UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended June 30, 2004
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File Number: 0-15938
Farmstead Telephone Group, Inc.
-------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-1205743
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
22 Prestige Park Circle
East Hartford, CT 06108
(Address of principal executive offices) (Zip Code)
(860) 610-6000
(Registrant's telephone number)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities
Exchange Act of 1934 during the 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 whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of July 31, 2004, the registrant had 3,315,638 shares of its
$0.001 par value Common Stock outstanding.
TABLE OF CONTENTS TO FORM 10-Q
PART I. FINANCIAL INFORMATION
Page
----
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
Consolidated Balance Sheets - June 30, 2004 and
December 31, 2003 3
Consolidated Statements of Operations - Three and
Six Months Ended June 30, 2004 and 2003 4
Consolidated Statements of Cash Flows - Six Months
Ended June 30, 2004 and 2003 5
Notes to Consolidated Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 9
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 13
ITEM 4. CONTROLS AND PROCEDURES 13
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 13
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 13
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 13
ITEM 5. OTHER INFORMATION 13
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 13
SIGNATURES 14
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
(In thousands) 2004 2003
----------------------------------------------------------------------------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 311 $ 827
Accounts receivable, net 1,509 1,408
Inventories, net 2,146 1,969
Other current assets 392 447
----------------------------------------------------------------------------------
Total Current Assets 4,358 4,651
----------------------------------------------------------------------------------
Property and equipment, net 263 313
Other assets 375 327
----------------------------------------------------------------------------------
Total Assets $ 4,996 $ 5,291
==================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,253 $ 1,248
Debt maturing within one year 218 -
Accrued expenses and other current liabilities 448 274
----------------------------------------------------------------------------------
Total Current Liabilities 1,919 1,522
----------------------------------------------------------------------------------
Other liabilities 535 478
----------------------------------------------------------------------------------
Total Liabilities 2,454 2,000
----------------------------------------------------------------------------------
Commitments and contingencies (Note 9)
Stockholders' Equity:
Preferred stock, $0.001 par value;
2,000,000 shares authorized;
no shares issued and outstanding - -
Common stock, $0.001 par value; 30,000,000
shares authorized; 3,315,638 and 3,311,601
shares issued and outstanding at March 31, 2004
June 30, 2004 and December 31, 2003, respectively 3 3
Additional paid-in capital 12,318 12,316
Accumulated deficit (9,751) (8,996)
Accumulated other comprehensive loss (28) (32)
----------------------------------------------------------------------------------
Total Stockholders' Equity 2,542 3,291
----------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 4,996 $ 5,291
==================================================================================
See accompanying notes to consolidated financial statements.
3
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three For the Six
Months Ended Months Ended
June 30, June 30,
----------------- -----------------
(In thousands, except loss per share amounts) 2004 2003 2004 2003
----------------------------------------------------------------------------------------
Revenues:
Equipment $2,584 $3,053 $5,506 $7,080
Services and other revenue 305 817 789 1,294
----------------------------------------------------------------------------------------
Total revenues 2,889 3,870 6,295 8,374
Cost of revenues:
Equipment 1,970 2,109 4,016 4,886
Services and other revenue 189 597 461 930
Other cost of revenues 126 189 337 447
----------------------------------------------------------------------------------------
Total cost of revenues 2,285 2,895 4,814 6,263
----------------------------------------------------------------------------------------
Gross profit 604 975 1,481 2,111
Selling, general and administrative expenses 1,010 1,094 2,220 2,369
----------------------------------------------------------------------------------------
Operating loss (406) (119) (739) (258)
Interest expense (6) (8) (12) (10)
Other income 1 1 2 3
----------------------------------------------------------------------------------------
Loss before income taxes (411) (126) (749) (265)
Provision for income taxes 3 6 6 12
----------------------------------------------------------------------------------------
Net loss $ (414) $ (132) $ (755) $ (277)
========================================================================================
Basic and diluted net loss per common share: $ (.12) $ (.04) $ (.23) $ (.08)
Weighted average common shares outstanding:
Basic 3,316 3,305 3,314 3,302
Diluted 3,351 3,334 3,357 3,319
========================================================================================
See accompanying notes to consolidated financial statements.
