Edgar Filing: FARMSTEAD TELEPHONE GROUP INC

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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, 2005

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
incorporation or organization) Identification No.)

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 pursuant to Section 12(b) of the Act:

Title of each class Name of each Exchange on which registered
Common Stock, $.001 par value NASD: Over-the-Counter Bulletin Board

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ ] No [X]

Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [X] No [ ]

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 a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [x]

Indicate by check mark whether the registrant is a shell company (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 price at which the common
equity was last sold , as of the last business day of the registrant's most
recently completed second fiscal quarter, was $3,387,242.

As of March 24, 2006, the registrant had 3,936,032 shares of $0.001 par
value Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
Certain exhibits filed with this registrant's prior registration statements
and forms 10-K, 10-Q and 8-K are incorporated by reference into Part IV of
this Report.

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TABLE OF CONTENTS TO FORM 10-K

PART I

Page
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ITEM 1. BUSINESS 3
ITEM 1A. RISK FACTORS 11
ITEM 1B. UNRESOLVED STAFF COMMENTS 17
ITEM 2. PROPERTIES 17
ITEM 3. LEGAL PROCEEDINGS 18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 18

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 18
ITEM 6. SELECTED FINANCIAL DATA 19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION 19
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE 29
ITEM 9A. CONTROLS AND PROCEDURES 29
ITEM 9B. OTHER INFORMATION. 29

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 29
ITEM 11. EXECUTIVE COMPENSATION 32
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS 35
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 37
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 37

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES 37

SIGNATURES 39

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. From December
1998 to the program's termination in July 2004, we provided refurbished
"Classic Lucent(TM)" and "Classic Avaya(TM)" telecommunications equipment
pursuant to an "Authorized Remarketing Supplier Program" with Lucent
Technologies and Avaya. Since the termination of this program, we have
continued to supply refurbished equipment to our customers. We also offer
Avaya's full-line of new telecommunications parts and complete systems as
an Avaya-certified "Platinum 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. This business segment has been referred to
in this document as the "Legacy Telecommunications Equipment Business" or
the "Telecommunications Equipment Business".

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, and the
company was dissolved effective December 31, 2005.

Our operating results have declined significantly over the past
several years, with the Company incurring net losses of $3,314,000,
$1,424,000 and $709,000 for the years ended December 31, 2005, 2004 and
2003 on revenues of $15.2 million, $12.3 million and $14.9 million,
respectively. Although the Company experienced a 23% improvement in
revenues in 2005 as compared to 2004, revenues and profit margins have been
impacted by reduced business spending by our larger customers on enterprise
communications equipment coupled with intense competition between the
Company and other telecommunications equipment dealers and aftermarket
resellers.

Beginning in the fourth quarter of 2004, and continuing throughout
2005, we have been implementing a strategic redirection, which is
principally based upon building a larger and more highly qualified sales
force, and diversifying the Company's product offerings and targeted
customers. The business strategy is to transition to a full communications
solutions provider, becoming less dependent on parts sales, and developing
more sources of recurring revenues. During 2005, we expanded our product
offerings beyond traditional voice communications products by offering
Internet Protocol, or IP, telephony products and unified communications
products including voice messaging, and we expanded our customer base and
began generating incremental revenues by targeting the small to medium-
sized (under 200 employees) business market ("SMB").

Effective March 1, 2005 we launched a program to market SMB products
and services nationally. In connection therewith we significantly increased
our direct sales force and support staff, including the hiring of several
former Avaya sales and support professionals already engaged in this market
sector.

In May, 2005, we formed a wholly-owned subsidiary named One IP Voice,
Inc. ("OIPV"). OIPV was formed to provide carrier-based VoIP telephony
solutions along with network services. Its primary target market is the SMB
market. OIPV's product offerings include Hosted IP Centrex and IP Trunking
services, bundled with

private OIPV "last mile" connectivity on a national basis, long distance
calling, On Net calling, local area calling, 911 capabilities and Wide Area
Network ("WAN") voice and data connectivity. Since its formation, OIPV has
achieved several business plan milestones, including the hiring of key
management personnel and the completion of the initial buildout of its
first feature server platform, located in Denver, Colorado. In January
2006, the Company launched the national marketing of OIPV's products and
services. The OIPV business is critical to the Company's future business
strategy and will require significant capital in order to achieve success.
This business segment has been referred to in this document as the "IP
Telephony Business".

VoIP Industry Overview

Voice over Internet Protocol, commonly referred to as "VoIP", is a
technology that enables communications over layer 3 based networks, taking
advantage of the convergence of voice, video and/or other media into data
packets that can be efficiently transmitted over layer 3 networks and then
converted back into the original media at the other end. Data networks,
such as the Internet or local area networks, have always utilized packet-
switched technology to transmit information between two communicating
terminals (for example, a PC downloading a page from a web server, or one
computer sending an e-mail message to another computer). The most common
protocol used for communicating on these packet switched networks is IP.
VoIP allows for the transmission of voice along with other data over these
same packet switched networks, and provides an alternative to traditional
telephone networks, which use a fixed, and costly, electrical path to carry
voice signals through a series of switches to a destination.

As a result of the potential cost savings and added features of VoIP,
consumers, enterprises, traditional telecommunication service providers and
cable television providers are viewing VoIP as the future of
telecommunications. VoIP has experienced significant growth in recent years
due to:

* Demand for lower cost telephone service;
* Improved quality and reliability of VoIP calls due to
technological advances, increased network development and greater
bandwidth capacity;
* New product innovations that allow VoIP providers to offer
services not currently offered by traditional telephone companies;
and
* The advantage of a single infrastructure to transmit all
communications applications, instead of the traditional method of
separate networks for each application.

The traditional telephone networks maintained by many local and long
distance telephone companies were designed solely to carry low-fidelity
audio signals with a high level of reliability. Although these traditional
telephone networks are very reliable for voice communications, these
networks are not well suited to service the explosive growth of digital
communication applications for the following reasons:

* They are expensive to build because each subscriber's telephone
must be individually connected to the central office switch, which
is usually several miles away from a typical subscriber's
location;
* They transmit data at very low rates and resolutions, making them
poorly suited for delivering high-fidelity audio, entertainment-
quality video or other rich multimedia content;
* They use dedicated circuits for each telephone call, which allot
fixed bandwidth throughout the duration of each call, whether or
not voice is actually being transmitted; and
* They may experience difficulty in providing new or differentiated
services or functions, such as video communications, that the
network was not originally designed to accommodate.

Until recently, traditional telephone companies have avoided the use
of packet switched networks for transmitting voice calls due to the
potential for poor sound quality attributable to latency issues (delays),
jitter, and lost packets which can prevent real-time transmission. Recent
improvements in packet switch technology, compression and broadband access
technologies, as well as improved hardware and provisioning techniques,
have significantly improved the quality and usability of packet-switched
voice calls.

Packet-switched networks have been built mainly for carrying non
real-time data. The advantages of such networks are their efficiency,
flexibility and scalability. Bandwidth is only consumed when needed.
Networks can be built in a variety of configurations to suit the number of
users, client/server application requirements and desired availability of
bandwidth and many terminals can share the same connection to the network.
As a result, significantly more traffic can be transmitted over a packet
switched network than a circuit-switched telephony

network. Packet switching technology allows service providers to converge
their traditionally separate voice and data networks and more efficiently
utilize their networks by carrying voice, video, fax, and data traffic over
the same network. The improved efficiency of packet switching technology
creates network cost savings that can be passed on to the consumer in the
form of lower overall communications rates.

The growth of Internet technology in recent years has proven the
scalability of these underlying packet switched networks. As broadband
connectivity, including cable modem and digital subscriber line, or DSL,
has become more available and less expensive, it is now possible for
service providers like us to offer voice and video services that run over
these IP networks to businesses. Providing such services has the potential
to both substantially lower the cost of telephone service and equipment
costs to these customers, and to increase the breadth of features available
to our subscribers.

A technology research firm has estimated that North American VoIP
service revenues approximated $1.3 billion in 2004 and are expected to
increase to $19 billion by 2009. Another research firm has reported that
the market for VoIP equipment sold to corporations and other enterprises,
including phones, hardware and software, grew 78% to $3.07 billion in 2004,
and is seen rising to nearly $11 billion in sales by 2009. Still another
research study shows that 23% of SMBs, of which there are approximately 22
million in the U.S., are already using VoIP technology and the study
expects their share to grow to 50% by 2008, with the majority of SMBs to
switch their networks at least partially to VoIP within the next five
years. VoIP solutions are finding particular favor within SMBs, as a recent
study indicated that 70% indicated they would prefer a hosted VoIP solution
to a premises-based one.

Businesses are installing VoIP systems in hopes of saving money on
their telephone bills. Beyond costs, customers demand intelligent VoIP
features, such as being able to customize how calls are answered, and
universal voice mail. In addition, the VoIP market growth will be driven by
carrier footprint and solution expansion, marketing and service bundling,
which will lead to greater adoption by new business, government, education,
residential and small-office/home-office (SOHO) customers.

Strategy

Since October 1, 2004, the Company has focused its efforts in two
specific areas. The first was to stabilize and grow the Company's 'core'
telecommunications equipment business, and the second was to strategically
re-direct the Company to become a carrier-based provider of VoIP solutions
to the SMB market. To date we have made significant progress in both of
these areas, and they remain as key strategic objectives.

