deferred tax assets consist primarily of net operating loss
and
13
capital loss carryforwards, and timing differences between the book and tax
treatment of inventory and other asset valuations. Realization of these net
deferred tax assets is dependent upon our ability to generate future
taxable income. Given the significant losses that we incurred in 2002 and
2001, management determined that it was prudent to provide a full valuation
allowance against its net deferred tax assets. Tax expense in 2001
consisted of estimated minimum required state taxes.
Liquidity and Capital Resources
Working capital, defined as current assets less current liabilities,
was $3,129,000 at December 31, 2003, a decrease of $616,000 or 16% from
$3,745,000 at December 31, 2002. The working capital ratio was 3.1 to 1 at
December 31, 2003, compared to 3.5 to 1 at December 31, 2002. Operating
activities used $87,000 during 2003, compared to the use of $104,000 in
2002. Net cash used by operating activities in 2003 consisted of a net loss
of $709,000 adjusted for non-cash items of $267,000, and net cash generated
by changes in operating assets and liabilities of $355,000. Net cash
generated by changes in operating assets and liabilities was primarily
attributable to improved collections on accounts receivable and planned
reductions in inventory stocking levels.
Investing activities used $83,000 during 2003, compared to $257,000
in 2002. Net cash used by investing activities in 2003 consisted of capital
expenditures. Net cash used by investing activities in 2002 consisted of
(i) the $153,000 purchase price for the acquisition of TriNET's 49.9%
ownership interest in InfiNet, and (ii) $104,000 in capital expenditures.
During 2002, we started the development of an e-business platform, to
enable customers to transact business with us electronically. Capitalized
costs as of December 31, 2003 amounted to $92,000, $48,000 of which was
incurred in 2003. There are currently no material commitments for capital
expenditures. Pursuant to our loan agreement with BACC, we are restricted
from committing to capital expenditures in any fiscal year period in excess
of $150,000without their prior approval.
Financing activities provided $3,000 during 2003 from the issuance of
12,643 shares of common stock to employees under our employee stock purchase
plan ("ESPP"), compared to using $124,000 in 2002. Net cash used by financing
activities in 2002 consisted of $37,000 in capital lease payments to fully
pay-off a lease obligation, a $100,000 capital distribution to TriNET out of
the accumulated earnings of InfiNet, and $13,479 from 26,379 common shares
issued to employees under the ESPP.
On February 19, 2003 the Company entered into a one-year, $1.5
million revolving loan agreement (the "BACC Agreement") with Business
Alliance Capital Corporation ("BACC"), replacing a similar $500,000 credit
facility with Wachovia Bank, National Association that was expiring
February 28, 2003. Under the terms of the BACC Agreement, borrowings are
advanced at 75% of eligible accounts receivable, as defined (primarily
receivables that are less than 90 days old and, in the case of system
sales, the receivable does not become "eligible" until the system has been
installed), and at 25% of the value of eligible inventory, as defined
(primarily inventory that was purchased pursuant to a firm customer order),
provided that the amount advanced against eligible inventory shall not
exceed $200,000 or 30% of all outstanding advances under the BACC
Agreement. Interest is charged at the per annum rate of one and one-half
percentage points (1.5%) above the prime rate, but not less than 5.75%,
subject to a minimum interest charge based on an average daily loan balance
of $250,000 regardless of the actual average loan balance. Under the BACC
Agreement, the Company is charged an annual facility fee of 1% of the
facility and a monthly servicing fee equal to .25% of the average
outstanding loan balance, subject to a minimum average daily loan balance
of $250,000. As additional security to BACC, the Company issued a $300,000
standby letter of credit in favor of BACC, secured by cash, which can be
drawn upon 90 days after an event of default. The BACC Agreement restricts
the Company from the payment of dividends and limits capital expenditures
during the term of the agreement to $150,000, without the consent of BACC.
The BACC Agreement contains no specific financial covenants however, it
defines certain circumstances under which the agreement can be declared in
default and subject to termination, including among others if (i) there is
a material adverse change in the Company's business or financial condition;
(ii) an insolvency proceeding is commenced; (iii) the Company defaults on
any of its material agreements with third parties; (iv) the Company fails
to comply with the terms, representations and conditions of the agreement,
and (v) there are material liens or attachments levied against the
Company's assets. In the event the BACC Agreement is terminated prior to
its expiration date, the Company shall pay a fee in an amount equal to 4%
of the advance limit.
14
On February 19, 2004, the BACC Agreement was extended for an
additional one-year term with the following modifications: (i) the advance
limit was increased to $1.7 million; and (ii) the amount which could be
advanced against eligible inventory was increased to $400,000.
We are dependent upon generating positive cash flow from operations
and upon our revolving credit facility to provide cash to satisfy working
capital requirements. No assurances can be given that we will have
sufficient cash resources to finance future growth. Historically, our
working capital borrowings have increased during periods of revenue growth.
This is because our cash receipts cycle is longer than our cash
disbursements cycle. As our revenues from systems sales increases, as
management expects, the cash receipts cycle may lengthen, unless we can
consistently negotiate progress payments under our systems sales contracts.
Under the current lending agreement, we are prohibited from borrowing
against receivables generated by systems sales until the systems are
installed. Under these circumstances, we could run out of availability
and/or require a higher credit line. In order to obtain additional
financing, we may first need to demonstrate improved operating performance.
No assurances can be given that we will have sufficient cash resources to
finance possible future growth, and it may become necessary to seek
additional financing sources for such purpose.
Recent Accounting Pronouncement
In December 2003, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 132 (revised 2003), "Employers' Disclosures about Pensions
and Other Postretirement Benefits, an Amendment of FASB Statements No. 87,
88 and 106" ("SFAS No. 132"). SFAS No. 132 requires, for defined benefit
pension plans and other defined postretirement benefit plans, additional
disclosures regarding plan assets, investment strategy, measurement date,
plan obligations, cash flows and components of net periodic benefit cost,
effective upon issuance. The Company adopted the disclosure requirements
under SFAS 132 for the year ended December 31, 2003. See Note 12 of the
Notes to Consolidated Financial Statements included herein.
Critical Accounting Policies and Estimates
Our financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America. These
accounting principles require management to make a number of assumptions
and estimates about future events that affect the reported amounts of
assets, liabilities, revenue and expenses in our consolidated financial
statements and accompanying notes. Management bases its estimates on
historical experience and various other assumptions about future events
that are believed to be reasonable. These estimates are based on
management's best knowledge of current events and actions that may impact
the Company in the future. Actual results could differ from these
estimates, and any such differences could be material to the financial
statements. We believe that the following policies may involve a higher
degree of judgment and complexity in their application and represent the
critical accounting policies used in the preparation of our financial
statements.
Revenue recognition: Revenue from sales of equipment is generally
recognized when persuasive evidence of an agreement exists, shipment has
occurred, the sales price is fixed and determinable, and collection of the
resulting receivable is probable. Additionally, for sales of systems where
installation requirements are our responsibility, revenue is recognized on
the equipment portion of the transaction upon shipment of the equipment,
and revenue is recognized on the installation portion of the transaction
upon completion of the installation. Revenues on other services are
recognized when the services are rendered. We record reductions to revenue
for estimated product returns, based on historical experience.
Inventory valuation: We periodically assess the valuation of
inventory and adjust the value for estimated excess and obsolete inventory
based upon assumptions about current and future demand and market
conditions. Such estimates are difficult to make under current volatile
economic conditions. Reviews for excess inventory are done periodically
during the year and required reserve levels are calculated with reference
to the projected ultimate usage of that inventory. In order to determine
the ultimate usage, we take into account recent sales history, forecasts,
projected obsolescence and our current inventory levels. The excess balance
determined by this analysis becomes the basis for our excess inventory
charge. If actual market conditions are less favorable than those projected
by management, additional write-downs may be required. If actual market
conditions are more favorable than anticipated, inventory previously
written down may be sold, resulting in lower cost of sales and higher
earnings from operations than expected in that period.
15
Collectibility of Accounts Receivable: The allowance for doubtful
accounts is based upon our assessment of the collectibility of specific
customer accounts and the aging of the accounts receivable. Reviews of our
receivables are performed continuously during the year, and reserve levels
are adjusted when determined necessary. If there were a deterioration of a
major customer's creditworthiness, or actual defaults were higher than our
historical experience, we could be required to increase our allowance and
our earnings could be adversely affected.