4
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months Ended June 30, 2004 and 2003
(In thousands) 2004 2003
-------------------------------------------------------------------------
Cash flows from operating activities:
Net loss $(755) $ (277)
Adjustments to reconcile net loss to net cash
flows used in operating activities:
Provision for doubtful accounts receivable 18 16
Provision for losses on inventories 68 15
Depreciation and amortization 73 88
Decrease in accumulated other comprehensive loss 4 -
Changes in operating assets and liabilities:
Increase in accounts receivable (119) (784)
Increase in inventories (245) (65)
Decrease (increase) in other assets 7 (374)
Increase in accounts payable 5 323
Increase (decrease) in accrued expenses and
other current liabilities 174 (38)
Increase in other liabilities 57 51
-------------------------------------------------------------------------
Net cash used in operating activities (713) (1,045)
-------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (23) (24)
-------------------------------------------------------------------------
Net cash used in investing activities (23) (24)
-------------------------------------------------------------------------
Cash flows from financing activities:
Borrowings under revolving credit line 218 365
Issuance of common stock 2 2
-------------------------------------------------------------------------
Net cash provided by financing activities 220 367
-------------------------------------------------------------------------
Net decrease in cash and cash equivalents (516) (702)
Cash and cash equivalents at beginning of period 827 994
-------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 311 $ 292
=========================================================================
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 14 $ 7
Income taxes 4 4
See accompanying notes to consolidated financial statements.
5
FARMSTEAD TELEPHONE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated financial statements presented herein consist of the
accounts of Farmstead Telephone Group, Inc. and its wholly owned
subsidiaries, FTG Venture Corporation (inactive) and InfiNet Systems, LLC
(inactive). The accompanying consolidated financial statements as of June
30, 2004 and for the three and six months ended June 30, 2004 and 2003 have
been prepared in accordance with accounting principles generally accepted
in the United States of America and the rules and regulations of the
Securities and Exchange Commission for interim financial statements. In the
Company's opinion, the unaudited interim consolidated financial statements
and accompanying notes reflect all adjustments, consisting of normal and
recurring adjustments that are necessary for a fair statement of results
for the interim periods presented. The results of operations for the
interim periods are not necessarily indicative of the results to be
experienced for the entire fiscal year. This Form 10-Q should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2003.
2. OPERATIONS
As presented in the consolidated financial statements contained in
this report, the Company incurred a net loss of $414,000 for the quarter
ended June 30, 2004, a net loss of $755,000 for the six months ended June
30, 2004, and has incurred substantial losses in each of the past three
fiscal years. These losses have been primarily the result of significant
declines in revenues over these periods, and some deterioration in profit
margins. There is currently no clear indication that sales levels will
significantly increase in the near term and, in fact, they could continue
to decline. The Company has been restructuring its operations in order to
align its operating expenses with its revenue levels. During 2004, these
actions resulted in a reduction of 21% of its workforce, primarily
operations and administrative positions. The Company is currently focusing
on strategies to increase revenues, which may include a further
diversification of its product offerings, and increasing the size of its
sales force. The Company is also currently seeking out business partners
interested in merging with the Company, as well as investment banking
relationships to assist in obtaining capital to finance any
mergers/acquisitions. With continuing softness in the demand for
telecommunications products, growth through external means may be the
quickest way for the Company to bolster revenues and operating results and
achieve a more diverse product offering for its customers.
On August 2, 2004, the Company received notification from Avaya, Inc.
that, effective July 30, 2004, it was terminating the Authorized
Remarketing Supplier aftermarket program (the "ARS Program") under which
the Company sold "Classic Avaya(TM)" products. The Company will be allowed
continued use of the Classic Avaya licensed trade mark for a period of 90
days from the termination date. Avaya is currently developing successor
programs to the ARS Program, and the Company expects to be included in
these programs. Since the beginning of 2004, in anticipation of the
possible termination of the ARS Program, the Company has been selling
"Farmstead Certified" refurbished equipment in addition to "Classic Avaya"-
labeled equipment. The Company believes that the termination of the ARS
Program will not have a material adverse impact on the Company.
3. RECLASSIFICATIONS
Certain amounts in the Consolidated Statement of Operations for the
three and six months ended June 30, 2003 were reclassified to conform to
the current period presentation.