Our goal is to transition the Company, through its OIPV subsidiary,
to become the largest domestic provider of hosted IP services to the SMB
marketplace, providing "best in class", profitable and reliable products
and services. We will accomplish this by offering complete bundled
offerings to the end-user customer inclusive of:
* private network
* feature sets and voicemail
* data and telephony products
* ordering, implementation and billing
* installation by interconnect business partners
* on going management of all products and services post-installation

We believe that our competitive advantage is based on our ability to
(i) deliver voice and data services over a private network, versus the
internet, thereby offering dynamic, secure dedicated bandwidth, including
"last mile connectivity", to each individual customer location; and (ii)
bundle all the necessary components for implementation at the customer
location including routers, gateways, LAN switches, analog telephone
adapters, and telephones.

In addition, a key strategy is to market our products and services
through the utilization of indirect channel partners, including
interconnect businesses, of which there are approximately 9,000 in the U.S.
Our interconnect business partners will provide the sales channel,
installation and maintenance services in the field for the end user
customer locations.

In May, 2005, we formed OIPV to provide carrier-based VoIP Telephony
solutions along with network services. Its primary target market will be
the SMB market. As further described below, OIPV's product offerings will
include Hosted IP Centrex and IP Trunking services, bundled with private
OIPV "Last Mile" connectivity on a

national basis, long distance calling, On Net calling, local area calling,
911 capabilities and Wide Area Network (WAN) voice and data connectivity.
Since its formation, OIPV has achieved several business plan milestones,
including the hiring of key management personnel and the completion of the
initial buildout of its first feature server platform, located in Denver,
Colorado. In January 2006, the Company launched the national marketing of
its IP telephony product offerings.

PRODUCTS

Telecommunications Equipment Business:

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.

Equipment sales consist of both new and refurbished parts (commonly
referred to as "aftermarket" sales), complete systems and software
applications. 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 79%, 89% and 87% of total revenues in 2005, 2004 and 2003,
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 other equipment installation
companies on a subcontract basis to install telecommunication parts and
systems nationwide, 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 commissions
received on the sale of Avaya communications equipment maintenance
contracts. In these transactions, once the contract is executed, we receive
a one-time commission, and all future service obligations are borne
entirely by Avaya.

Service revenues accounted for 15%, 8% and 10% of total revenues in
2005, 2004 and 2003, respectively, primarily attributable to installation
services. Other revenues accounted for 6%, 3% and 3% of revenues in 2005,
2004 and 2003, respectively.

IP Telephony Business:

One IP Voice offers a complete suite of product and service offerings
to address the voice and converged communications requirements of the
business community. Unlike other providers that focus in a specific segment
of the VoIP marketplace, we provide a true "one stop shopping" experience
for businesses which would include the system/network configuration plan,
equipment ordering, installation and training.

Our core products include: One IP Voice (hosted PBX); IP Connect
(Trunking migration strategy for traditional PBX's), One IP Net, (WAN
deployment with converged functionality through Voice over Intelligent
Protocol, our private IP network) and SIP Direct Connect.

Supporting products include SIP telephones, soft phones for your
computer, edge devices for bandwidth allocation, fail over protection for
network connectivity and software applications such as automatic call
distribution that address the special requirements of many businesses.

One IP Voice: provides hosted PBX Class 5 Plus features offered by
our carrier grade soft switch feature server that includes find-me, follow-
me; phone customization; single number/single mailbox for mobile users; and
standards-based interface to MS Outlook. Users have access to One IP Voice
through our internet-based portals.

IP Connect: provides Trunking network connection options for
traditional PBX's to take advantage of on net dialing, local and long
distance calling plans and Universal Messaging.

One IP Net: is our private IP network ("Voice over Intelligent
Protocol" TM pending) that enables our business partners to provide their
customers with private, dedicated, and secure bandwidth that offers QoS
("Quality of Service"), guaranteed CIR, bandwidth allocation and optional
fail over-protection. It does not touch the internet.

SIP ("Session Initiated Protocol") Direct Connect: allows an end user
the option of retaining the capital investment in its existing station
equipment while migrating to IP technology.

The IP Connect and SIP Direct Connect offerings provide our channel
partners with a clear migration strategy for their imbedded base of
customers to move to an IP based model.

RELATIONSHIP WITH AVAYA INC.

Avaya is one of the leading providers of communications products in
the United States. Avaya provides support to its dealer network and to the
telecommunications equipment aftermarket by providing installation and
maintenance services, technical and marketing support. Avaya also provides
up to a one-year warranty on its products.

We are currently one of several hundred independent companies in the
United States who are authorized "Dealers" of Avaya products and services.
We are an Avaya-certified "Platinum Dealer", selling new voice and data
systems and applications nationwide. Platinum Dealer status also allows us
certain product purchasing discounts, and participation in incentive rebate
programs based upon purchasing volume and other cash incentive programs
connected with eligible business development and marketing initiatives. We
are also a "2 Star" Services partner selling Avaya installation,
maintenance, and moves, adds and changes (MAC) products. Our various dealer
agreements with Avaya principally contain language governing the products
we are authorized to sell, the territories in which we can sell these
products, our price structure under which we are charged for purchases of
their products for resale, the level of technical product knowledge we are
required to maintain, and product warranty and support provisions. No
agency relationship has been created in these agreements. These provisions
apply to the sale of both new and used products.

Until July 2004, we also had separate agreements with Avaya which
granted us a license to sell used equipment branded with a "Classic Avaya"
label. Under these agreements, we refurbished equipment to "like new"
condition under their quality standards, remarketing the finished product
as "Classic Avaya" equipment. This process was under the umbrella of an
"Authorized Remarketing Supplier" aftermarket program (initiated by Avaya's
predecessor, Lucent Technologies several years ago), in which we were one
of only five other companies nationwide authorized to refurbish and resell
Avaya product under their "Classic" trademark. As consideration for this
right, we paid Lucent/Avaya a license fee, calculated as a percentage
(which varied over the term of the agreement) of the sales price of
equipment sold with the "Classic" label. Effective July 30, 2004, Avaya
terminated this program, and we discontinued affixing their label to the
used equipment that we sell. We recorded in cost of revenues approximately
$110,000 and $323,000 of fee expense in 2004 and 2003, respectively. The
revenues generated and subject to these license fees approximated 11% (21%
at the time of contract termination) and 29% of total revenues for 2004 and
2003, respectively. The termination of this program has not had a material
adverse impact on our operations. Since the beginning of 2004, we have sold
refurbished equipment branded with our own "Farmstead Certified" label for
which we have received widespread customer acceptance since Avaya continues
to maintain and service this equipment.

We believe that we have an excellent relationship with Avaya, and
that Avaya will continue to support us in the sale of their products and
services.

SALES AND MARKETING

We market our legacy telecommunications equipment product offerings
nationally through a direct sales staff, which includes salespersons
located throughout the United States. 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 97%, 87% and
91% of our total revenues in 2005, 2004 and 2003, respectively, while sales
to dealers and other resellers accounted for approximately 3%, 13% and 9%
of revenues during the same respective periods. During the year ended
December 31, 2005, one customer accounted for 12% of revenues. During the
years ended December 31, 2004 and 2003, no single customer accounted for
more than 10% of revenues. We do not consider our business to be seasonal.

OIPV's product offerings are marketed nationally, primarily through
business partner agreements with established telecommunications equipment
providers. The traditional telephone system providers, known as
Interconnect Companies, are accountable for the sale, installation and
service of a majority of the business telephone systems in this country.
They are the single source for their customer to contact. We have targeted
this group of over 9,000 interconnect companies to bring our OIPV offering
to market. They have established relationships with their customers. We
offer a robust annuity compensation package based on a utility model. We
give them the opportunity to save their greatest asset, their base of
customer accounts, with VoIP migration strategies and hosted PBX
replacement products that are not manufacturer-specific.

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 standalone voice systems to
more highly integrated, software-driven systems.

Telecommunications Equipment Business:

Our legacy telecommunications business principally sells Avaya
products, therefore 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 the other Avaya business partners. We believe
that key competitive factors in this 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.

IP Telephony Business:

The Company competes against many companies in the VoIP industry
including providers of hosted offerings such as AT&T, Callvantage, MCI
Advantage, Voiceone, Net2Phone, Cbeyond, Covad and Vonage; cable television
companies, such as Cablevision, Cox and Time Warner, incumbent telephone
carriers, such as SBC and Verizon and other providers of traditional and
legacy telephone service. While competition will be intense in this
burgeoning industry, we believe that our products will effectively compete
because we are delivering a complete product and service offering to the
SMB business segment.

SUPPLIERS

Telecommunications Equipment Business:

Our agreement with Avaya requires us to purchase new equipment from a
designated "master distributor". The performance of our master distributor
in meeting our product and delivery demands has been satisfactory to date.
Should there be an adverse change in this company'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
aftermarket 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 number of aftermarket suppliers
and availability of used equipment in the marketplace is presently
sufficient to enable the Company to meet its customers' used equipment
delivery requirements.

IP Telephony Business:

We rely upon independent third party providers and manufacturers of
the equipment, networks and software that are integrated into our product
offerings. Should we experience availability and/or reliability problems
with our current suppliers, there are alternative sources in the
marketplace that could meet our availability and reliability requirements.

TECHNOLOGY

OIPV bases its technology foundation on open systems architecture
which would not limit us to any particular manufacturer's product sets. We
believe integrated "best in class" products allow for flexibility with
future growth as VoIP matures.