Long-Lived Assets: We have recorded property and equipment and
intangible assets at cost less accumulated depreciation. The determination
of useful lives and whether or not those assets are impaired involves
significant judgment. We conducted the required annual goodwill impairment
review during the fourth quarter of 2002. In considering the facts that our
wholly-owned subsidiary, InfiNet, was downsized during the year, was
inactive at year-end with no operating employees, and that management had
no current plans for generating business through InfiNet, we recorded a
goodwill impairment charge of $101,000 as an operating expense, fully
writing off all previously recorded goodwill from the acquisition of this
entity.
Income Taxes and Deferred Tax Assets: Significant judgment is
required in determining our provision for income taxes and in determining
whether deferred tax assets will be realized in full or in part. The
deferred tax valuation allowance was calculated in accordance with the
provisions of SFAS No. 109, "Accounting for Income Taxes", which places
primary importance on a company's cumulative operating results for the
current and preceding years. Additionally, when it is more likely than not
that all or some portion of specific deferred tax assets such as net
operating loss carryovers will not be realized, a valuation allowance must
be established for the amount of the deferred tax assets that are
determined not to be realizable. In our judgment, the significant losses
incurred in 2003, 2002 and 2001 represented sufficient evidence to require
a valuation allowance, and for 2003 and 2002 we established a full
allowance against our deferred tax assets as of December 31 of each year.
In 2002, that resulted in a fourth quarter charge to income tax expense of
$455,000.
Risks, Uncertainties and Other Factors That May Affect Future Results
Our prospects are subject to certain uncertainties and risks.
Management recognizes the challenges that it faces, particularly during
this period of diminished sales levels, and has adopted a number of
strategies and action steps to deal with its current operating environment.
Disclosure of our strategies and action steps is contained in the
discussions set forth in Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations", and elsewhere herein. These
risks and uncertainties are also detailed from time to time in reports we
file with the SEC, including Forms 8-K, 10-Q, and 10-K, and include, among
other factors, the following principal risks:
* Our business is materially impacted by capital spending levels for
telecommunications products and services in the United States.
As a result of the economic downturn that commenced in 2001, many
businesses have reduced or deferred capital expenditures for
telecommunications equipment. Our reported 2003 revenues were 23% lower
than 2002 revenues, and 2002 revenues were in turn 43% lower than 2001
levels. In addition, this situation has resulted in increased pricing and
competitive pressures, which have contributed to our revenue erosion. If
business capital spending for telecommunications products does not improve,
or if economic conditions in the U.S. deteriorate, our revenues may
continue to decline and our operating results will be adversely affected.
We remain cautious about the telecommunications product marketplace going
forward, and cannot predict whether the level of capital spending for the
Company's products will improve in the near term. As a result, we believe
that there will be continued pressure on our ability to generate revenue in
excess of current levels.
* Our business is heavily dependent upon Avaya, as our primary
supplier of equipment for resale.
We primarily sell Avaya telecommunications products and services
through various Dealer and license agreements with Avaya. The Company is
dependent upon the quality and price-competitiveness of current Avaya
products as well as Avaya's continued development of new products in order
to compete. The Company's current sales levels for new parts and systems
would be adversely impacted should market demand for these Avaya products
significantly decline. Should Avaya's operations deteriorate to the point
that it either cannot continue to introduce technologically new products or
effectively compete with other equipment manufacturers, our long-term
business strategy to continue as an Avaya dealer would be adversely
affected.
16
Our new parts and systems sales levels would also be adversely
impacted if the Avaya dealer and license agreements were terminated, or if
Avaya eliminated its "Business Partner" programs. It is Avaya's current
intent to generate a larger percentage of its revenues from its dealer
base, of which we are one. On some of its major accounts, companies such as
Farmstead are selected to participate in the fulfillment of certain parts
of the customer's orders through a "partnering" arrangement with the local
Avaya sales team. Through these partnering arrangements, we are referred
opportunities to supply both parts and systems, for which the Avaya sales
team receives compensation from Avaya. Revenues generated by us through
this program are significant to our near-term overall revenues and our
operating results are dependent upon this program continuing.
The ARS aftermarket program currently expires December 31, 2004;
however, Avaya is currently considering replacing it with a successor
program that would require the ARS companies to purchase refurbished
"Classic Avaya" equipment directly from Avaya, instead of their exclusive
use of the "Classic Avaya" label. The program, as it's currently
contemplated, would allow other companies to purchase refurbished "Classic
Avaya" equipment directly from Avaya as well. We cannot predict whether the
ARS program will continue throughout 2004 or what the terms and conditions
of any successor program might be or how it might impact us. We believe
that should the ARS program not be renewed, it will not have a material
adverse impact on our ability to sell refurbished equipment.
* Our gross profit margins vary from period to period.
Our gross profit margins are dependent upon a variety of factors
including (1) product mix - gross margins can vary significantly among
parts sales, system sales and our various service offerings. The parts
business, for example, involves hundreds of parts that generate
significantly varying gross profit margins depending upon their
availability, competition, and demand conditions in the marketplace; (2)
customer mix - we sell parts to both end-users and to other equipment
resellers. In our partnering relationship with Avaya, certain customers
receive pre-negotiated discounts from Avaya which could lower our gross
margins as we do business with these customers; (3) the level and amount of
vendor discounts and purchase rebates available to us from Avaya and its
master distributors; (4) excess capacity - as sales volume falls, overhead
costs become a higher percentage of sales dollars; (5) competitive
pressures - as a result of the slowdown in capital equipment spending in
our industry, we have been faced with increased price competition; and (6)
obsolescence charges. The combined effect of all of these factors will
result in varying gross profit margins from period to period.
* Our gross profit margins and operating expenses could be adversely
affected by a reduction in purchase discount and other rebate or incentive
programs currently offered by Avaya.
As an Avaya Dealer, we receive substantial rebates and other cash
incentives from Avaya, based upon volume levels of certain product
purchases, which are material to our operating results and which help
reduce product purchase costs, market development and marketing expenses.
These incentive programs are subject to change by Avaya, and no assurances
can be given that they would not be altered so as to adversely impact our
profit margins or operating expenses.
* We may not have adequate cash or credit lines to finance the
Company's working capital requirements.
As further discussed under "Liquidity and Capital Resources", our
operating losses over the past three years have significantly reduced the
amount of credit available to us from outside lenders, and increased the
cost of borrowed funds. We are currently dependent upon cash generated from
operations, and borrowings under a revolving credit facility, to satisfy
our working capital requirements. Our revolving credit borrowings are based
upon the generation of eligible accounts receivable. As our revenues have
declined, so too have our receivables and borrowing availability. A
material adverse change in our business going forward could result in a
covenant default, which could lead to an early termination of the credit
facility. In addition, continued losses could consume our current cash
reserves, and negatively affect our ability to obtain replacement financing
until we could demonstrate improved operating results or a return to
profitability. No assurances can be given that we will have sufficient cash
resources to finance future growth, and it may become necessary to raise
additional funds through public or private debt or equity financings, which
may also not be available to us until operating performance improves, and
which may dilute stockholder ownership in us.
* We are faced with intense competition and rapidly changing
technologies, and we may become unable to effectively compete in our
marketplace.
17
We operate in a highly competitive marketplace. Over the years, our
marketplace has become subject to more rapid technological change as
communications systems have been evolving from stand-alone voice systems to
more highly integrated, software-driven systems. Since we principally sell
Avaya products, our competitive position in the marketplace is highly
dependent upon Avaya's ability to continue to be a market leader in the
product lines that we sell. Our competitors principally include Avaya and
other new equipment manufacturers that similarly compete against Avaya
products, including Nortel Networks Corporation, Siemens
Aktiengesellschaft, Alcatel S.A. and NEC Corporation along with their local
and regional dealers, and other Avaya business partners. In the sale of
Classic Avaya(TM) products, we compete with the other Avaya-designated ARS
Dealers. We believe that key competitive factors in our market are price,
timeliness of delivery, service and product quality and reliability. Due to
the reduction in business capital spending on telecommunications products,
which has developed in the U.S. over the past few years, competitive
pressures have intensified. We also anticipate 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 converged products, we
anticipate encountering a broader variety of competitors, including new
entrants from related computer and communication industries.
* If we are unable to attract and retain key management and sales
employees, we will not be able to compete effectively and our business may
not be successful.
Our success is highly dependent upon our ability to hire and retain
key technical, sales and executive personnel. Competition for such
personnel is currently intense in our industry, and our deterioration in
revenues over the past two years has been partly due to turnover of such
key employees. If we fail to hire and retain a sufficient number of high-
quality personnel, we may not be able to maintain or expand our business.