4. ACCOUNTS RECEIVABLE, NET
June 30, December 31,
(Dollars in thousands) 2004 2003
-----------------------------------------------------------------
Trade accounts receivable $1,484 $1,410
Less: allowance for doubtful accounts (67) (80)
-----------------------------------------------------------------
Trade accounts receivable, net 1,417 1,330
Other receivables 92 78
-----------------------------------------------------------------
Accounts receivable, net $1,509 $1,408
=================================================================
Other receivables primarily consist of commissions, rebates and other
dealer incentives due from Avaya, Inc., and are recorded in the
consolidated financial statements when earned.
6
5. INVENTORIES, NET
June 30, December 31,
(Dollars in thousands) 2004 2003
------------------------------------------------------------------------------
Finished goods and spare parts $1,924 $1,817
Work in process (a) 472 450
Rental equipment 47 61
------------------------------------------------------------------------------
2,443 2,328
Less: reserves for excess and obsolete inventories (297) (359)
------------------------------------------------------------------------------
Inventories, net $2,146 $1,969
==============================================================================
(a) Work in process inventories consist of used equipment requiring
repair or refurbishing.
6. DEBT MATURING WITHIN ONE YEAR
On February 19, 2004, the Company's revolving credit facility with
Business Alliance Capital Corporation ("BACC") was extended for an
additional one-year term with the following modifications: (i) the credit
facility advance limit was increased from $1.5 million to $1.7 million; and
(ii) the amount that could be advanced against eligible inventory was
increased from $200,000 to $400,000. For additional information on the
terms and conditions of the BACC credit facility, refer to the Company's
Form 10-K filed with the Securities and Exchange Commission for the year
ended December 31, 2003.
As of June 30, 2004, outstanding borrowings with BACC were $218,000.
The unused portion of the credit facility as of June 30, 2004 was
$1,482,000, of which $451,000 was available to borrow. The average and
highest amounts borrowed during the three months ended June 30, 2004 were
approximately $166,000 and $401,000, respectively. The average and highest
amounts borrowed during the six months ended June 30, 2004 were
approximately $159,000 and $401,000, respectively. The Company was in
compliance with the provisions of its loan agreement as of June 30, 2004.
7. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
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 annual disclosure
requirements for the year ended December 31, 2003. The Company adopted the
interim disclosure requirements in the first quarter of 2004, with current
quarter disclosures provided in Note 10.
8. STOCK OPTIONS
The Company applies the disclosure only provisions of Financial
Accounting Standards Board Statement ("SFAS") No. 123, "Accounting for
Stock-based Compensation" ("SFAS 123") and SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" for employee stock
option awards. Had compensation cost for the Company's stock option plan
been determined in accordance with the fair value-based method prescribed
under SFAS 123, the Company's net loss and basic and diluted net loss per
share would have approximated the pro forma amounts indicated below
(dollars in thousands except per share amounts):
Three months ended Six months ended
June 30, June 30,
------------------ ----------------
2004 2003 2004 2003
--------------------------------------------------------------------------------------------
Net loss, as reported $(414) $(132) $(755) $(277)
Add: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax effects (17) (23) (38) (46)
-------------------------------------------------------------------------------------------
Pro forma net loss (431) $(155) (793) $(323)
Pro forma net loss per share:
Basic and diluted $(.13) $(.05) $(.24) $(.10)
===========================================================================================
7
The weighted-average fair value of options granted during the three
and six months ended June 30, 2004 and 2003 was $.37 and $.47,
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: dividend yield of 0% for 2004 and 2003; expected
volatility of 108% for 2004 and 113% for 2003; average risk-free interest
rate of 3.30 % for 2004 and 2.78% for 2003; and an expected option holding
period of 4.3 years for 2004 and 5.6 years for 2003.
9. COMMITMENTS AND CONTINGENCIES
Lease Agreements. On March 23, 2004, the Company entered into a new
lease agreement on its corporate offices and distribution center located at
22 Prestige Park Circle, East Hartford, CT. This agreement replaced the
Company's existing lease due to expire in December 2004. Under the new
lease agreement, which became effective May 1, 2004, the Company is leasing
25,051 square feet for a 10-year, 8-month period expiring December 31,
2014. The lease contains one five-year renewal option. The lease also
allows the Company the one-time option to terminate the lease without
penalty on December 31, 2009. Minimum monthly rent will amount to $11,377
for 2004, $13,047 for years 2005 - 2009, and $13,569 for years 2010 - 2014.