We rely upon independent third party providers and manufacturers of
the equipment, networks and software that are integrated into our product
offerings. As such, resources dedicated to internal research and
development are not expected to be material. Our National Operations Center
("NOC") located in Denver, CO, however, will consistently test and monitor
our vendors' software releases prior to launching into production, in order
to evaluate and eliminate any possible errors to our customers. In
addition, our NOC tests and evaluates related products from various
manufacturers to ensure that our products maintain state of the art
technology. We are party to telecommunications interconnect and service
agreements with VoIP providers and public switched telephone network
("PSTN") telecommunications carriers. Pursuant to these agreements, VoIP
calls originating on our network can be terminated on other VoIP networks
or the PSTN. Correspondingly, calls originating on other VoIP networks and
the PSTN can be terminated on our network.

We realize that availability and reliability is a cornerstone to our
success and we have incorporated redundancy into our platform. Our platform
is housed in a Tier one hosting facility providing state of the art
Security, Power, Cooling, Fire suppression and Overhead cable management.
In addition to the physical facility there are several levels of redundancy
built into the One IP Voice solution. The collocation center houses many
carriers which

provide for redundant data paths out of the building with multiple carriers
to choose from. The platform itself has redundancy as well, with call
agents and admin servers being fully mirrored and in hot standby mode. The
One IP Net offering has full layer 2 and 3 redundancy, as well as
geographic separation and redundancy. The Session Border controllers are
fully redundant.

PATENTS, LICENSES AND TRADEMARKS

Patents: We hold no patents in either our legacy telecommunications
business or our new IP telephony business.

Licenses: We currently rely upon certain technology, including
hardware and software, which is licensed from third parties. These licenses
are for our hosted feature and voice mail applications, and are purchased
on a "per seat" basis. As applications are added, we may be subject to
further licensing arrangements with other parties.

Trademarks: We have applied for the following trademarks with the
U.S. Patent and Trademark Office: "Voice Over Intelligent Protocol", "One
IP Voice" and "1 IP Voice".

We presently use a "Farmstead Certified" label on our used equipment,
but this has not been trademarked or registered.

RESEARCH AND DEVELOPMENT

We did not incur any research and development expenses during the
three years ended December 31, 2005, and research and development
activities are not material to our business. See "Technology" section
above.

BACKLOG

The backlog of unshipped orders believed to be firm was approximately
$400,209 at December 31, 2005, compared to $182,000 at December 31, 2004.
We expect this entire backlog to ship and be recognized as revenue during
the current fiscal year.

EMPLOYEES

At December 31, 2005, we had 72 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 Internet websites at www.farmstead.com and
www.oneipvoice.com. We make available free of charge through our corporate
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 AND KEY EMPLOYEES OF THE REGISTRANT

The executive officers and key employees of the Company are as
follows (age as of January 1, 2006):

Name Age Position(s)
---------------------------- --- -----------------------------------------------------

Executive Officers:

Mr. Jean-Marc Stiegemeier 60 President & Chief Executive Officer, Chairman of the
Board of Directors

Mr. Robert G. LaVigne 54 Executive Vice President, Chief Financial Officer,
Secretary and Treasurer

Mr. Alfred G. Stein 61 Executive Vice President

Mr. Nevelle R. Johnson 48 Executive Vice President

Frederick E. Robertson, Jr., 47 Vice President- Operations

Key Employees:

Michael R. Dozier 59 Vice President-Sales (One IP Voice)

James A. Hart 44 Vice President-Technology (One IP Voice)

Spence Kiddle 47 Vice President of Business Development (One IP Voice)

See Part III, Item 10 for the biographies of the Company's Executive
Officers.

Mr. Dozier, Vice President-Sales of our subsidiary, One IP Voice,
Inc. since September 2005. Mr. Dozier has more than 30 years experience
developing and managing telecommunications organizations of significant
scale and complexity. From 2004 to 2005 he was the Chief Operating Officer
("COO") of IPtimize, Inc. From 2002 to 2004 he was Vice President of Sales
and COO of Digital Telecom. From 1999 to 2002 he was the COO of Convergent
Communications. From 1996 to 1999 he was the Vice President of Business
Development and later President and COO of Tie Communications.

Mr. Hart, Vice President-Technology of our subsidiary, One IP Voice,
Inc. since August 2005. Mr. Hart has an extensive background in systems
engineering and technology management. From 2004 to 2005 he was Senior
Services Consultant for NEC Unified Solutions. In 2004 to 2005 he was an
independent consultant, specializing in VoIP related projects for such
companies as Goldman Sachs, PowerNetGlobal and PacWest Telecommunications.
From 2000 to 2004 he was the Vice President-Technology and Chief Network
Architect for ICG Communications. From 1996 to 2000 he was a Consulting
Systems Engineer, SE Manager and TAC Engineer for Cisco Systems. From 1995
to 1996 he was a Network Manager at Airborne Express.

Mr. Kiddle, Vice President/ Director of Business Development of our
subsidiary, One IP Voice, Inc. since August 2005. Mr. Kiddle has extensive
experience in business development, sales and marketing. From 2003 to 2005
he was a Senior Business Development Manager at Avaya, Inc. From 2000 to
2003 he was a sales Director-Major Accounts, and a Staff Director for
Senior management at Exp@Nets, Inc. From 1993 to 2000 he served as an SMB
Sales manager, Marketing Manager and Staff Director at Lucent Technologies.
Prior thereto he served in various sales and sales management positions at
AT&T, Inc.

ITEM 1A. RISK FACTORS

Risks, Uncertainties and Other Factors That May Affect Future Results

General Risk Factors

We operate in a changing environment that involves numerous known and
unknown risks and uncertainties that could materially adversely affect our
operations. The following highlights some of the factors that have
affected, and/or in the future could affect, our operations. Our prospects
are subject to many 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:

We have incurred net losses over the last several years and we are
uncertain as to our future profitability.

We recorded net losses of $3,314,000, $1,424,000 and $709,000 during
the years ended December 31, 2005, 2004 and 2003, respectively. We expect
that, due to the buildout of our new carrier-based, hosted IP telephony
business as further described below, we will continue to incur operating
losses for the foreseeable future, and such losses may be substantial. We
will need to generate significant revenue growth to achieve an operating
profit.

We are pursuing a significant new business direction - the marketing
of carrier-based, hosted VoIP products and related network services - which
may not be profitable.

Since the beginning of 2005, we have been devoting significant
management and capital resources to the development of this business, and
we expect to continue to do so; however we cannot provide assurance that
this new business venture will be profitable. Our business model is still
being developed, and it has not yet been proven out. There is also no
guarantee that we will be successful in generating significant revenues
from future sales of our planned IP products and services. If we are not
able to generate significant revenues selling into the VoIP telephony
market, our business and operating results would be seriously harmed.

We currently have limited cash resources, and we may not have
adequate cash or credit lines to finance our current working capital
requirements or the buildout of our new IP telephony business.

We are currently dependent upon cash generated from operations, and
borrowings under a revolving credit facility, to satisfy our working
capital requirements, which have increased since we are incurring costs
associated with the development of One IP Voice ("OIPV") and its associated
products and service offerings. A material adverse change in our business
going forward could prompt our lender to terminate our credit facility. In
addition, continued losses will consume our current cash reserves, and
negatively affect our ability to obtain additional or replacement financing
until we could demonstrate improved operating results or a return to
profitability.

Our working capital requirements are expected to significantly
increase as we continue the build out of the infrastructure of capital
equipment, systems, licenses and personnel required to deploy our hosted
VoIP service offerings through OIPV. Our current telephone equipment
business does not generate sufficient cash to meet the additional cash
requirements of OIPV. In the event that we are unable to obtain sufficient
external financing for this project, we may be unable to complete the
buildout of the OIPV business as currently planned. No assurances can be
given that we will have sufficient cash resources to finance future growth,
and it has become necessary to raise additional funds through public and/or
private debt and equity financings, which may also not be available to us
until operating performance improves, and which may significantly dilute
stockholder ownership in us. If, however, we perform according to our
expectations, we believe that additional sources of financing would become
available to us.

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 management personnel who have critical
industry experience and relationships that we rely on to execute our
business plans. Competition for such personnel is currently intense in our
industries. 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.

Risks Attributable to the new IP Telephony Business

The success of our new OIPV business venture is dependent on the
growth and public acceptance of VoIP telephony products and services.

As we enter this emerging marketplace, we will be dependent upon
future demand for VoIP telephony systems and services. In order for the IP
telephony market to continue to grow, several things need to occur.
Telephony service providers must continue to invest in the deployment of
high speed broadband networks to residential and business customers. VoIP
networks must improve quality of service for real-time communications,
managing effects such as packet jitter, packet loss, and unreliable
bandwidth, so that toll-quality service can be provided. VoIP telephony
equipment and services must achieve a similar level of reliability that
users of the public switched

telephone network have come to expect from their telephone service. VoIP
telephony service providers such as ourselves must offer cost and feature
benefits that are sufficient to cause customers to switch away from
traditional telephony service providers. Furthermore, end users in markets
serviced by recently deregulated telecommunications providers are not
familiar with obtaining services from competitors of these providers and
may be reluctant to use new providers, such as ourselves. We will need to
devote substantial resources to educate customers and end users about the
benefits of VoIP telephony solutions in general and our services in
particular. If any or all of these factors fail to occur, our business may
not be successful.

The VoIP telephony market is subject to intense competition and rapid
technological change, and we will depend on new product and service
introductions in order to establish, maintain and grow our business.