We have been attempting to expand our systems sales business, which
requires more highly skilled technical and sales personnel than our
aftermarket parts business, and a failure to hire and retain such personnel
would restrict our ability to effectively develop this sales growth
strategy.
* We could be delisted by the American Stock Exchange.
Should we continue to record operating losses, fall below minimum
required levels of stockholders' equity, fall below required minimum
shareholder or market capitalization levels and /or if our common stock
continues to trade at a "low price per share", we could be subject to
delisting by the American Stock Exchange (the "Exchange"). In considering
whether a security warrants continued trading and/or listing on the
Exchange, many factors are taken into account, such as the degree of
investor interest in the company, its prospects for growth, the reputation
of its management, the degree of commercial acceptance of its products, and
whether its securities have suitable characteristics for auction market
trading. Thus, any developments which substantially reduce the size of a
company, the nature and scope of its operations, the value or amount of its
securities available for the market, or the number of holders of its
securities, may occasion a review of continued listing by the Exchange. The
determination as to whether a security warrants continued trading is not
based on any precise mathematical formula rather, each case is considered
on the basis of all relevant facts and circumstances and in light of the
objectives of the Exchange's policies regarding continued listing.
* Other risks
In addition to the specific risks and uncertainties discussed above,
our future operating performance can also be affected by: performance and
reliability of products; the maintenance of our level of customer service
and customer relationships; adverse publicity; business disruptions; acts
of terrorism within the U.S., and the impact of those acts on the U.S.
economy; and other events that can impact revenues and business costs. The
risks included here are not exhaustive. Other sections of this report may
include additional factors, which could adversely affect our business and
financial performance. Moreover, we operate 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.
18
Investors should also be aware that while we do, from time to time,
communicate with securities analysts, it is against our policy to disclose
to them any material information unless such information shall have been
previously or is simultaneously disclosed in a manner intended to provide
broad, non-exclusionary distribution of the information to the public.
Accordingly, shareholders should not assume that we agree with any
statement or report issued by any analyst irrespective of the content of
the statement or report. Furthermore, we have 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 our
responsibility.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rates: Market risks which have the potential to affect our
earnings and cash flows result primarily from changes in interest rates.
Our cash equivalents, which consist of an investment in a money market fund
consisting of high quality short term instruments, principally U.S.
government and agency issues and commercial paper, are subject to
fluctuating interest rates. A 10 percent change in such current interest
rates would not have a material effect on our results of operations or cash
flow. We are also exposed to market risk from changes in the interest rate
related to our revolving credit facility, which is based upon the Prime
Rate, which is a floating interest rate. Assuming an average borrowing
level of $250,000 (which amount approximated the average amount borrowed
under our revolving credit facility during the year ended December 31,
2003), each 1 percentage point increase in the Prime Rate would result in
$2,500 of additional annual interest charges. We do not currently use
interest rate derivative instruments to manage exposure to interest rate
changes.
Cash Surrender Value of Company-owned insurance policies: The Company
invests the cash surrender value of its Company-owned insurance policies in
various investment portfolios administered by the respective insurance
companies, which include investments in debt and equity securities. The
cash surrender value is therefore subject to market risk and market
fluctuations. The Company believes that this risk is moderated by the
diversity of the underlying investments. As of December 31, 2003, the cash
surrender value of these policies amounted to $302,156. A hypothetical 10%
decline in cash surrender value, resulting from a decline in the market
value of the underlying investments, would result in a $30,215 loss to the
Company.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Financial Statements and Financial Statement Schedule in
Item 15.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Our Chief Executive
Officer and Chief Financial Officer have evaluated the effectiveness of our
disclosure controls and procedures (as such term is defined in Rules 13a-
14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended
(the "Exchange Act")) as of a date within 90 days prior to the filing date
of this Annual Report on Form 10-K. Based on such evaluation, such officers
have concluded that our disclosure controls and procedures are effective in
alerting them on a timely basis to material information relating to our
Company required to be included in our reports filed or submitted under the
Exchange Act.
(b) Changes in Internal Controls. There were no significant changes in our
internal controls or in other factors that could significantly affect such
controls subsequent to the date of their most recent evaluation.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is included, in part, in Item 1,
"Executive Officers of the Registrant", and is incorporated by reference to
our Proxy Statement in connection with our Annual Meeting of Stockholders
to be held June 10, 2004, which will be filed with the SEC pursuant to
regulation 14A on or before April 29, 2004.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11is incorporated by reference to
our Proxy Statement in connection with our Annual Meeting of Stockholders
to be held June 10, 2004, which will be filed with the Securities and
Exchange Commission, pursuant to regulation 14A, on or before April 29,
2004.
19
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
The information required by Item 12 is incorporated by reference to
our Proxy Statement in connection with our Annual Meeting of Stockholders
to be held June 10, 2004, which will be filed with the Securities and
Exchange Commission, pursuant to regulation 14A, on or before April 29,
2004.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference to
our Proxy Statement in connection with our Annual Meeting of Stockholders
to be held June 10, 2004, which will be filed with the Securities and
Exchange Commission, pursuant to regulation 14A, on or before April 29,
2004.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is incorporated by reference to
our Proxy Statement in connection with our Annual Meeting of Stockholders
to be held June 10, 2004, which will be filed with the Securities and
Exchange Commission, pursuant to regulation 14A, on or before April 29,
2004.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Index to Financial Statements and Financial Statement Schedule
Page
----
Report of Carlin, Charron & Rosen LLP 22
Report of DiSanto Bertoline & Company, P.C. 23
Consolidated Balance Sheets - December 31, 2003 and 2002 24
Consolidated Statements of Operations -
Years Ended December 31, 2003, 2002 and 2001 25
Consolidated Statements of Changes in Stockholders' Equity -
Years Ended December 31, 2003, 2002, and 2001 25
Consolidated Statements of Cash Flows -
Years Ended December 31, 2003, 2002, and 2001 26
Notes to Consolidated Financial Statements 27
Financial Statement Schedule:
Report of Carlin, Charron & Rosen LLP 38
Report of DiSanto Bertoline & Company, P.C. 39
Schedule II - Valuation and Qualifying Accounts 40
(b) Exhibits: See Index to Exhibits on page 41.
(c) Reports on Form 8-K: On December 22, 2003, a Form 8-K was filed
with the Securities and Exchange Commission to report that on December 22,
2003 a press release was issued announcing (i) the renewal of our
Authorized Remarketing agreements with Avaya for an additional one-year
term; (ii) the extension of the Chief Executive Officer's full-time
employment period to December 31, 2004; the extension of the Chief
Financial Officer's employment agreement through December 31, 2004; (iii)
our appointment by Avaya as a "Gold" Business Partner, making us one of
Avaya's top 40 business partners out of a total number of business partners
that exceeds 1,500; and (iv) our appointment as an Avaya "2 Star Services
Partner" in recognition of our principle use of the Avaya services
organization to perform installation, maintenance, and moves, adds and
changes for our customers.
20
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, 2004.
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, 2004.
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/ Ronald P. Pettirossi Director
-----------------------------
Ronald P. Pettirossi
21
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Farmstead Telephone Group, Inc.
We have audited the accompanying consolidated balance sheets of Farmstead
Telephone Group, Inc. (the "Company") as of December 31, 2003 and 2002, and
the related consolidated statements of operations, changes in stockholders'
equity and cash flows for the years 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 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 audits 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 audits provide 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. as of December 31, 2003 and 2002, and the results of
their operations and their cash flows for the year then ended in conformity
with accounting principles generally accepted in the United States of
America.
/S/ CARLIN, CHARRON & ROSEN, LLP
Glastonbury, Connecticut
February 27, 2004
22
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Farmstead Telephone Group, Inc.
We have audited the accompanying consolidated statements of operations,
changes in stockholders' equity and cash flows of Farmstead Telephone
Group, Inc. and subsidiaries (the "Company") for the year ended December 31,
2001. 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 statements of
operations, changes in stockholders' equity and cash flows are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated statements of
operations, changes in stockholders' equity and cash flows. An audit also
includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall presentation of the
consolidated statements of operations, changes in stockholders' equity and
cash flows. We believe that our audit of the consolidated statements of
operations, changes in stockholders' equity and cash flows provides a
reasonable basis for our opinion.
In our opinion, the consolidated statements of operations, changes in
stockholders' equity and cash flows referred to above present fairly, in all
material respects, the results of operations and cash flows of Farmstead
Telephone Group, Inc. and subsidiaries for the year ended December 31, 2001
in conformity with U.S. generally accepted accounting principles.