The Company is additionally obligated to pay the lessor its proportionate
share of the property operating costs at an amount equal to $1.20 per
square foot, subject to a 2% annual increase.
On March 31, 2004, the Company terminated, without penalty, its lease
agreement on 15,137 square feet of warehouse space that was scheduled to
expire December 31, 2004. The lease termination was effective April 1,
2004.
Letter of Credit. In connection with the Company's revolving credit
agreement with BACC, the Company issued a $300,000 irrevocable standby
letter of credit ("LC") in favor of BACC. The LC can be drawn upon by BACC
to satisfy any outstanding obligations under the Company's loan agreement
ninety days after an event of default. The LC is secured by cash, and since
this cash is restricted from use by the Company during the term of the LC,
it has been classified under other current assets in the consolidated
balance sheet at June 30, 2004 and December 31, 2003.
10. EMPLOYEE BENEFIT PLANS
The components of the net periodic benefit cost included in the
results of operations for the three and six months ended June 30, 2004 and
2003 are as follows:
Three months ended Six months ended
June 30, June 30,
------------------ ----------------
(Dollars in thousands) 2004 2003 2004 2003
---------------------------------------------------------------------
Service cost $20 $17 $40 $35
Interest cost 9 7 18 15
Recognized actuarial losses 2 - 4 -
---------------------------------------------------------------------
Net expense $31 $24 $62 $50
=====================================================================
11. STOCKHOLDERS' EQUITY
On May 7, 2004 the Company received notice from the American Stock
Exchange (the "Amex" or the "Exchange") that it did not meet certain of the
Exchange's continued listing standards as a result of having stockholders'
equity less than $4 million and net losses in three out of its four most
recent fiscal years, as set forth in Section 1003 (a) (ii) of the Amex
Company Guide. The Company was afforded the opportunity to submit a plan of
compliance to the Exchange and on June 15, 2004 presented its plan to the
Exchange. On July 19, 2004 the Exchange notified the Company that it
accepted its plan of compliance and granted the Company an extension of
time to regain compliance with the continued listing standards. The Company
will be subject to periodic review by Exchange Staff during the extension
period which expires November 7, 2005. Failure to make progress consistent
with the plan or to regain compliance with the continued listing standards
by the end of the extension period could result in the Company being
delisted from the American Stock Exchange.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The discussions set forth below and elsewhere in this Quarterly
Report on Form 10-Q contain certain statements, based on current
expectations, estimates, forecasts and projections about the industry in
which we operate and management's beliefs and assumptions, which are not
historical facts and are considered forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995 ("the
Act"). Forward-looking statements include, without limitation, any
statement that may predict, forecast, indicate, or imply future results,
performance, or achievements, and may contain the words "believe," "will
be," "will continue," "will likely result," "anticipates," "seeks to,"
"estimates," "expects," "intends," "plans," "predicts," "projects," and
similar words, expressions or phrases of similar meaning. Our actual
results could differ materially from those projected in the forward-looking
statements as a result of certain risks, uncertainties and assumptions,
which are difficult to predict. Many of these risks and uncertainties are
described under the heading "Risks, 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.