VoIP telephony is an emerging market that is characterized by rapid
changes in customer requirements, frequent introductions of new and
enhanced products, and continuing and rapid technological advancement. To
compete successfully in this emerging market, we will have to offer VoIP
telephony products and services that will incorporate the latest
technological advancements in features, performance and cost-effectiveness,
and respond to changing customer requirements. To that end, we will be
reliant upon independent third party providers and manufacturers of the
equipment, networks and software that are integrated into our product
offerings. In particular, we rely heavily on Straitshot Communications,
Inc., a Washington corporation, ("Straitshot") for certain communications
services and equipment in connection with our OIPV offering. Our Chairman
and CEO, Mr. Stiegemeier, is currently a member of the Board of Directors
of Straitshot. In the event that Straitshot was unable or unwilling to
provide services or equipment under its agreement with OIPV, service to the
Company's customers could be materially impacted.

Decreasing telecommunications rates may diminish or eliminate our
planned competitive pricing structure.

Decreasing telecommunications rates may diminish or eliminate the
competitive pricing structure of our services. Telecommunications rates
have decreased significantly over the last few years in most of the markets
in which we intend to operate, and we anticipate that rates will continue
to be reduced. Users who select our services to take advantage of the
current pricing differential between traditional telecommunications rates
and our rates may switch to traditional telecommunications carriers as such
pricing differentials diminish or disappear, and we will be unable to use
such pricing differentials to attract new customers in the future.
Continued rate decreases could require us to lower our rates to remain
competitive and adversely impact our profit margins.

Our success will depend on third parties in our planned distribution
channels.

We plan to sell our products primarily through resellers, and we are
focusing our business development efforts on establishing distribution
channels. Our planned revenues and future growth will depend in large part
on sales of our products through reseller and other distribution
relationships. We may not be successful in developing these distribution
relationships. Agreements with distribution partners may not require
minimum purchases or restrict development or distribution of competitive
products. In addition, our planned distribution channels may not dedicate
sufficient resources or give sufficient priority to selling our products.
Our failure to develop distribution channels, the loss of a key
distribution relationship or a decline in the efforts of a material
reseller or distributor could have a material adverse effect on our
business, financial condition or results of operations.

Risks Attributable to our Legacy Telecommunications Equipment Business

Our business is materially impacted by capital spending levels for
telecommunications products and services in the United States.

Although the Company experienced a 23% improvement in revenues in
2005 as compared to 2004, revenues have been impacted by reduced business
spending by our larger customers on enterprise communications equipment
over the last several years. In addition, this environment has resulted in
increased pricing and competitive pressures, which have affected revenues
and profit margins. If business capital spending for telecommunications
products does not improve, or if economic conditions in the U.S.
deteriorate, our telecommunications equipment revenues may 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 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. Our new parts
and systems sales levels would also be adversely impacted if the Avaya
dealer agreements were terminated, or if Avaya eliminated its "Business
Partner" programs.

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. Our larger "Enterprise"
companies often receive significant purchase discounts from Avaya, which
could lower our gross margins as we compete against Avaya directly for this
business; (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, and the several hundred Avaya dealers
nationwide , 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.

Risks Related to our Current Financing Arrangements and Financing Plans:

If we are required to repay our outstanding borrowings under our Secured
Revolving Note or Secured Convertible Minimum Borrowing Notes to Laurus at
an unexpected time, we could deplete our working capital. An inability to
repay the outstanding borrowings when required could require the sale of
substantial assets.

Our Secured Revolving Note and Secured Convertible Minimum Borrowing
Notes (collectively, the "Notes") with Laurus for a maximum of $3 million,
of which $1,832,000 was outstanding at December 31, 2005, are repayable
March 31, 2008, unless sooner converted into shares of our common stock. An
Event of Default, as defined under these agreements and including, for
example, a change in the Company's financial condition which is deemed to
have a "material adverse effect", which is not cured within specified grace
periods, can result in the

acceleration of the Note repayments. The Notes are secured by the Company's
assets. An inability to repay the Notes when required could result in the
sale of substantial of the Company's assets.

Future equity transactions, including exercise of options or warrants
and shares issued under convertible notes and equity securities, could
depress the market price of our common stock and could result in
significant dilution to our existing stockholders.

From time to time, the Company may sell preferred stock and warrants,
and convertible debt, to investors in private placements conducted by
broker-dealers, or in negotiated transactions. These transactions cause
dilution to existing shareholders. Also, from time to time, options are
issued to employees and third parties, with exercise prices equal to
market. Exercise of in-the-money options and warrants will result in
dilution to existing shareholders; the amount of dilution may depend on the
spread between market and exercise price, and the number of shares
involved. The Company will continue to grant options to employees and
consultants with exercise prices equal to market price at the grant date,
and in the future may sell restricted stock and warrants, all of which may
result in dilution to existing shareholders. As of March 24, 2006, we had
3,936,032 shares of common stock issued and outstanding and we had (i)
convertible notes and warrants issued to the Laurus Master Fund, Ltd which
could require the issuance of 1,460,630 additional shares of common stock;
(ii) shares of Series A convertible preferred stock outstanding which are
convertible into 1,945,200 shares of common stock; (iii) warrants issued to
investors and the placement agent in connection with the Company's 2006
private placement transactions which could require the issuance of
1,480,591 additional shares of common stock; (iv) warrants issued to the
placement agent in connection with the Company's 2006 private placement
transactions which could require the issuance of Series A convertible
preferred stock which would be convertible into 203,320 shares of common
stock; and (v) and outstanding stock options and warrants issued to
employees and affiliates which could require the issuance of 3,685,369
additional shares of common stock.

Terms of subsequent financing may adversely impact your investment.

We may have to raise equity by issuing debt or preferred stock
financing in the future. Your rights and the value of your investment in
our common stock could be reduced. For example, if we continue to issue
secured debt, the creditors would have a claim to our assets that would be
prior to the rights of stockholders until the debt is paid. Debt service
would increase costs and negatively impact operating results. Preferred
stock could also be issued in series from time to time with such
designations, rights, preferences, and limitations as needed to raise
capital. The terms of preferred stock offerings could be more advantageous
to those investors than to the holders of common stock.

We are currently listed on the Over-the-Counter Bulletin Board.

On November of 2005, the Company received notice from the American
Stock Exchange (the "AMEX") that the Company no longer complied with the
AMEX's continued listing standards as set forth in Section 1003 (a) (ii) of
the AMEX Company Guide (the "Company Guide"), and that its securities were,
therefore, subject to being delisted from the AMEX. The Company was
previously granted an eighteen month period to regain compliance with this
standard, and such compliance period ended as of November 7, 2005.

The Company subsequently appealed this determination and on December
14, 2005 participated in a formal hearing before an appointed Listing
Qualifications Panel (the "Panel"). On December 19, 2005, the Company
received written notice from the AMEX that the Panel had affirmed the
earlier determination to delist the common stock of the Company. The notice
cited that the Company was as of November 7, 2005, and continued to be, not
in compliance with (1) Section 1003(a)(i) of the Company Guide as its
stockholders' equity was less than $2 million and it had sustained losses
from continuing operations and/or net losses in two of its three most
recent fiscal years; and (2) Section 1003(a)(ii) of the Company Guide as
its stockholders' equity was less than $4 million and it had sustained
losses from continuing operations and/or net losses in three of its four
most recent fiscal years.

The Company obtained quotation of its securities on the Over-the-
Counter Bulletin Board (the "OTCBB") effective December 30, 2005, and its
Common Stock is currently listed under the symbol "FTGP". The OTC Bulletin
Board(R) is a regulated quotation service that displays real-time quotes,
last-sale prices, and volume information in over-the-counter (OTC) equity
securities. An OTC equity security generally is any equity that is not
listed or traded on Nasdaq(R)(R) or a national securities exchange. OTCBB
securities include national, regional, and

foreign equity issues, warrants, units, American Depositary Receipts
(ADRs), and Direct Participation Programs (DPPs).

The recent delisting described above and being listed on the OTCBB
could reduce the ability of our shareholders to purchase or sell shares as
quickly and as inexpensively as they have done historically. For instance,
failure to obtain listing on another market or exchange may make it more
difficult for traders to sell our securities. Broker-dealers may be less
willing or able to sell or make a market in our common stock which could

* result in a decrease in the trading price of our common stock;
* lessen interest by institutions and individuals in investing in
our common stock;
* make it more difficult to obtain analyst coverage; and
* make it more difficult for us to raise capital in the future.

If we are unable to obtain, and/or maintain the effectiveness of the
registration statement for the shares underlying the Laurus Minimum
Borrowing Notes and Warrants, we may incur substantial financial penalties

Pursuant to the terms of a Registration Rights Agreement with Laurus
in connection with the current credit facility, the Company is obligated to
file and obtain effectiveness for a registration statement registering the
resale of shares of the Company's Common Stock issuable upon conversion of
the Laurus Notes and the exercise of the Warrant. If the registration
statement is not filed or declared effective in a timely manner, the
Company will be subject to certain penalties including a daily penalty at a
rate of 2% per month of the outstanding principal amount of any Minimum
Borrowing Notes.

If we sell any securities at an effective price below $1.54 per share, the
conversion price of the Laurus convertible notes will be lowered, resulting
in additional dilution to stockholders

Pursuant to our convertible note agreements with Laurus, if we issue
securities at a price that is lower than the then current conversion price,
which was $1.54 as of December 31, 2005, the conversion price applicable to
Laurus would be lowered to this amount. If this occurs, stockholders may
incur substantial additional dilution as a result of the potential issuance
of additional securities upon conversion. In January 2006 Laurus's
conversion price was in fact lowered to $1.27 from $1.54 as a result of the
issuance of warrants to investors at a $1.27 exercise price.