/S/ DISANTO BERTOLINE & COMPANY, P.C.
Glastonbury, Connecticut
February 21, 2002
23
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002
(In thousands, except share amounts) 2003 2002
-------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 827 $ 994
Accounts receivable, net (Note 3) 1,408 1,869
Inventories, net (Note 4) 1,969 2,309
Other current assets (Note 10) 447 69
-------------------------------------------------------------------------------------------
Total Current Assets 4,651 5,241
-------------------------------------------------------------------------------------------
Property and equipment, net (Note 5) 313 394
Other assets (Note 12) 327 238
-------------------------------------------------------------------------------------------
Total Assets $ 5,291 $ 5,873
===========================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,248 $ 1,111
Accrued expenses and other current liabilities (Note 7) 274 385
-------------------------------------------------------------------------------------------
Total Current Liabilities 1,522 1,496
-------------------------------------------------------------------------------------------
Other liabilities (Note 12) 478 348
-------------------------------------------------------------------------------------------
Total Liabilities 2,000 1,844
-------------------------------------------------------------------------------------------
Commitments and contingencies (Note 10)
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; 3,311,601 and 3,298,958 shares issued and outstanding
at December 31, 2003 and 2002, respectively 3 3
Additional paid-in capital 12,316 12,313
Accumulated deficit (8,996) (8,287)
Accumulated other comprehensive loss (32) -
-------------------------------------------------------------------------------------------
Total Stockholders' Equity 3,291 4,029
-------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 5,291 $ 5,873
===========================================================================================
See accompanying notes to consolidated financial statements.
24
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2003, 2002 and 2001
(In thousands, except per share amounts) 2003 2002 2001
-----------------------------------------------------------------------------------------------
Revenues:
Equipment $12,929 $17,321 $30,856
Services and other revenue 1,751 1,829 2,483
-----------------------------------------------------------------------------------------------
Net revenues 14,680 19,150 33,339
-----------------------------------------------------------------------------------------------
Cost of revenues:
Equipment 8,836 13,021 23,226
Services and other revenue 1,131 1,098 1,707
Other cost of revenues 827 1,408 1,748
-----------------------------------------------------------------------------------------------
Total cost of revenues 10,794 15,527 26,681
-----------------------------------------------------------------------------------------------
Gross profit 3,886 3,623 6,658
Selling, general and administrative expenses 4,561 5,753 8,119
-----------------------------------------------------------------------------------------------
Operating loss (675) (2,130) (1,461)
Interest expense (28) (24) (144)
Other income 7 97 42
-----------------------------------------------------------------------------------------------
Loss before income taxes and minority interest
in income of subsidiary (696) (2,057) (1,563)
Provision for income taxes 13 473 17
-----------------------------------------------------------------------------------------------
Loss before minority interest in income of subsidiary (709) (2,530) (1,580)
Minority interest in income of subsidiary - - 128
-----------------------------------------------------------------------------------------------
Net loss $ (709) $(2,530) $(1,708)
===============================================================================================
Basic and diluted net loss per common share $ (.21) $ (.77) $ (.52)
Basic and diluted weighted average common shares outstanding 3,305 3,289 3,272
-----------------------------------------------------------------------------------------------
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2003, 2002, and 2001
Accumulated
Common Stock Additional Accum- other
---------------- Paid-in ulated comprehensive
(In thousands) Shares Amount Capital Deficit loss Total
----------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 3,272 $3 $12,248 $(4,049) $ - $8,202
Net loss - - - (1,708) - (1,708)
Compensatory stock options issued - - 37 - - 37
----------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 3,272 3 12,285 (5,757) - 6,531
Net loss - - - (2,530) - (2,530)
Compensatory stock options issued - - 15 - - 15
Issuance of common stock 26 - 13 - - 13
----------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 3,298 3 12,313 (8,287) - 4,029
Net loss - - - (709) - (709)
Pension liability adjustment - - - - (32) (32)
Comprehensive loss - - - - - (741)
Issuance of common stock 13 - 3 - 3
----------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 3,311 $3 $12,316 $(8,996) $(32) $3,291
==========================================================================================================
See accompanying notes to consolidated financial statements.
25
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2003, 2002 and 2001
(In thousands) 2003 2002 2001
------------------------------------------------------------------------------------------------------
Operating Activities:
Net loss $(709) $(2,530) $(1,708)
Adjustments to reconcile net loss to net cash flows
(used in) provided by operating activities:
Provision for (reversal of) doubtful accounts receivable 75 (33) 104
Provision for losses on inventories 28 143 1,443
Depreciation and amortization 164 215 257
Provision for impairment of goodwill - 101 -
Minority interest in income of subsidiary - - 128
Deferred income taxes - 455 -
Value of compensatory stock options issued - 15 37
Changes in operating assets and liabilities:
Decrease in accounts receivable 386 1,297 3,290
Decrease in inventories 312 1,975 1,311
(Increase) decrease in other assets (467) 36 (18)
Increase (decrease) in accounts payable 137 (1,683) (995)
Decrease in accrued expenses and other liabilities (13) (95) (848)
------------------------------------------------------------------------------------------------------
Net cash (used in) provided by operating activities (87) (104) 3,001
------------------------------------------------------------------------------------------------------
Investing Activities:
Purchases of property and equipment (83) (104) (130)
Acquisition of InfiNet - (153) -
------------------------------------------------------------------------------------------------------
Net cash used in investing activities (83) (257) (130)
------------------------------------------------------------------------------------------------------
Financing Activities:
Repayments under revolving credit lines - - (1,689)
Repayments of capital lease obligation - (37) (102)
Capital (distribution to) contribution from minority interest partner - (100) 25
Proceeds from issuance of common stock 3 13 -
------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 3 (124) (1,766)
------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (167) (485) 1,105
Cash and cash equivalents at beginning of year 994 1,479 374
------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 827 $ 994 $ 1,479
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 26 $ 25 $ 155
Income taxes 5 16 87
Non-cash Items:
Increase in accrued benefit obligation recorded in
Stockholders' equity $ 32 $ - $ -
See accompanying notes to consolidated financial statements.
26
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 provider of new and used Avaya, Inc. ("Avaya")
business telecommunications parts and complete systems. The Company
provides used, "Classic Avaya(TM) " telecommunications equipment parts
pursuant to an "Authorized Remarketing Supplier Program" with Avaya, and
offers the full-line of new telecommunications parts and systems as an
Avaya Dealer. Its products are primarily customer premises-based private
switching systems and peripheral products, including voice processing
systems. The Company also provides telecommunications equipment
installation, repair and refurbishing, short-term rental, inventory
management, and related value-added services. The Company sells its
products and services to large and mid-size, multi-location businesses as
well as to small businesses, government agencies, and other equipment
resellers. During the years ended December 31, 2003, 2002 and 2001, no
single customer accounted for more than 10% of revenues.
Principles of Consolidation
The consolidated financial statements presented herein consist of the
accounts of Farmstead Telephone Group, Inc. and its wholly-owned
subsidiaries, FTG Venture Corporation (inactive) and InfiNet Systems, LLC
(which became wholly-owned effective January 1, 2002; prior thereto the
Company owned a 50.1% interest). Since the Company owned greater than a 50%
interest in, and exercised significant control over, InfiNet, the financial
statements of InfiNet have been consolidated herein for all applicable
years. All intercompany balances and transactions have been eliminated.
Use of Estimates
The preparation of consolidated financial statements in conformity
with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities, revenues and expenses and
related disclosures in the consolidated financial statements. Actual
results could differ from those estimates. Estimates are used in accounting
for the allowances for uncollectible receivables, inventory obsolescence,
warranty reserves, 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
Revenue from sales of equipment is generally recognized when
persuasive evidence of an agreement exists, shipment has occurred, the
sales price is fixed and determinable, and collection of the resulting
receivable is probable. Additionally, for sales of systems where
installation services are the responsibility of the Company, revenue is
recognized on the equipment portion of the transaction upon shipment of the
equipment to the installation location, and on the installation portion of
the transaction upon completion of the installation. Revenues on other
services are recognized when the services are rendered. Reductions to
revenues are recorded for estimated product returns, based on historical
experience.
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. The Company periodically assesses the valuation
of inventory and will adjust the value for estimated excess and obsolete
inventory based upon assumptions about current and future demand and market
conditions.