RESULTS OF OPERATIONS
OVERVIEW. For the three months ended June 30, 2004, we recorded a net
loss of $414,000 or $.12 per share on revenues of $2,889,000. This compares
with a net loss of $132,000 or $.04 per share on revenues of $3,870,000
recorded for the three months ended June 30, 2003. For the six months ended
June 30, 2004, we recorded a net loss of $755,000 or $.23 per share on
revenues of $6,295,000. This compares with a net loss of $277,000 or $.08
per share on revenues of $8,374,000 recorded for the six months ended June
30, 2003. The operating results for 2004, as compared to the prior year
periods, have resulted from significant declines in revenues, coupled with
some deterioration in gross profit margins. There are several factors which
have contributed to these declines. First, there is increased competition
in the market areas that we serve, and this has led to continued sales
price erosion and some loss of market share, particularly in the sale of
parts, which we believe has become more of a commodity and subject to
"price shopping" by customers. Our strategy to diversify our product
offerings by selling complete systems and system upgrades has generated
incremental revenues, but sales to date have not been consistent enough to
compensate for the decline in parts sales. Second, our sales force has
undergone significant turnover in the last two years, and the productivity
ramp-up of new salespersons has taken longer than expected. Revenue growth
is dependent upon a stable, and highly trained sales force. Third, we
continue to believe that corporations are still cautious about capital
equipment spending. We believe that equipment sales have been affected by
the downsizing of many of our customers over the last few years, which
resulted in excess equipment available for re-deployment in their
operations. This has resulted in a decrease in both the number of orders
received and their average order size. Although there have been some signs
of improvement in our industry as evidenced by improved operating results
from some of the key manufacturers, and increased sales quotation
activities, our overall order flow has been below our expectations.
During these tough times, we have been reorganizing our operations to
properly size our business in relation to current revenue run-rates, while
trying to preserve our key technical personnel that are critical to
maintaining and growing a systems and services business. Our primary focus
during 2004 has been on strategies to increase revenues while continuing
close controls over operating expenses. However, there is currently no
clear indication that sales levels will significantly increase in the near
term and, in fact, they could continue to decline. In reaction to lower
than expected revenue levels, during 2004 we reduced our workforce by 21%,
primarily operations and administrative positions, but keeping key
technical resources intact. We are currently seeking out business partners
interested in merging with the Company, as well as investment banking
relationships to assist in obtaining capital to finance any
mergers/acquisitions. With continuing softness in the demand for
telecommunications products, growth through external means may be the
quickest way for the Company to bolster revenues and operating results and
achieve a more diverse product offering for our customers. Additional
information on major components of our operating performance for the three
and six months ended June 30, 2004 follows below.
9
REVENUES
Three months ended Six months ended
June 30, June 30,
------------------ ----------------
(in thousands) 2004 2003 2004 2003
--------------------------------------------------------------------------
Equipment:
End-user equipment sales $2,272 $2,661 $5,035 $6,283
Equipment sales to resellers 312 392 471 797
--------------------------------------------------------------------------
Total equipment sales 2,584 3,053 5,506 7,080
--------------------------------------------------------------------------
Services:
Installations 189 651 520 934
Rentals and repair 35 32 71 139
Other revenue 81 134 198 221
--------------------------------------------------------------------------
Total services and other revenue 305 817 789 1,294
--------------------------------------------------------------------------
Consolidated revenues $2,889 $3,870 $6,295 $8,374
==========================================================================
Equipment Sales
---------------
Total equipment sales for the three months ended June 30, 2004, were
$2,584,000, a decrease of $469,000 or 15% from the comparable 2003 period.
The decrease consisted of a $389,000 or 15% decline in end-user sales, and
an $80,000 or 20% decline in equipment sales to resellers ("wholesale
sales"). Total equipment sales for the six months ended June 30, 2004, were
$5,506,000, a decrease of $1,574,000 or 22% from the comparable 2003
period. The decrease consisted of a $1,248,000 or 20% decline in end-user
sales, and a $326,000 or 41% decline in wholesale sales. End user sales
consist of both parts sales (new and refurbished), and systems sales
(complete systems and system upgrades).
Factors affecting end-user equipment sales for the three and six
months ended June 30, 2004 are described in the "Overview" section above.
Wholesale sales have been impacted by some of these same factors. In
addition, our principal supplier of used equipment for resale into the
wholesale market has significantly curtailed operations, thereby limiting
our ability to acquire equipment at a low enough cost for profitable resale
into the wholesale market.
As a marketing tool to help generate future equipment revenues, we
have developed an electronic commerce framework called "ECONNECT". For the
six months ended June 30, 2004, approximately 5% of our equipment sales
were processed through our on-line catalog. We have, however, signed
agreements with two large aftermarket customers whom we will service
through ECONNECT. We will be monitoring the effectiveness and leverage of
this type of program as the year progresses.