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.

Stockholders 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, stockholders 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.

We may be subject of securities class action litigation due to future
stock price volatility.

In the past, when the market price of a stock has been volatile,
holders of that stock have often instituted securities class action
litigation against the company that issued the stock. If any of our
stockholders brought a lawsuit against us, we could incur substantial costs
defending the lawsuit. The lawsuit could also divert the time and attention
of our management.

Provisions of Delaware law could delay or prevent a change of
control.

As a Delaware corporation, we are subject to the General Corporation
Law of the State of Delaware, including Section 203, an anti-takeover law
enacted in 1988. In general, Section 203 restricts the ability of a public
Delaware corporation from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder. Subject
to exceptions, an interested stockholder is a person who, together with
affiliates and associates, owns, or within three years did own, 15% or more
of a corporation's voting stock. As a result of the application of Section
203, potential acquirers may be discouraged from attempting to acquire us,
thereby possibly depriving our stockholders of acquisition opportunities to
sell or otherwise dispose of our stock at above-market prices typical of
acquisitions.

The price of our common stock could be volatile.

Prior to December 30, 2005, our stock traded on the AMEX. Since that
time, our common stock has traded on the OTCBB. It has experienced, and is
likely to experience in the future, significant price and volume
fluctuations which could adversely affect the market price of our common
stock without regard to our operating performance. In addition, the trading
price of our common stock could be subject to significant fluctuations in
response to actual or anticipated variations in our quarterly operating
results, announcements by us or our competitors, factors affecting the
telecommunications industry generally, changes in national or regional
economic conditions, changes in securities analysts' estimates for our
competitors' or industry's future performance or general market conditions.
The market price of our common stock could also be affected by general
market price declines or market volatility in the future or future declines
or volatility in the prices of stocks for companies in our industry.

We do not intend to pay dividends in the foreseeable future.

We have never declared or paid a dividend on our common stock. We
intend to retain earnings, if any, for use in the operation and expansion
of our business and therefore do not anticipate declaring or paying any
dividends in the foreseeable future.

Our directors and management will exercise significant control over
our Company.

Our directors and executive officers and their affiliates
collectively control or beneficially own approximately 47% of our
outstanding common stock. As a result, these stockholders, if they act
together, will be able to influence our management and affairs and all
matters requiring stockholder approval, including the election of directors
and approval of significant corporate transactions. The concentration of
ownership may have the effect of delaying or preventing a change in control
of our company and might affect the market price of our common stock.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Our principal executive offices and warehouse facility are located in
a single-story building located in East Hartford, Connecticut in which we
lease 25,051 square feet. The lease contract, which expires December 31,
2014, contains one five-year renewal option. The lease also allows us the
one-time option to terminate the lease without penalty on December 31,
2009. We maintain a sales office in New York, New York, leasing
approximately 1,700 square feet under a non-cancelable lease expiring May
31, 2007.

Our One IP Voice feature server platform is collocated in a facility
owned and operated by Level 3 Communications (NASDAQ: LVLT) in Denver,
Colorado, under a one-year agreement expiring August 29, 2006.

Our One IP Voice National Operations Center is located in Denver, Colorado,
where we lease 2,684 square feet in an office park under a 26-month lease
expiring January 31, 2008. The lease contract contains one three-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 may be involved in legal proceedings arising in
the ordinary course of business. There is currently 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

On December 16, 2005, the Company held a Special Meeting of the
Stockholders. All of the proposals were approved, and the voting results
were as follows:

(1) Proposal to Approve the issuance of More than 20% of
Outstanding Shares of Common Stock in Connection with the March
2005 Laurus Financing : The proposal was approved with
1,884,381 votes for, 116,852 votes against and 23,542
abstentions.

(2) Proposal to Approve the Issuance of More Than 20% of the
Company's Outstanding Shares of Common Stock in Any One or
Series or Combinations of Private Offerings Sales and Issuances
to Investors of the Company's Securities and a Secondary
Offering Sale and Issuance to the Public of Common Stock, in an
Approximate Amount in the Range of $6,000,000 to $26,000,000
(Exclusive of Any Securities Which May Be Sold Upon Exercise of
Overallotment Options: The proposal was approved with 1,888,785
votes for, 112,185 votes against and 23,805 abstentions.

(3) Proposal to Approve an Amendment to the 2002 Stock Option Plan
to Increase the Number of Shares of Common Stock Available for
Grants and Awards Under the 2002 Stock Option Plan By 1,000,000
Shares, From 1,300,000 to 2,300,000. The proposal was approved
with 1,708,083 votes for, 281,587 votes against and 35,105
abstentions.

(4) Proposal to Permit the Company's Board of Directors Or Its
Chairman Or Its Designee, In Its Or His Discretion, to Adjourn
or Postpone the Meeting. The proposal was approved with
1,887,911 votes for, 80,352 votes against and 56,512
abstentions.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our Common Stock was traded on the American Stock Exchange until
December 30, 2005, under the symbol "FTG". Beginning December 30, 2005 our
Common Stock has been listed on the Over-the Counter Bulletin Board (the
"OTCBB") under the symbol FTGP. The following sets forth, for the periods
indicated, the range of quarterly high and low sales prices for our Common
Stock as reported on the American Stock Exchange and the OTCBB:

2005 2004
------------- ------------
Quarter Ended High Low High Low
------------- ---- --- ---- ---

March 31 $2.51 $ .53 $.79 $.50
June 30 2.60 1.00 .69 .31
September 30 4.92 1.01 .50 .26
December 31 3.55 1.12 .76 .36

There were 3,817,132 and 3,322,182 common shares outstanding at
December 31, 2005 and 2004, respectively. As of December 31, 2005 there
were 529 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 December 16, 2005 Special 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 our credit facility with Laurus Master Fund Ltd., 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.

ITEM 6. SELECTED FINANCIAL DATA

(In thousands, except per share amounts) Years ended December 31
---------------------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----

Revenues $15,203 $12,344 $14,909 $19,456 $33,631
Loss from continuing operations (3,314) (1,424) (709) (2,530) (1,708)
Loss from continuing operations per
common share:
Basic and diluted (.95) (.43) (.21) (.77) (.52)
Total Assets 5,604 4,050 5,291 5,873 10,342
Convertible debt, net (1) 868 - - - -
Long term debt, net of current portion 49 39 - - -
Stockholders' equity (deficiency) (497) 1,879 3,291 4,029 6,531
Dividends paid - - - - -
---------------------------------------------------------------------------------------------------

Net of unamortized discounts aggregating $964. The net long-term portion
is $8.

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, 2005, we reported a net loss of
$3,314,000 or $.95 per share on revenues of $15,203,000. This compares with
a net loss of $1,424,000 or $.43 per share on revenues of $12,344,000
recorded for the year ending December 31, 2004. The net loss for 2005
includes a $1,091,000 loss attributable to the 2005 start up of our new
business venture One IP Voice, Inc.

There continues to be intense competition in the telephone equipment
market areas that we serve, particularly with our larger, "Enterprise"
customers. This has particularly been the case in the aftermarket parts
business in which, over the last several years, the Company has experienced
significant sales price erosion, as aftermarket parts have become more of a
commodity and subject to "price shopping" by customers. In response, the
Company has taken several measures to generate higher sales levels and
turnaround its operating performance. The turnaround

strategy is based upon growing its revenue base principally through
building a larger and more highly qualified sales force, and diversifying
the Company's product offerings and targeted customers. The current
business strategy is to transition to a full communications solutions
provider, becoming less dependent on equipment sales, and developing more
sources of recurring revenues, such as through installation and maintenance
services, and by providing VoIP products and services as further described
below. We have made significant progress during 2005 in implementing these
strategies as evidenced by a 23% increase over 2004 in telecommunications
equipment and service revenues, and by the launch of our new One IP Voice
product offerings in January 2006.

In March 2005, the Company implemented measures to increase revenues
from its legacy telecommunication equipment business by increasing its
sales force and targeting the small-to-medium size business ("SMB") market.
In May 2005, the Company took steps to further diversify its product
offerings, forming a wholly-owned subsidiary named "One IP Voice" which
offers carrier-based hosted IP telephony services along with network
services. Its primary target is also the SMB market.

In order to finance its business turnaround and expansion plans, the
Company increased its credit lines in March 2005, obtaining a $3 million
credit facility with Laurus Master Fund Ltd. which replaced a $1.7 million
credit facility. During 2006, the Company has raised approximately $3
million of additional capital through offerings of convertible debt and
Preferred Stock to unaffiliated private investors. This new capital will be
used to continue the build out and national deployment of its IP telephony
products and services. For additional information on our financial
resources, refer to Note 6, "Convertible Debt", Note 19, "Subsequent
Events-Financing Transactions" and the "Liquidity and Capital Resources"
section which follows.