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 the estimated useful
life or the remaining lease term. Maintenance, repairs and minor renewals
are charged to operations as incurred. When assets are retired or sold, the
cost of the assets and
27
the associated accumulated depreciation is removed from the accounts and
any resulting gain or loss is recorded that period.
Stock Compensation Plans
The Company accounts for stock option awards granted to officers,
directors and employees (collectively "employees") under the recognition
and measurement principles of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"). Under APB 25, no
stock-based employee compensation cost is reflected in net income, as all
options granted to employees under these plans have been granted at no less
than fair market value on the date of grant. The Company applies the
disclosure only provisions of Financial Accounting Standards Board
Statement ("SFAS") No. 123, "Accounting for Stock-based Compensation"
("SFAS 123") and SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure" ("SFAS 148") for such employee stock option
awards. The Company accounts for stock option awards granted to consultants
under the fair value recognition provisions of SFAS 123. Under this method,
options are valued using the Black-Scholes option pricing method, and the
calculated option value is recorded as an expense in the financial
statements. Had compensation cost for the Company's stock option plans been
determined in accordance with the fair value-based method prescribed under
SFAS 123, the Company's net loss and basic and diluted net loss per share
would have approximated the pro forma amounts indicated below (dollars in
thousands except per share amounts):
Year ended December 31,
-----------------------------
2003 2002 2001
----------------------------------------------------------------------------------
Net loss, as reported $(709) $(2,530) $(1,708)
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (78) (178) (250)
----------------------------------------------------------------------------------
Pro forma net loss $(787) $(2,708) $(1,958)
==================================================================================
Loss per share:
As reported $(.21) $ (.77) $ (.52)
Pro forma $(.24) $ (.82) $ (.60)
==================================================================================
The weighted-average fair value of options granted during 2003, 2002
and 2001 was $.27, $.62, and $1.24, respectively. The fair value of stock
options used to compute pro forma net loss and net loss per share
disclosures was estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions:
2003 2002 2001
---- ---- ----
Dividend yield 0% 0% 0%
Average risk-free rate 2.93% 3.68% 4.3%
Expected option holding period (yrs.) 4.7 5.6 5.0
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. Deferred tax assets are reduced by a valuation allowance if it is
probable that a benefit will not be realized in the future.
Net Loss Per Common Share
Basic net loss per common share was computed by dividing net loss
(the numerator) by the weighted average number of common shares outstanding
(the denominator) during the period. Diluted net loss per common share was
computed by increasing the denominator by the weighted average number of
additional shares that could have been outstanding from securities
convertible into common stock, such as stock options and warrants, unless
their effect on net loss per share is antidilutive. The following table
shows securities outstanding as of December 31 that could potentially
dilute basic earnings or loss per common share in the future that were not
included in the current computation of diluted loss per common share
because to do so would have been antidilutive. The amounts presented below
for the Warrants and the Underwriter Options and Warrants (which represent
options to acquire
28
Units convertible into common stock and warrants) for 2001 reflect the
maximum common shares issuable upon their full conversion (Note 13).
(In thousands) 2003 2002 2001
-------------------------------------------------------------
Stock Options 1,871 1,852 1,875
Warrants * - - 2,472
Underwriter Options and Warrants * - - 339
-------------------------------------------------------------
Total 1,871 1,852 4,686
=============================================================
* expired unexercised on June 30, 2002.
Segment Information
In the opinion of management, the Company operates in one industry
segment, which is the sale of telecommunications equipment.
Fair Value of Financial Instruments
The carrying amounts of Farmstead's financial instruments, including
cash and cash equivalents, accounts receivable, debt obligations, accounts
payable and accrued expenses, approximate fair value due to their short
maturities.
Reclassifications
Certain amounts in prior years' financial statements and related
notes have been reclassified to conform to the 2003 presentation.
2. CASH AND CASH EQUIVALENTS
Cash and cash equivalents totaled $826,764 and $994,437 at December
31, 2003 and 2002, respectively. Included in each period are investments 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, 2003 and
2002.
3. ACCOUNTS RECEIVABLE, NET
As of December 31, the components of accounts receivable were as
follows (in thousands):
2003 2002
----------------------------------------------------------
Trade accounts receivable $1,410 $1,893
Less: allowance for doubtful accounts (80) (47)
----------------------------------------------------------
Trade accounts receivable, net 1,330 1,846
Other receivables 78 23
----------------------------------------------------------
Accounts receivable, net $1,408 $1,869
==========================================================
Other receivables consist of commissions, rebates and other dealer
incentives due from Avaya, Inc., and are recorded in the consolidated
financial statements when earned.
4. INVENTORIES, NET
As of December 31, the components of inventories were as follows (in
thousands):
2003 2002
-----------------------------------------------------------------------
Finished goods and spare parts $1,817 $2,362
Work in process 450 456
Rental equipment 61 53
-----------------------------------------------------------------------
2,328 2,871
Less: reserves for excess and obsolete inventories (359) (562)
-----------------------------------------------------------------------
Inventories, net $1,969 $2,309
=======================================================================
Work in process inventories consists of used equipment requiring
repair or refurbishing.
29
5. PROPERTY AND EQUIPMENT, NET
As of December 31, the components of property and equipment, net were
as follows (in thousands):
Estimated
Useful Lives (Yrs.) 2003 2002
-------------------------------------------------------------------------------------------
Computer and office equipment 3 - 5 $1,174 $1,318
Furniture and fixtures 5 - 10 290 290
Leasehold improvements 10 190 190
Capitalized software development costs 5 92 44
-------------------------------------------------------------------------------------------
1,746 1,842
Less: accumulated depreciation and amortization (1,433) (1,448)
-------------------------------------------------------------------------------------------
Property and equipment, net $ 313 $ 394
===========================================================================================
The Company has capitalized software development costs incurred by
subcontract programmers in the development of on-line product catalogs and
ordering processes. Depreciation and amortization expense was $164,009,
$215,294 and $256,797 for the years ended December 31, 2003, 2002 and 2001,
respectively.
6. DEBT OBLIGATIONS
As of December 31, 2002 the Company had a $500,000 revolving credit
facility with Wachovia Bank, National Association ("Wachovia Facility")
that was scheduled to expire February 28, 2003. On February 19, 2003 the
Company entered into a one-year, $1.5 million revolving loan agreement (the
"BACC Agreement") with Business Alliance Capital Corporation ("BACC"),
replacing the Wachovia Facility. Under the terms of the BACC Agreement,
borrowings are advanced at 75% of eligible accounts receivable, as defined
(primarily receivables that are less than 90 days old and, in the case of
system sales, the receivable does not become "eligible" until the system
has been installed), and at 25% of the value of eligible inventory, as
defined (primarily inventory that was purchased pursuant to a firm customer
order), provided that the amount advanced against eligible inventory shall
not exceed $200,000 or 30% of all outstanding advances under the BACC
Agreement. Interest is charged at the per annum rate of one and one-half
percentage points (1.5%) above the prime rate, but not less than 5.75%,
subject to a minimum interest charge based on an average daily loan balance
of $250,000 regardless of the actual average loan balance. Under the BACC
Agreement, the Company is charged an annual facility fee of 1% of the
facility and a monthly servicing fee equal to .25% of the average
outstanding loan balance, subject to a minimum average daily loan balance
of $250,000. As additional security to BACC, the Company issued a $300,000
standby letter of credit in favor of BACC, secured by cash, which can be
drawn upon 90 days after an event of default. The BACC Agreement restricts
the Company from the payment of dividends and limits capital expenditures
during the term of the agreement to $150,000, without the consent of BACC.
The BACC Agreement contains no specific financial covenants however, it
defines certain circumstances under which the agreement can be declared in
default and subject to termination, including among others if (i) there is
a material adverse change in the Company's business or financial condition;
(ii) an insolvency proceeding is commenced; (iii) the Company defaults on
any of its material agreements with third parties; (iv) the Company fails
to comply with the terms, representations and conditions of the agreement,
and (v) there are material liens or attachments levied against the
Company's assets. In the event the BACC Agreement is terminated prior to
its expiration date, the Company shall pay a fee in an amount equal to 4%
of the advance limit.
On February 19, 2004, the BACC Agreement was extended for an
additional one-year term with the following modifications: (i) the advance
limit was increased to $1.7 million; and (ii) the cap on inventory advances
was increased to $400,000.
As of December 31, 2003, there were no borrowings under the BACC
credit facility, and based upon borrowing formulas, the Company had
$727,000 in borrowing availability. The average and highest amounts
borrowed during the year ended December 31, 2003 were approximately
$250,000 and $967,000, respectively.