Services and Other Revenue
--------------------------
Services revenues for the three months ended June 30, 2004, were
$224,000, a decrease of $459,000 or 67% from the comparable 2003 period.
The decrease was attributable to lower installation revenues, which in turn
partly resulted from a 13% decline in system sales compared to the prior
year period. Services revenues for the six months ended June 30, 2004 were
$591,000, down $482,000 or 45% from the comparable 2003 period. The
decrease was attributable to (i) a 44% decline in installation revenues,
which in turn partly resulted from a 20% decline in system sales compared
to the prior year period; and (ii) a 49% decline in equipment rental and
repair revenues. Equipment rental revenues are erratic and difficult to
predict, since they tend to be project-oriented. An increase or decrease in
installation revenues does not always coincide with the reported increase
or decrease in system sales since installations may occur in different
periods than the related system sale, and the Company may sell new systems
or system upgrades without being contracted to perform the installation.
Other revenue for the three and six months ended June 30, 2004 and
2003 consisted primarily of freight billed to customers on product
shipments, and commissions earned from selling Avaya maintenance contracts.
In these transactions we act as a sales agent of Avaya, and the service
obligations are borne entirely by Avaya. Other revenue for the three months
ended June 30, 2004 was $81,000, down $53,000 or 40% from the comparable
2003 period, primarily attributable to lower commissions earned on Avaya
maintenance contracts. Other revenue for the six months ended June 30, 2004
was $198,000, down $23,000 or 10% from the comparable prior year period due
to lower freight revenues and lower commissions earned on Avaya maintenance
contracts.
COST OF REVENUES AND GROSS PROFIT. Total cost of revenues for the
three months ended June 30, 2004 was $2,285,000, a decrease of $610,000 or
21% from the comparable 2003 period. The gross profit for the three months
ended
10
June 30, 2004 was $604,000, a decrease of $371,000 or 38% from the
comparable 2003 period. As a percentage of revenue, the gross profit margin
was 21% for 2004, compared to 25% for the comparable 2003 period.
Total cost of revenues for the six months ended June 30, 2004 was
$4,814,000, a decrease of $1,449,000 or 23% from the comparable 2003
period. The gross profit for the six months ended June 30, 2004 was
$1,481,000, a decrease of $630,000 or 30% from the comparable 2003 period.
As a percentage of revenue, the gross profit margin was 24% for 2004,
compared to 25% for the comparable 2003 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 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.
Gross Profit on Equipment Sales. For the three months ended June 30,
2004, the gross profit margin on equipment sales revenues decreased to 24%,
from 31% recorded during the comparable prior year period. For the six
months ended June 30, 2004, the gross profit margin on equipment sales
revenues decreased to 27%, from 31% recorded during the comparable prior
year period. The decrease in each period was attributable to lower profit
margins on sales of parts to both end-users and to wholesalers, partly
offset by increased profit margins on systems sales. In addition, the gross
profit margin was negatively impacted in each current year period by
charges to increase inventory valuation reserves - a $53,000 incremental
increase for the current three-month period compared with the prior year,
and a $43,000 incremental increase for the current six-month period
compared with the prior year. As previously discussed, product demand
conditions and increased competition has led to downward pressure on our
sales pricing. We have been focusing on lowering our product acquisition
costs in order to help stabilize our gross margin levels; however we expect
continued pressure on our profit margins going forward.
Gross Profit on Services and Other Revenues. For the three months
ended June 30, 2004, the gross profit margin on services and other revenues
increased to 38%, from 27% in the comparable prior year period. For the six
months ended June 30, 2004, the gross profit margin on services and other
revenues increased to 42%, from 28% in the comparable prior year period.
The increase in each period was primarily attributable to higher profit
margins on installation services.
Other Cost of Revenues. Other cost of revenues consists of product
handling, purchasing and facility costs and expenses. For the three months
ended June 30, 2004, these expenses were 33% lower than the comparable
prior year period, and represented 5% of equipment sales revenues during
the current period, compared to 6% of equipment sales revenues in 2003. For
the six months ended June 30, 2004, these expenses were 25% lower than the
comparable prior year period, representing 6% of equipment sales revenues
during both the current period and comparable prior year periods. The
reduction in other cost of revenues primarily resulted from personnel
reductions implemented in 2004 as well as planned reductions in facility
costs and expenses. During the three and six months ended June 30, 2004,
we incurred $7,000 and $25,000, respectively, in termination pay expense
related to the personnel reductions.