Results of Operations

Year Ended December 31, 2005 Compared To 2004

Revenues Year Ended December 31,
--------------------------------
(Dollars in thousands) 2005 % 2004 %
--------------------------------------------------------------------

End-user equipment sales $11,593 76 $ 9,323 76
Equipment sales to resellers 487 3 1,641 13
--------------------------------------------------------------------
Total equipment sales 12,080 79 10,964 89
--------------------------------------------------------------------

Services 2,234 15 1,050 8
Other revenue 889 6 330 3
--------------------------------------------------------------------
Total services and other revenue 3,123 21 1,380 11
--------------------------------------------------------------------
Consolidated revenues $15,203 100 $12,344 100
====================================================================

Equipment Sales. Total equipment sales for the year ended December
31, 2005 were $12,080,000, an increase of $1,116,000 or 10% from the
comparable 2004 period. The increase consisted of a $2,270,000 increase in
end-user sales, less a $1,154,000 decrease in equipment sales to resellers
("wholesale sales"). The increase in end-user sales was attributable to a
$3,369,000 or 110% increase in system sales less a $1,099,000 or 18%
decrease in parts sales. During 2005, we implemented a strategy of
diversifying our product offerings by marketing the sale of complete
telecommunications systems to our customer base. In March 2005, we expanded
our sales force and began targeting the SMB marketplace, which is primarily
oriented towards systems sales. Other factors affecting end-user equipment
sales for 2005 have previously been described in the "Overview" section
above. Wholesale sales have been impacted by some of the same factors which
affected end user sales and our shift in emphasis to new system sales.

Service revenues for the year ended December 31, 2005 were
$2,234,000, an increase of $1,184,000 or 113% from the comparable 2004
period. The increase was attributable to growth in installation services
which have increased due to the increases in system sales. An increase or
decrease in installation revenues, however, 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. Equipment rental
and repair revenues were 57% lower than 2004. These revenues are irregular
and difficult to predict, since they tend to be project-oriented.

Other revenue for the year ended December 31, 2005 was $889,000, an
increase of $559,000 or 169% from the comparable 2004 period. The increase
was attributable to growth in our sales of Avaya maintenance contracts.

In the sale of these maintenance contracts, we receive a one-time
commission at the point of sale, and all of the future equipment service
obligations are borne entirely by Avaya.

We did not generate any revenues in 2005 from our new One IP Voice
product offerings. We began the marketing of these product offerings to
businesses in the first quarter of 2006.

Cost of Revenues and Gross Profit. Total cost of revenues for the
year ended December 31, 2005 was $11,434,000, an increase of $1,983,000 or
21% from the comparable 2004 period. The gross profit for the year ended
December 31, 2005 was $3,769,000 an increase of $876,000 or 30% from the
comparable 2004 period. As a percentage of revenue, the overall gross
profit margin was 25% for the year ended December 31, 2005, compared to 23%
for the comparable 2004 period.

In general, 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. Our larger "Enterprise" companies often receive significant
purchase discounts from Avaya, which could cause us to accept lower gross
margins as we compete against Avaya directly for this business; (3) the
level and amount of vendor discounts and purchase rebates available to us
from Avaya and its master distributors; (4) capacity - as sales volume
rises or falls, overhead costs, consisting primarily of product handling,
purchasing, and facility costs, can become a lower or higher percentage of
sales dollars; (5) competitive pressures - as a result of the slowdown in
capital equipment spending in our industry, and the large number of Avaya
dealers nationwide, we have been faced with increased price competition;
and (6) obsolescence charges. The combined effect of all of these factors
could result in varying gross profit margins from period to period.

Gross Profit Margins on Equipment Sales. For the year ended December
31, 2005, the gross profit margin on equipment sales decreased to 24% from
27% in 2004. Two percentage points of the decrease was primarily
attributable to product sales mix. Aftermarket parts sales generated lower
profit margins than the prior year since this has become more of a
"commodity" business and less of a "value-added" business and, therefore
more prone to price-shopping by customers, who are tending more towards
awarding contracts to the lowest bidder. In addition, a higher percentage
of the Company's equipment revenues are being generated by systems sales
which have historically generated lower profit margins than parts sales.
The profit margins on systems sales, however, have improved over the prior
year due to increased sales to the SMB marketplace which is not as
competitively priced as the Enterprise customer marketplace. The remaining
one percentage point decrease in gross profit margin was attributable to
increased obsolescence reserves, which had a four percentage point negative
impact on margins, partly offset by the elimination of Avaya license fees
resulting from the termination of the "Authorized Remarketing Supplier"
aftermarket program in 2004 which had a three percentage point comparative
favorable impact on margin. The increased obsolescence reserves were
attributable to the parts business, which has declined over the past
several years due to competition and the Company's shift towards systems
sales, and to changes in demand for older generation products.

Gross Profit Margins on Services and Other Revenue. For the year
ended December 31, 2005, the Company realized an overall 41% profit margin
on its combined service and other revenues, compared to 39% recorded in
2004. The overall improvement in profit margins was attributable to
significantly higher commission revenues earned from the sale of Avaya
maintenance contracts, which generate a 100% profit margin, partly offset
by the significant increase in installation revenues at lower profit
margins than the prior year.

Other Cost of Revenues. Other cost of revenues consists of product
handling, purchasing and facility costs and expenses. For the year ended
December 31, 2005, these expenses were 35% lower than 2004, and represented
approximately 3% of 2005 equipment sales revenues, compared to 6% of 2004
equipment sales revenues. The reduction in other cost of revenues primarily
resulted from lower personnel levels and other overhead costs, as the
Company increasingly used certain suppliers to direct ship products to
customers.

Selling, General and Administrative ("SG&A") Expenses. SG&A expenses
for the year ended December 31, 2005 were $7,253,000, an increase of
$2,958,000 or 69% from the comparable 2004 period. SG&A expenses were 48%
of revenues in 2005, compared to 35% of revenues in 2004. Approximately 87%
of the increase in SG&A in 2005 was attributable to increased personnel
levels and resulting increases in compensation and benefits, recruiting
fees, and incremental office and travel expenses. The increase in SG&A
expenses reflected the

implementation of a business turnaround strategy and its two major
strategic initiatives - a rebuilding of the legacy telecommunications
equipment business, and the development of the One IP Voice business
venture.

As a part of the Company's turnaround plan, it hired a new President
and CEO in October 2004, and two Executive Vice Presidents - one
responsible for operations (hired in January 2005) and one responsible for
sales (hired in March 2005). In addition, during March 2005 the Company
significantly increased its sales and sales

support group and launched an initiative to market its legacy
telecommunications equipment products and services to the SMB marketplace.
During 2005 the Company incurred approximately $1,087,000 of SG&A expenses
related to the formation of One IP Voice, Inc. and the development of an IP
telephony services business segment. The expenses consisted primarily of
compensation, consulting, marketing, training and office expenses, as the
Company began the process of hiring its management and support teams and
developing its product offerings and marketing materials.

During the fourth quarter of 2005, the Company incurred $158,000 of
expenses related to its efforts to maintain its listing on the American
Stock Exchange (the "AMEX") and to secure additional equity capital to (i)
finance the buildout of One IP Voice and (ii) regain compliance with the
AMEX's minimum shareholder equity requirements. Included in these expenses
were the costs of conducting a Special Meeting of Stockholders in order to
get required stockholder approval to issue securities in planned future
private and public offerings.

In March 2005, the Company replaced its revolving credit facility
with BACC with a larger credit facility with Laurus Master Fund Ltd. In
doing so, the Company incurred one-time expenses totaling $84,000,
consisting of a $68,000 early termination fee, and a $16,000 charge to
write-off of the remaining balance of its annual loan commitment fee with
BACC. In addition, the Company incurred $155,000 of legal fees and other
costs associated with the acquisition of the Laurus credit facility. These
costs are included in deferred financing costs on the balance sheet and are
being amortized to SG&A expense over the term of the facility. As of
December 31, 2005 approximately $36,000 had been expensed.

We expect our SG&A expenses to increase as we continue the
infrastructure development and deployment of our One IP Voice product
offerings, and continue the rebuild of our legacy telecommunications
equipment business.

Other Income (Expense). Other income (expense) for the year ended
December 31, 2005 was $181,000, compared with $(22,000) for 2004. The
principal components of other income (expense) are as follows.

Interest Expense. Interest expense for the years ended December 31,
2005 and 2004 was comprised of the following components:

2005 2004
---- ----

Interest expense on outstanding borrowings $ 76,000 $28,000
Amortization of deferred financing costs 35,000 -
Amortization of discounts on convertible notes 57,000 -
-------- -------
$168,000 $28,000
======== =======

The increase in interest expense on outstanding borrowings was
attributable to higher average borrowing levels under the Company's credit
facilities and to higher interest rates. Amortization of deferred
financing costs consists of $6,000 amortization of an imputed discount on
warrants issued to the Laurus Master Fund LTD ("Laurus") and $29,000 of
amortization of a prepaid facility fee of $117,000 in connection with a
revolving credit facility entered into with Laurus on March 31, 2005.
These costs are included in deferred financing costs on the Consolidated
Balance Sheet, and are being amortized to interest expense over the three-
year term of the facility. Discounts imputed in accounting for the
Company's convertible notes issued to the Laurus Master Fund pursuant to
this credit facility, are being amortized to interest expense over their
term using the effective interest method.

Derivative instrument income, net. The Company recorded income of
$339,000 during the year ended December 31, 2005 from its derivative
instrument liabilities arising from its financing transactions with Laurus,
due primarily to the decline in the fair market value of such derivative
instruments from their inception to December 31, 2005. Income or losses
generated from these derivative liabilities principally arise from changes
in the fair market value of the Company's common stock price during each
reporting period, as the Company is required to record "mark-to-market"
adjustments to the value of its derivative liabilities. These "mark-to-
market" adjustments are non-cash, with no impact on liquidity. Refer to
Notes 1, 6 and 7 in the Notes to Consolidated Financial Statements

contained herein for further discussion on the nature of the derivative
financial instruments and the Company's accounting policies.