30
7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
As of December 31, the components of accrued expenses and other
current liabilities were as follows (in thousands):
2003 2002
--------------------------------------------------------------
Salaries, commissions and benefits $120 $241
License fees 102 24
Other 52 120
--------------------------------------------------------------
Accrued expenses and other current liabilities $274 $385
==============================================================
8. STOCK OPTIONS
On April 3, 2002, the Board of Directors adopted the Farmstead
Telephone Group, Inc. 2002 Stock Option Plan (the "2002 Plan"), which was
approved by stockholders at the June 13, 2002 Annual Meeting of
Stockholders. The 2002 Plan replaced the 1992 Stock Option Plan that
terminated in May 2002. Options previously granted under the 1992 Plan, of
which there are 1,708,206 options outstanding at December 31, 2003, may
continue to be exercised in accordance with the terms of the individual
grants. The 2002 Plan permits the granting of options to employees,
directors and consultants of the Company, which shall be either incentive
stock options ("ISOs") as defined under Section 422 of the Internal Revenue
Code, or non-qualified stock options ("NSOs"). ISOs may be granted at no
less than market value at the time of grant, with a maximum term of ten
years except, for a 10% or more stockholder, the exercise price shall not
be less than 110% of market value, with a maximum term of five years. NSOs
may be granted at no less than 50% of market value at the time of granting,
with a maximum term of 10 years. Any option granted pursuant to this Plan
which for any reason fails to qualify as an ISO shall be deemed to have
been granted as an option not qualified under Section 422 of the Code. The
maximum number of shares issuable under the 2002 Plan, which expires April
3, 2012, are 1,300,000, of which there were162,500 options outstanding at
December 31, 2003. Options currently granted expire on various dates
through 2013. A summary of stock option transactions for each of the three
years in the period ended December 31, 2003 is as follows:
Weighted
Average
Number Exercise Exercise
of Shares Price Range Price
--------------------------------------------------------------------------
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 - 11.80 $1.91
Granted 254,500 .29 - 1.50 .79
Exercised - - -
Canceled or expired (277,000) .68 - 2.04 1.53
--------------------------------------------------------------------------
Outstanding at December 31, 2002 1,852,306 .29 - 11.80 1.81
Granted 101,500 .28 - .79 .35
Exercised - - -
Canceled or expired (83,100) .28 - 11.80 1.78
--------------------------------------------------------------------------
Outstanding at December 31, 2003 1,870,706 $ .28 - 7.30 $1.73
==========================================================================
As of December 31, 2003:
Exercisable 1,672,456 $ .28 - 7.30 $1.84
Available for future grant 1,137,500
31
The following summarizes information about stock options outstanding
and exercisable as of December 31, 2003:
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
--------------- ----------- ---------------------- -------------- ----------- --------------
$ .28 - 1.00 221,500 8.6 $ .59 109,000 $ .65
$1.01 - 1.50 262,150 7.3 1.28 184,400 1.35
$1.51 - 2.00 1,366,556 4.0 1.96 1,358,556 1.96
$2.01 - 7.30 20,500 2.9 4.75 20,500 4.75
--------------------------------------------------------------------------------------------------------
Total 1,870,706 5.0 $1.73 1,672,456 $1.84
========================================================================================================
9. 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 became 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.
Effective January 1, 2002, the Company acquired TriNET's 49.9%
ownership interest in InfiNet for an aggregate cash purchase price of
$153,334. The $100,512 excess of the purchase price over the fair value of
the net assets acquired was initially allocated to goodwill, in accordance
with SFAS 142. Due to the downsizing of InfiNet's operating activities
during 2002, which included the reduction of its entire workforce and a
business decision to fulfill systems sales orders directly through
Farmstead, the entire $100,512 balance of goodwill was written off as an
operating expense in December 2002.
The following pro forma information presents the Company's
consolidated results of operations for the year ended December 31, 2001 as
if the acquisition had been completed as of the beginning of that year. The
consolidated results of operations for the year ended December 31, 2002
include the effects of the acquisition from January 1, 2002.
Year ended
December 31, 2001
------------------------
(In thousands, except per share data) As Reported Pro forma
---------------------------------------------------------------------
Revenues $33,339 $33,339
Loss before minority interest in
income of subsidiary (1,580) (1,580)
Minority interest in income of subsidiary 128 -
---------------------------------------------------------------------
Net loss $(1,708) $(1,580)
Loss per share: basic $ (.52) $ (.48)
diluted $ (.52) $ (.48)
=====================================================================
10. LEASES AND OTHER COMMITMENTS AND CONTINGENCIES
Leases: As of December 31, 2003, the Company occupied two buildings
in East Hartford, CT, aggregating 49,897 square feet of office and
warehouse space under lease contracts expiring December 31, 2004. The
leases contain two, three-year renewal options. The Company also leases
1,700 square feet of office space in New York, NY under a non-cancelable
lease expiring March 31, 2005. This lease contains one, two-year renewal
option.
32
As of December 31, 2003, aggregate future minimum annual rental
payments under the initial terms of the leases were as follows: $313,692
for 2004 and $14,250 for 2005. Rent expense was $313,692 in 2003, $285,946
in 2002 and $250,146 in 2001.
Employment Agreement: The Company has an employment agreement with
the Chief Executive Officer ("CEO") dated January 1, 1998 and as amended
August 1, 2001, January 1, 2003 and January 1, 2004 (the "Agreement").
Under the Agreement, the CEO will be employed on a full-time basis until
December 31, 2004 (the "Active Period") at a base salary of $160,000.
Commencing January 1, 2005, the CEO will be employed on a limited basis for
a five-year period expiring December 31, 2009 (the "Limited Period").
During each year of the Limited Period, the CEO will be paid a base salary
equal to one-third of the base salary rate in effect at the time of
commencement of the Limited Period, but not less than $100,000, as
consideration for up to fifty days of active service per year. In addition,
during the first year of the Limited Period, the CEO will receive an
additional payment of $142,423. The CEO will also be eligible for an annual
bonus of up to 50% of base salary during the term of the Agreement. The
Agreement provides severance pay should the CEO terminate the Agreement for
"good cause", as defined, or 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 would amount to three
times (i) the amount of the then-current base pay (deemed to be $300,000
for purposes of severance pay calculations), plus (ii) the average bonus
paid during the three most recent calendar years. During the Limited
Period, severance pay will equal the total amount of base salary that would
have been due for the time remaining in the Limited Period. The CEO will
not be entitled to any severance or other compensation during the Active
Period or Limited Period if he voluntarily terminates his employment or if
the Company terminates the Agreement "for cause", as defined.
License Fees: Under a license agreement with Avaya, the Company is
required to pay fees to Avaya based upon a percentage (currently 6.5%) of
the sales price of Classic Avaya(TM) products sold by the Company. The
Company is also required to pay fees to Avaya based upon a percentage
(currently 15%) of the sales price of Classic Avaya(TM) products sold
through the Company's call center. The Company recorded in cost of revenues
approximately $323,000, $507,000 and $1,341,000 of fee expense in 2003,
2002 and 2001, respectively.
Letter of Credit: In connection with the Company's revolving credit
agreement with BACC, the Company issued a $300,000 irrevocable standby
letter of credit ("LC") in favor of BACC. The LC can be drawn upon by BACC
to satisfy any outstanding obligations under the Company's loan agreement
ninety days after an event of default. The LC is secured by cash, and since
this cash is restricted from use by the Company during the term of the LC,
it has been classified under other current assets in the consolidated
balance sheet at December 31, 2003.
11. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENT
In December 2003, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 132 (revised 2003), "Employers' Disclosures about Pensions
and Other Postretirement Benefits, an Amendment of FASB Statements No. 87,
88 and 106" ("SFAS No. 132"). SFAS No. 132 requires, for defined benefit
pension plans and other defined postretirement benefit plans, additional
disclosures regarding plan assets, investment strategy, measurement date,
plan obligations, cash flows and components of net periodic benefit cost,
effective upon issuance. The Company adopted the disclosure requirements
under SFAS 132 for the year ended December 31, 2003. See Note 12 of the
Notes to Consolidated Financial Statements included herein.
12. EMPLOYEE BENEFIT PLANS
The Company maintains a Supplemental Executive Retirement Plan
("SERP") for the benefit of its CEO. The SERP is a defined 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 Company used the Projected Unit Credit Method in
determining the amount of benefit obligation expense to accrue each year.