SELLING, GENERAL AND ADMINISTRATIVE ("SG&A") EXPENSES. SG&A expenses
for the three months ended June 30, 2004 were $1,010,000, a decrease of
$84,000 or 8% from the comparable 2003 period. SG&A expenses for the six
months ended June 30, 2004 were $2,220,000, a decrease of $149,000 or 6%
from the comparable 2003 period. SG&A expenses, however, were 35% of
revenues in each period of 2004 as compared to 28% of revenues in each
period of 2003, which is attributable to the relative "fixed" nature of a
significant portion of our SG&A. The decrease in SG&A expenses in each
period was primarily attributable to (i) lower compensation expense from
lower personnel levels and lower sales commissions; (ii) lower facility
rental and operating costs as a result of a reduction in the number of
square feet leased, and (iii) reductions in various other administrative
expenses as a result of cost reduction initiatives. The decreases were
partly offset by (i) higher marketing and other sales-related expenses;
(ii) higher costs associated with maintaining our ECONNECT on-line catalog;
(iii) higher insurance costs and (iv) lower earned Avaya dealer marketing
rebates. During the three and six months ended June 30, 2004, we incurred
$14,000 and $17,000, respectively, in termination pay expense related to
personnel reduction initiatives.
INTEREST EXPENSE AND OTHER INCOME. Interest expense for the three
months ended June 30, 2004 was $6,000, compared with $8,000 for the
comparable 2003 period. Interest expense for the six months ended June 30,
2004 was $12,000, compared with $10,000 for the comparable 2003 period. The
fluctuations in interest expense period-over-period
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was attributable to changes in average borrowing levels. Other income
consisted of interest earned on invested cash in all reported periods.
PROVISION FOR INCOME TAXES. The provision for income taxes represents
estimated minimum state taxes in all reported periods. We maintain a full
valuation allowance against our net deferred tax assets, which consist
primarily of net operating loss and capital loss carryforwards, and timing
differences between the book and tax treatment of inventory and other asset
valuations. Realization of these net deferred tax assets is dependent upon
our ability to generate future taxable income.
LIQUIDITY AND CAPITAL RESOURCES
Working capital, defined as current assets less current liabilities,
was $2,439,000 at June 30, 2004, a decrease of $690,000 or 22% from
$3,129,000 at December 31, 2003. The working capital ratio was 2.3 to 1 at
June 30, 2004, compared with 3.1 to 1 at December 31, 2003.
Operating activities used $713,000 during the six months ended June
30, 2004. Net cash used by operating activities consisted of a net loss of
$755,000 adjusted for non-cash expense items of $163,000, and net cash used
by changes in operating assets and liabilities of $121,000. Net cash used
by changes in operating assets and liabilities was primarily attributable
to an increase in inventories and accounts receivable, partly offset by an
increase in accrued expenses and other current liabilities.
Investing activities used $23,000 during the six months ended June
30, 2004 to fund capital expenditures.
Financing activities provided $220,000 during the six months ended
June 30, 2004, primarily attributable to working capital borrowings under
our revolving credit facility with BACC. On February 19, 2004, the BACC
credit facility was extended for an additional one-year term with the
following modifications: (i) the credit facility advance limit was
increased from $1.5 million to $1.7 million; and (ii) the amount that could
be advanced against eligible inventory was increased from $200,000 to
$400,000. For additional information on the terms and conditions of the
BACC credit facility, refer to our Form 10-K filed with the Securities and
Exchange Commission for the year ended December 31, 2003.
As of June 30, 2004, outstanding borrowings with BACC were $218,000.
The unused portion of the credit facility as of June 30, 2004 was
$1,482,000, of which $451,000 was available to borrow. The average and
highest amounts borrowed during the three months ended June 30, 2004 were
approximately $166,000 and $401,000, respectively. The average and highest
amounts borrowed during the six months ended June 30, 2004 were
approximately $159,000 and $401,000, respectively. The Company was in
compliance with the provisions of its loan agreement as of June 30, 2004.