Other Income. Other income for all periods presented consisted of
interest earned on invested cash.

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.

Year Ended December 31, 2004 Compared To 2003.

The following analysis does not take into consideration the
reclassification of freight billed to customers to other revenues. Prior to
2004, freight billed to customers on product sales was recorded in cost of
sales as a contra account to freight expense. Accordingly, the amounts
presented below in services and other revenue, and in consolidated
revenues, would have increased by $230,000 for 2003.

Revenues Year Ended December 31,
--------------------------------
(Dollars in thousands) 2004 % 2003 %
--------------------------------------------------------------------

End-user equipment sales $ 9,323 76 $11,560 78
Equipment sales to resellers 1,641 13 1,368 9
--------------------------------------------------------------------
Total equipment sales 10,964 89 12,928 87
--------------------------------------------------------------------

Services 1,050 8 1,520 10
Other revenue 330 3 461 3
--------------------------------------------------------------------
Total services and other revenue 1,380 11 1,981 13
--------------------------------------------------------------------
Consolidated revenues $12,344 100 $14,909 100
====================================================================

Equipment Sales. Total equipment sales for the year ended December
31, 2004 were $10,964,000, down $1,964,000 or 15% from the comparable 2003
period. The decrease consisted of a $2,237,000 or 19% decline in end-user
sales, partly offset by a $273,000 or 20% increase 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). Factors affecting end-user equipment sales for 2004 have
previously been described in the "Overview" section above. The increase in
wholesale sales was the result of our efforts to pursue partnering
arrangements with other equipment dealers and aftermarket resellers as a
means to bolster equipment revenues. As a marketing tool to help generate
equipment revenues, we developed an electronic commerce framework called
"ECONNECT". Approximately 4% of our equipment sales were processed through
this on-line catalog.

During 2004, we 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. For the year ended December 31, 2004 however, system sales
were $3,051,000, down $76,000 or 2% from 2003.

Service revenues for the year ended December 31, 2004 were
$1,050,000, down $470,000 or 31% from the comparable 2003 period. The
decrease was primarily attributable to a 30% decline in installation
revenues, due to (i) the decline in our parts sales resulted in lower move,
add and change billings and (ii) during 2004 we sold more systems for which
we were not contracted to perform the installation. 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 as previously noted,
the Company may sell new systems or system upgrades without being
contracted to perform the installation. The decrease was secondarily
attributable to a 37% decline in equipment rental and repair revenues.
Equipment rental revenues are irregular and difficult to predict, since
they tend to be project-oriented.

Other revenue for the year ended December 31, 2004 was $330,000, down
$131,000 or 28% from 2003. The decrease was attributable to lower
commissions earned on Avaya maintenance contract sales and lower freight
billed to customers on product shipments due to lower sales volume. In the
sale of Avaya maintenance contracts, we act as a sales agent of Avaya, and
all of the equipment service obligations are borne entirely by Avaya.

Cost of Revenues and Gross Profit. Total cost of revenues for the
year ended December 31, 2004 was $9,451,000, down $1,572,000 or 14% from
the comparable 2003 period. The gross profit for the year ended December
31, 2004 was $2,893,000, down $993,000 or 26% from the comparable 2003
period. As a percentage of revenue, the overall gross profit margin was 23%
for 2004, compared to 26% for the comparable 2003 period.

In general, 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. Our larger "Enterprise" companies often receive significant
purchase discounts from Avaya, which could cause us to accept lower gross
margins as we compete against Avaya directly for this business; (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, consisting primarily of product handling,
purchasing, and facility costs, become a higher percentage of sales
dollars; (5) competitive pressures - as a result of the slowdown in capital
equipment spending in our industry, and the large number of Avaya dealers
nationwide, 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.

Gross Profit Margins on Equipment Sales. For the year ended December
31, 2004, the gross profit margin on equipment sales decreased to 27% from
32% in 2003. The decrease 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. The reduced profit margins are
attributable to the fact that the parts business has become more of a
"commodity" business and less of a "value-added" business. It has therefore
become more prone to price-shopping by customers, who are tending more
towards awarding contracts to the lowest bidder. In addition, increased
competition has led to downward pressure on our sales pricing in order to
capture business. We expect continued pressure on our equipment profit
margins going forward, particularly in the sale of parts to our larger
customers.

Gross Profit Margins on Services and Other Revenue. For the year
ended December 31, 2004, the gross profit margin on services and other
revenue increased to 38.7%, from 33.8%in 2003. The increase was
attributable to the installation services component, which generated a 25%
profit margin in 2004 compared to a 16% profit margin in 2003. The 16%
profit margin in 2003 included the effect of a loss incurred on the
installation of a large systems contract, without which the profit margin
would have otherwise been 24%. During 2004 we began outsourcing a higher
percentage of our installation work to subcontractors other than Avaya who
charge us lower hourly labor rates. We will continue to employ this
strategy in instances where our customer has no installer preference.

Other Cost of Revenues. Other cost of revenues consists of product
handling, purchasing and facility costs and expenses. For the year ended
December 31, 2004, these expenses were 25% lower than 2003, and represented
approximately 5.6% of 2004 equipment sales revenues, compared to 6.4% of
2003 equipment sales revenues. The reduction in other cost of revenues
primarily resulted from personnel reductions implemented during 2004 as
well as planned reductions in facility costs and expenses.

Selling, General and Administrative ("SG&A") Expenses. SG&A expenses
for the year ended December 31, 2004 were $4,295,000, down $266,000 or 6%
from the comparable 2003 period. SG&A expenses for the year ended December
31, 2004 were 35% of revenues, compared to 31% of revenues in 2003. In
response to lower sales levels, we have been actively managing our
headcount and tightly controlling discretionary SG&A expenses. The decrease
in SG&A expenses in 2004 was primarily attributable to (i) lower
compensation expense from lower personnel levels, and lower sales
commissions earned as a result of lower sales volume; (ii) lower facility
rental and operating costs as a result of a reduction in the number of
square feet leased, (iii) lower depreciation expense; and (iv)reductions in
various other administrative expenses as a result of cost reduction
initiatives. The decreases were partly offset by (i) $113,000 in fees and
expenses incurred by business consultants (prior to their being hired by
the Company in October 2004 and January 2005 as previously described in
this section and in Item 1, "Executive Officers and Significant Employees
of the Registrant"), hired during the latter half of the year to assist the
Company in developing a business turnaround plan, (ii) increased insurance
costs; (iii) higher costs incurred to support our ECONNECT on-line catalog,
and (iv) lower marketing rebates earned from Avaya. We expect our SG&A
expenses to increase as we complete the build out of our executive
management and sales team; however we will continue the close monitoring of
our expense levels going forward into 2005 and expect that our SG&A
expenses will decline as a percent of sales by the end of 2005.

Interest Expense and Other Income. Interest expense for the years
ended December 31, 2004 and 2003 was $28,000. Although average borrowing
rates were slightly higher in 2004 than 2003, our average borrowings were
$179,000 as compared with $250,000 during 2003. Other income for the year
ended December 31, 2004 was $6,000 compared to $7,000, consisting of
interest earned on invested cash.

Provision for Income Taxes. The provision for income taxes represents
estimated minimum state taxes in all reported periods. The minimum state
tax expense of $8,000 recorded in 2004 was fully offset by an overaccrual
of prior year state taxes. 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

The Company had a working capital deficiency of $568,000 at December
31, 2005, as compared to working capital of $2,136,000 at December 31,
2004, a decrease of $2,319,000. The working capital deficiency at December
31, 2005 includes a $385,000 derivative instrument liability related to the
Company's convertible revolving credit facility which is not expected to be
settled with cash. The working capital ratio was .88 to 1 at December 31,
2005, compared to 2.4 to 1 at December 31, 2004. Approximately $1 million
of the Company's working capital was expended during 2005 on the formation
and development of One IP Voice and its product offerings.

Operating activities used $1,613,000 during 2005, compared with
$1,037,000 during 2004. Net cash used by operating activities in 2005
consisted of a net loss of $3,314,000, less non-cash items of $378,000, and
less net cash generated by changes in operating assets and liabilities of
$1,323,000. Net cash generated by changes in operating assets and
liabilities was primarily attributable to increases in accounts payable and
accrued expenses, and reductions in inventory, partly offset by an increase
in accounts receivable. The increase in our accounts receivable was
primarily attributable to significant growth in our systems sales revenues
over the prior year period, for which the cash receipts cycle is longer
than for parts sales since there is typically an installation requirement
to be completed prior to full payment. The increase in our accounts payable
was attributable to increased One IP Voice expenditures during the last
quarter of 2005 as it continued its infrastructure buildout, and to a
planned slowdown in cash disbursements in order to minimize the Company's
cash outflow pending the receipt of cash raised from 2006 financings as
described under Financing Activities below.

Investing activities used $412,000 in 2005, compared to $29,000 in
2004. Net cash used by investing activities in 2005 and 2004 consisted of
capital expenditures. Capital expenditures during 2005 were principally for
the purchase of network equipment and licenses in connection with the
buildout of an IP telephony platform for our One IP Voice ("OIPV")
subsidiary, and computer and office equipment to support our expanded
personnel levels. Pursuant to our loan agreement with Laurus, we may obtain
external financing on capital expenditures up to $500,000 in any fiscal
year period before requiring Laurus's prior approval.