During 2002, the Company calculated the amount of benefit obligation
expense using a 7% interest rate assumption. During 2003, the interest rate
assumption was lowered to 6.25%, resulting in the recognition of an
actuarial loss of $31,906 which will be amortized to expense over a four-
year period beginning 2004. The amount of the unrecognized actuarial loss
as of December 31, 2003 has been recorded in Accumulated Other
Comprehensive Loss as a component of Stockholders' Equity.
33
The components of the net periodic benefit cost included in the
results of operations for the three years ended December 31, 2003 are set
forth as follows (in thousands):
2003 2002 2001
-------------------------------------
Service cost $69 $65 $61
Interest cost 29 23 17
-------------------------------------
Net expense $98 $88 $78
=====================================
The following information summarizes activity in the SERP for the two
years ended December 31, 2003 (in thousands):
2003 2002
-------------------------------------------------------------------------------
Changes in Benefit Obligation
Benefit obligation at beginning of year $ 348 $ 260
Service cost 69 65
Interest cost 29 23
Actuarial loss 32 -
-------------------------------------------------------------------------------
Benefit obligation at end of year $ 478 $ 348
===============================================================================
Fair Value of Plan Assets (1) $ - $ -
===============================================================================
Reconciliation of Funded Status
Funded status $(478) $(348)
Unrecognized actuarial loss 32 -
-------------------------------------------------------------------------------
Accrued net periodic pension cost $(446) $(348)
===============================================================================
Amounts Recognized in the Consolidated Balance Sheets
Accrued benefit obligation $(478) $(348)
Accumulated other comprehensive loss 32 -
-------------------------------------------------------------------------------
Net liability reflected in the consolidated balance sheets $(446) $(348)
===============================================================================
The SERP is an unfunded plan; however, it is being informally funded
through a Company-owned life insurance policy with an annual premium
payment of $50,000 for ten years. The cash surrender value of this
policy was $259,882 and $151,584 at December 31, 2003 and 2002,
respectively.
The benefits expected to be paid under the SERP in each of the next
five fiscal years, and in the aggregate for the five fiscal years
thereafter are as follows: $0 (2004 - 2006), $100,000 (2007), $100,000
(2008) and $500,000 (2009 - 2013).
The Company has for the past several years provided a split dollar
life insurance program for certain officers as a means of providing a life
insurance benefit and a future retirement benefit. As of December 31, 2003
the split dollar insurance program included only the Chief Financial
Officer. Under this plan, the Company may make discretionary payments of up
to 10% of the participant's annual compensation. Payments aggregated $0 in
2003, $19,259 in 2002 and $49,506 in 2001. The cash surrender value of a
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. As of December 31, 2003, $21,136 was vested.
Included in other assets at December 31, 2003 and 2002 is $302,156
and $212,644, respectively, representing the aggregate cash surrender value
of the insurance policies underlying the Company's SERP and split dollar
insurance programs.
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. The shares
issuable pursuant to the ESPP were registered on Form S-8 (No. 333-69290)
dated September 11, 2001. 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. No shares were added to the ESPP in 2003. The ESPP
34
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, participating employees are 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. During the
two years ended December 31, 2003, the Company issued 12,643 and 26,379
shares, respectively, of Common Stock.
13. STOCKHOLDERS' EQUITY
During the two years ended December 31, 2003, the Company issued
12,643 and 26,379 shares, respectively, of Common Stock under its 2001
Employee Stock Purchase Plan (see Note 12).
On June 30, 2002, the following securities expired unexercised: all
1,137,923 of the Class A Redeemable Common Stock Purchase warrants ("Class
A Warrants"); all 1,137,923 of the Class B Redeemable Common Stock Purchase
warrants ("Class B Warrants"); all 183,579 of the Warrants issued in
connection with the Company's 1987 initial public offering ("IPO
Warrants"); all 33,136 of the Underwriter Options to purchase 33,136 Units,
issued in connection with the Company's 1987 initial public offering
("Underwriter Options"); all 89,948 Representative Warrants to purchase
89,948 Units ("Representative Warrants") issued in 1996 to the Company's
underwriter in connection with a secondary offering of securities.
14. CONCENTRATIONS OF CREDIT RISK
The principal financial instruments subject to credit risk are as
follows:
Accounts Receivable: The Company extends credit to its customers in
the normal course of business. As of December 31, 2003, two customers
accounted for 15% and 10% of accounts receivable. As of December 31, 2002,
one customer accounted for 11% of accounts receivable. Although the Company
is subject to changes in economic conditions which may impact its overall
credit risk, the Company sells to a wide variety of customers, and does not
focus on any particular industry sector. The Company establishes its
allowance for doubtful accounts based upon factors surrounding the credit
risk of specific customers, historical trends and experience, and other
information available to it. Management considers the Company's credit risk
to be satisfactorily diversified and believes that its allowance for
doubtful accounts is adequate to absorb estimated losses as of December 31,
2003. During the three years ended December 31, 2003, no single customer
accounted for more than 10% of revenues.
Cash and Cash Equivalents: The Company maintains cash and cash
equivalents with various financial institutions. Cash equivalents consist
of investments in a money market fund consisting of high quality short term
instruments, principally U.S. Government and Agency issues and commercial
paper, and the fair value approximates the carrying value at each reporting
period. At times such amounts may exceed insurance limits.
Cash Surrender Value of Company-owned insurance policies: The Company
invests the cash surrender value of its Company-owned insurance policies in
various investment portfolios administered by the respective insurance
companies, which include investments in debt and equity securities. The
cash surrender value is therefore subject to market risk and market
fluctuations. The Company believes that this risk is moderated by the
diversity of the underlying investments. As of December 31, 2003, the cash
surrender value of these policies amounted to $302,156.
15. RELATED PARTY TRANSACTIONS
During 2002 and 2001, the Company engaged PFS Venture Group LLC
("PFS") to assist the Company with its strategic reorganization
initiatives. PFS provided business-consulting services to small to mid-
sized companies. Mr. Bruce S. Phillips who, in June 2001, became a director
of the Company, and remained a director until his death in August 2002, was
the principal owner of PFS. During 2002 PFS earned $51,000 in fees, and Mr.
Phillips received 11,250 options to acquire common stock at exercise prices
of $1.00 to $1.50 per share. During 2001, PFS earned $84,000 in fees, and
Mr. Phillips received 21,000 stock options at an exercise price of $1.50
per share.
35
16. INCOME TAXES
The following table provides a summary of the current and deferred
components of the provision for federal and state income taxes attributable
to earnings before income taxes for the three years ended December 31 (in
thousands):
2003 2002 2001
---------------------------------------------------
Federal income tax expense:
Current $ - $ - $ -
Deferred - 436 -
State income tax expense:
Current 13 18 17
Deferred - 19 -
---------------------------------------------------
Provision for income taxes $13 $473 $17
===================================================
Differences between the tax expense reflected in the consolidated
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):
2003 2002 2001
----------------------------------------------------------------------------------
Income tax benefit at statutory rate $(237) $ (699) $(581)
Increase (reduction) in income taxes
resulting from:
State and local income taxes, net of federal
income tax benefit (9) (12) (11)
Non-deductible life insurance (8) 30 25
Non-deductible meals and entertainment 7 17 19
Change in valuation allowance, net of temporary
differences for which benefit has not been provided 260 1,137 565
----------------------------------------------------------------------------------
Provision for income taxes $ 13 $ 473 $ 17
==================================================================================
The tax effects of temporary differences that give rise to
significant portions of deferred tax assets and liabilities at December 31,
2003 and 2002 are as follows (in thousands):
2003 2002
-----------------------------------------------------------------
Deferred tax assets:
Allowance for doubtful accounts $ 27 $ 16
Inventory allowances 122 190
Accrued pension benefit obligation 152 118
Property and equipment 34 31
Other 20 30
Net operating loss and other carryforwards 2,192 1,831
-----------------------------------------------------------------
Total gross deferred tax assets 2,547 2,216
Less: valuation allowance (2,547) (2,216)
-----------------------------------------------------------------
Net deferred tax assets $ - $ -
=================================================================
The Company has federal net operating loss carryforwards of
approximately $5,469,000 that expire through 2024. In 2003 and 2002, the
valuation allowance was increased by an amount that fully offset the
Company's deferred tax assets as of December 31, 2003 and 2002,
respectively. Management believes that the present valuation allowance is
prudent due to the net losses sustained during the three years ended
December 31, 2003 and the unpredictability of future earnings.