As a result of our reduced revenues and employment levels, we early-
terminated one building lease agreement covering 15,137 square feet of
warehouse space (otherwise scheduled to expire December 31, 2004), and
renegotiated the building lease on our main offices and distribution
center, reducing our square footage under rent from approximately 35,000
square feet to approximately 25,000 square feet. These actions are
estimated to reduce our 2004 building rental and operating costs by
approximately $16,000 per month. Refer to Note 9 for further information on
the new lease agreement.
We are dependent upon generating positive cash flow from operations
and upon our revolving credit facility to provide cash to satisfy working
capital requirements. If the trend in operating losses continues, we would
most likely not have the financial resources to sustain or fund our current
level of operations. Further, 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. 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.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion included in Item 7 of our Annual Report on Form 10-K
for the year ended December 31, 2003 under the subheading "Critical
Accounting Policies and Estimates" is still considered current and is
hereby incorporated into this Quarterly Report on Form 10-Q.
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RISKS, UNCERTAINTIES AND OTHER FACTORS THAT MAY AFFECT FUTURE RESULTS
The discussion included in Item 7 of our Annual Report on Form 10-K
for the year ended December 31, 2003 under the subheading "Risks,
Uncertainties and Other Factors That May Affect Future Results" is still
considered current and applicable, and is hereby incorporated into this
Quarterly Report on Form 10-Q.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The discussion included in Item 7A of our Annual Report on Form 10-K for
the year ended December 31, 2003, "Quantitative and Qualitative Disclosures
About Market Risk", is still considered current and applicable, and is
hereby incorporated into this Quarterly Report on Form 10-Q.
ITEM 4. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures. Our Chief Executive
Officer and Chief Financial Officer have evaluated the effectiveness of our
disclosure controls and procedures (as such term is defined in Rules 13a-
14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended
(the "Exchange Act")) as of a date within 90 days prior to the filing date
of this Quarterly Report on Form 10-Q. Based on such evaluation, such
officers have concluded that our disclosure controls and procedures are
effective in alerting them on a timely basis to material information
relating to our Company required to be included in our reports filed or
submitted under the Exchange Act.
(b) Changes in Internal Controls. There were no significant changes in our
internal controls or in other factors that could significantly affect such
controls subsequent to the date of their most recent evaluation.
PART II. OTHER INFORMATION.
ITEMS 1, 2, 3 and 5 have been omitted because there is nothing to report or
they are inapplicable.
Item 4. Submission of Matters to a Vote of Security Holders:
The proposals voted upon at the Company's Annual Meeting of Stockholders,
held June 10, 2004, along with the voting results, were as follows:
(1) Election of Directors: All nominees were elected: The results of
the balloting were as follows:
Votes Votes
Nominees For Withheld
--------------------- --------- --------
George J. Taylor, Jr. 3,061,963 120,219
Harold L. Hanson 3,061,893 120,289
Hugh M Taylor 3,059,043 123,139
Joseph J. Kelley 3,061,893 120,289
Ronald P. Pettirossi 3,061,893 120,289
(2) Ratification of the appointment of Carlin, Charron & Rosen LLP as
independent auditors of the Company for the year ending December 31, 2004:
The proposal was approved with 3,116,263 votes for, 63,952 votes against,
and 1,967 abstentions.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) Exhibits:
The following documents are filed as Exhibits to this Quarterly
Report on Form 10-Q:
31.1 Certification of the Chief Executive Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
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32.2 Certification of the Chief Financial Officer, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K: On July 23, 2004 the Company filed a
report on Form 8-K to report that on July 19, 2004 the Company
received approval from the American Stock Exchange (the "Amex")
on its plan to get back into compliance with the Amex's
continued listing requirements, and to report that it was given
an extension to November 7, 2005, subject to certain
requirements, to achieve compliance with said listing
requirements or be subject to delisting from the Amex.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
FARMSTEAD TELEPHONE GROUP, INC.
Dated: August 12, 2004 /s/ George J. Taylor, Jr.
----------------------------------
George J. Taylor, Jr.
Chief Executive Officer, President
Dated: August 12, 2004 /s/ Robert G. LaVigne
----------------------------------
Robert G. LaVigne
Executive Vice President,
Chief Financial Officer
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