36
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data for 2003 and 2002 is as follows
(in thousands except earnings (loss) per share):
Quarter
---------------------------------------------------------------------------------------
2003 First Second Third Fourth(a)
---------------------------------------------------------------------------------------
Revenues $4,439 $3,811 $3,237 $3,193
Gross Profit 1,136 975 946 829
Operating loss (139) (119) (134) (283)
Net loss (145) (132) (149) (283)
Basic and diluted:
Loss per common share (.04) (.04) (.05) (.09)
Weighted average common shares outstanding 3,299 3,305 3,306 3,311
=======================================================================================
Quarter
---------------------------------------------------------------------------------------
2002 First Second Third Fourth(b)
---------------------------------------------------------------------------------------
Revenues $6,027 $4,764 $4,766 $3,593
Gross Profit 1,306 755 1,065 497
Operating loss (354) (662) (287) (827)
Net loss (301) (660) (284) (1,285)
Basic and diluted:
Loss per common share (.09) (.20) (.09) (.39)
Weighted average common shares outstanding 3,281 3,289 3,290 3,299
=======================================================================================
(a) Includes a $93,000 credit to income from a reduction in the Company's
reserves for sales and product warranty returns, and a $41,000 charge
to bad debt expense.
(b) Includes a $101,000 write-off of goodwill, $333,000 of inventory
valuation charges, and a $455,000 charge to increase the deferred tax
asset valuation allowance.
37
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. (the "Company") as of December 31, 2003 and 2002, and
for the years then ended, and have issued our report thereon dated February
27, 2004; such consolidated financial statements and report are included
elsewhere in this Form 10-K. Our audit also includes the financial
statement schedules of Farmstead Telephone Group, Inc., listed in Item 15.
These financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion based on our
audits. In our opinion, such financial statement schedules, when considered
in relation to the basic consolidated financial statements taken as a
whole, present fairly in all material respects the information set forth
therein.
/S/ CARLIN, CHARRON & ROSEN, LLP
Glastonbury, Connecticut
February 27, 2004
38
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Farmstead Telephone Group, Inc.
We have audited the consolidated statements of operations, changes in
stockholders' equity and cash flows of Farmstead Telephone Group, Inc. and
subsidiaries (the "Company") for the year ended December 31, 2001, and have
issued our report thereon dated February 21, 2002; such report is included
elsewhere in this Form 10-K. Our audit also includes the financial
statement schedule of Farmstead Telephone Group, Inc. and subsidiaries for
the year ended December 31, 2001 listed in Item 15. 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 statements of operations, changes in stockholders' equity and
cash flows taken as a whole, presents fairly in all material respects the
information set forth therein.
/S/ DISANTO BERTOLINE & COMPANY, P.C.
Glastonbury, Connecticut
February 21, 2002
39
SCHEDULE II: VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
Column C- Additions
------------------------------
(1) (2)
Column B- Charged Charged Column E-
Balance at (credited) to (credited) to Balance at
beginning of costs and other Column D- End of
Column A- Description period expenses accounts Deductions period
-------------------------------------- ------------ ------------- ------------- ---------- ----------
Year 2003
---------
Allowance for doubtful accounts $ 47 $ 75 - $ 42* $ 80
Inventory valuation reserves 562 28 - 231* 359
Deferred tax asset valuation allowance 2,216 331** - - 2,547
Year 2002
---------
Allowance for doubtful accounts $ 150 $ (33) - $ 70* $ 47
Inventory valuation reserves 1,382 143 - 963* 562
Deferred tax asset valuation allowance 1,039 1,177 - - 2,216
Year 2001
---------
Allowance for doubtful accounts $ 244 $ 104 - $198* $ 150
Inventory valuation reserves 935 1,443 - 996* 1,382
Deferred tax asset valuation allowance 455 584 - - 1,039
* Represents write-offs of inventories and uncollectible accounts
receivable.
** Recorded to fully reserve for the increase in the Company's net
deferred tax assets.
40
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]
4(k) Farmstead Telephone Group, Inc. 2002 Stock Option Plan
[Appendix A to the Proxy Statement on Schedule 14A filed
April 19, 2002 for the 2002 Annual Meeting of Stockholders]
10(a) Form of Underwriter's Consulting Agreement [ Exhibit 10.1 to
the SB-2 Registration Statement dated June 3, 1996
(Registration No. 333-5103)]
10(b) 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(c) 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]
10(d) 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(e) 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(f) ARS Dealer Agreement Between Lucent Technologies and
Farmstead Telephone Group, Inc. For
41
Business Communications Systems [Exhibit 10(s) to the Annual
Report on Form 10-KSB for the year ended December 31, 1998]
10(g) 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(h) 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]
10(i) 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(j) 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(k) 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(l) 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(m) 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(n) 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(o) 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(p) Limited Liability Company Agreement of InfiNet Systems LLC,
effective February 1, 2001 [Exhibit 10(dd) to the Annual
Report on Form 10-K for the year ended December 31, 2001]
10(q) First Modification to Loan Agreement, entered into December
19, 2001 [Exhibit 10(ee) to the Annual Report on Form 10-K
for the year ended December 31, 2001]
10(r) Restated First Addendum To That Certain Employment Agreement
Between Farmstead Telephone Group, Inc. and George J. Taylor,
Jr., effective August 1, 2001 [Exhibit 10(ff) to the Annual
Report on Form 10-K for the year ended December 31, 2001]
10(s) Avaya Inc. Reseller Master Terms and Conditions; Agreement
No. AVNERA1-060601, dated May 31, 2002 . [Exhibit 10(a) to
the Quarterly Report on Form 10-Q for the quarter ended June
30, 2002]
10(t) Third Modification to Loan Agreement, dated September 23,
2002 between Farmstead Telephone Group, Inc. and Wachovia
Bank, National Association (f/k/a First Union National Bank).
[Exhibit 10(a) to the Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002]
10(u) Modification Number One To Promissory Note, dated October 9,
2002 between Farmstead Telephone Group, Inc. and Wachovia
Bank, National Association. [Exhibit 10(b) to the Quarterly
Report on Form 10-Q for the quarter ended September 30, 2002]
10(v) Fourth Modification to Loan Agreement, dated October 9, 2002
between Farmstead Telephone Group, Inc. and Wachovia Bank,
National Association (f/k/a First Union National Bank).
[Exhibit 10(c) to the Quarterly Report on Form 10-Q for the
quarter ended September 30, 2002]
10(w) Loan and Security Agreement dated February 19, 2003 by and
between Business Alliance Capital Corp. and Farmstead
Telephone Group, Inc. 2001 [Exhibit 10(v) to the Annual
Report on Form 10-K for the year ended December 31, 2002]
10(x) Revolving Credit Master Promissory Note dated February 19,
2003 between Business Alliance Capital Corporation and
Farmstead Telephone Group, Inc. [Exhibit 10(w) to the Annual
Report on Form 10-K for the year ended December 31, 2002]
10(y) Second Addendum to That Certain Employment Agreement Between
Farmstead Telephone Group, Inc. and George J. Taylor, Jr.,
Dated as of January 1, 1998, as Amended by That Certain
Restated First Addendum Dated as of August 1, 2001[Exhibit
10(x) to the Annual Report on Form 10-K for the year ended
December 31, 2002]
42
10(z) Revolving Credit Master Promissory Note dated February 19,
2004 between Business Alliance Capital Corporation and
Farmstead Telephone Group, Inc.
10(aa) Modification Agreement dated February 19, 2004 between
Business Alliance Capital Corporation and Farmstead Telephone
Group, Inc.
10(bb) Third Addendum to That Certain Employment Agreement Between
Farmstead Telephone Group, Inc. and George J. Taylor, Jr.,
Dated as of January 1, 1998, as Amended by That Certain
Restated First Addendum Dated as of August 1, 2001and as
Further Amended by That Certain Second Addendum Dated as of
January 1, 2003
10(cc) Second Addendum to That Certain Employment Agreement between
Farmstead Telephone Group, Inc. and Robert G. LaVigne dated
as of January 1, 2000 as Amended by That First Addendum Dated
as of January 1, 2003
10(dd) Amendment to Reseller Master Terms and Conditions: Authorized
Remanufactured Supplier (ARS) Program Between Avaya Inc. and
Farmstead Telephone Group, Inc., dated October 28, 2003
21 Subsidiaries
23(a) Consent of DiSanto Bertoline & Company, P.C.
23(b) Consent of Carlin, Charron & Rosen LLP
31.1 Certification of the Chief Executive Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
43