Financing activities provided $2,030,000 in 2005, compared with
$456,000 in 2004, principally from borrowings under our revolving credit
facility with the Laurus Master Fund Ltd ("Laurus"). On March 31, 2005, we
terminated our $1.7 million revolving credit facility with BACC, repaying
the outstanding balance on April 1, 2005, and entered into a financing
transaction with Laurus , providing for a three-year, $3 million revolving
loan credit facility. Refer to Note 6, "Convertible Debt", of the Notes to
Consolidated Financial Statements included herein for further information
on the principal terms and conditions of this financing transaction. As of
December 31, 2005, we had $1,832,000 outstanding under the Laurus facility,
with an unused credit line of $1,168,000 and excess borrowing availability,
pursuant to our borrowing formula, of $323,000.

The Company is not currently generating sufficient cash flow from
operations to cover the operating costs of both our legacy
telecommunications business and One IP Voice, and we are highly dependent
upon our current credit facility and generating cash through offerings of
Company securities to outside investors. During 2006 however, the Company
completed several private placements of convertible debt and equity
securities, raising approximately $3 million, in order to raise capital for
use in its current business and the working capital requirements of OIPV.
Refer to Note 19 - "Subsequent Events - Financing Transactions" of the
Notes to Consolidated Financial Statements contained herein, for a
description of the material terms of these financing transaction. To
summarize:

* On January 30, 2006, the Company issued a $400,000 Convertible
Promissory Note and a Warrant to purchase 22,047 shares of common stock to
Christopher P. Baker, pursuant to a Convertible Promissory Note and
Purchase Agreement of even date. The Convertible Promissory Note was
subsequently repaid in full, with interest, on February 8, 2006 and the
note was cancelled.

* On February 8, 2006, the Company issued a $1,000,000 Principal
Amount Convertible Promissory Note (the "Sotomar Note") to Sotomar -
Empreendimentos Industriaise e Imobiliarios, SA (the "Holder") pursuant to a
Convertible Note and Warrant Purchase Agreement (the "Purchase Agreement")
of even date. The proceeds received by the Company, net of placement agent
fees and expenses, amounted to approximately $913,000.

Pursuant to the terms of the Sotomar Note, as a result of the sale of Units
described below, on February 17, 2006 the Sotomar Note, together with
interest accrued thereon, converted into 58,970 shares of Series A
Preferred Stock.

* On February 17, 2006 the Company sold 44,117 Unit shares of Series
A Preferred Stock to Meadowbrook Opportunity Fund LLC at a price of $17.00
per Unit. On March 17, 2006 the Company sold 91,433 Unit shares of Series A
Preferred Stock to the following investors at a price of $17.00 per Unit:
Sotomar - Empreendimentos Industriais e Imobiliarios, SA, William A. Boyd,
Suzy Ulrich, Richard J Cranmer, Watamar & Partners SA, Thomas Barrett, Case
Holdings Co., Inc., Allan Sorensen, Chuck & Joy Hartz, Hartz Family
Foundation, Barton Ferris, Jr. and William Harner (together with
Meadowbrook Opportunity Fund LLC the "Investors"). Each Unit consists of
(i) one share of the Company's Series A Preferred Stock, $.001 par value
per share, and (ii) a Warrant to purchase five shares of the Company's
Common Stock, par value $.001 per share, at an exercise price of $2.125 per
share. The proceeds received by the Company, net of placement agent fees
and expenses, in the aggregate was approximately $2,095,958.

The development of the OIPV business to perform at the operating
levels anticipated by management will require additional financing during
2006. At a Special Meeting of the Stockholders of the Company, held
December 16, 2005, the Company received shareholder approval to conclude
one or a series or combination of private offerings to investors of the
Company's Securities, and a secondary offering to the public of Common
Stock, in the range of approximately $6,000,000 to $26,000,000 (exclusive
of any securities which may be sold upon exercise of any overallotment
options). No assurances can be given, however, that we will continue to be
successful in raising cash through securities offerings, since they are
dependent upon, among other factors, the market conditions prevailing
during the offering periods. In order to conclude such additional
financing, we may also need to demonstrate improved operating performance.

Contractual Obligations and Commercial Commitments

The following represents the contractual obligations and commercial
commitments of the Company as of December 31, 2005 (in thousands):

Payments Due by Period
---------------------------------------------------
Less than 1-3 3-5 More than
Contractual Obligations: Total 1 Year Years Years 5 years
------------------------------------------------------------------------------------------------------

Long-term debt and capital lease obligations
including current portion (1) $ 79 $ 30 $ 49 $ - $ -
Convertible debt, including current portion (2) 1,832 1,409 423 - -
Operating leases (3) 1,682 322 389 319 652
Postretirement benefit payments (4) 1,500 - 200 200 1,100
Service provider purchase commitments (5) 386 166 220 - -
-----------------------------------------------------------------------------------------------------
Total $5,479 $1,927 $1,281 $519 $1,752
=====================================================================================================

Principal only; excludes associated interest payments.
Principal only; excludes associated interest payments and unamortized
discounts. The revolving loan portion of the facility is classified
as current.
Consists of rental payments on facilities through the initial terms
of the associated contracts.
Consists of cash payments to the Company's former CEO pursuant to an
unfunded retirement plan.
See Note 10 to the Notes to Consolidated Financial Statements
contained herein.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 123 (Revised 2004),
"Share-Based Payment," ("SFAS No. 123 (revised 2004)"), revising FASB
Statement 123, "Accounting for Stock-Based Compensation" and superseding
APB Opinion No. 25, "Accounting for Stock Issued to Employees,". This
Statement establishes standards for the accounting for transactions in
which an entity exchanges its equity instruments for goods or services,
focusing primarily on transactions in which an entity obtains employee
services in share-based payment transactions. SFAS No. 123 (Revised 2004)
requires a public entity to measure the cost of employee services received
in exchange for an award of equity instruments based on the grant-date fair
value of the award (with limited exceptions). That cost will be recognized
over the period during which an employee is required to provide service in
exchange for the award. Accounting for share-based compensation
transactions using the intrinsic method supplemented by pro forma
disclosures will no longer be permissible. This statement is effective as
of the beginning of the first interim or annual reporting period that
begins after December 15, 2005 and the Company will adopt the standard in
the first quarter of fiscal 2006. The adoption of this standard will have
an impact on the Company's results of operations as it will be required to
expense the fair value of all share based payment; however the Company has
not yet determined whether or not this impact will be significant.

In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4," ("SFAS 151") to clarify the accounting
for abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously
stated that ". . . under some circumstances, items such as idle facility
expense, excessive spoilage, double freight, and rehandling costs may be so
abnormal as to require treatment as current period charges. . . .". SFAS
151 requires that those items be recognized as current-period charges
regardless of whether they meet the criterion of "so abnormal." In
addition, this Statement requires that allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the
production facilities. This statement also clarifies the circumstances
under which fixed overhead costs associated with operating facilities
involved in inventory processing should be capitalized. The provisions of
SFAS No. 151 are effective for fiscal years beginning after June 15, 2005
and the Company adopted this standard in its third quarter of fiscal 2005.
The adoption of this standard did not have a material impact on our
financial position or results of operations.

In December 2004, FASB Statement No. 153, "Exchanges of Nonmonetary
Assets an Amendment of APB Opinion No. 29" was issued amending APB Opinion
No. 29 to eliminate the exception allowing nonmonetary exchanges of similar
productive assets to be measured based on the carrying value of the assets
exchanged as opposed to being measured at their fair values. This exception
was replaced with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. A nonmonetary exchange has
commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The provisions of this
statement are effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. The adoption of this statement did
not have a material impact on our financial statements.

In May 2005, the Financial Accounting Standards Board ("FASB") issued
Statement No. 154, "Accounting Changes and Error Corrections--a replacement
of APB Opinion No. 20 and FASB Statement No. 3" ("SFAS 154"). This
Statement replaces APB Opinion No. 20, Accounting Changes, and FASB
Statement No. 3, Reporting Accounting Changes in Interim Financial
Statements, and changes the requirements for the accounting for, and
reporting of, a change in accounting principle. This Statement applies to
all voluntary changes in accounting principle. It also applies to changes
required by an accounting pronouncement in the unusual instance that the
pronouncement does not include specific transition provisions. When a
pronouncement includes specific transition provisions, those provisions
should be followed. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15,
2005. It will only affect our financial statements if we change any of our
accounting principles. At this time, no such changes are contemplated or
anticipated.

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 and post-sales obligations. We recognize revenue
from sales of equipment (both parts and the equipment component of system
sales) when the equipment is shipped, which is generally easily determined,
even when equipment is shipped to our customer directly from our supplier.
Revenues from installation and service transactions are recognized upon
completion of the activity and customer acceptance, which sometimes
requires our judgment. We record reductions to revenue for estimated
product returns, which are based on our historical experience, current
trends and other judgments on our part in order to estimate our liability
for such obligations.

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 and potentially obsolete 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, sales forecasts and projected obsolescence in
relation to our current inventory stocking levels. 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.

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 at cost
less accumulated depreciation. The determination of useful lives and
whether or not those assets are impaired involves significant judgment.

Derivative instruments. In connection with the issuance of debt or
equity instruments, we may also issue warrants to purchase our common
stock. In certain circumstances, these warrants may be classified as
derivative liabilities, rather than as equity. Additionally, the debt or
equity instruments may contain embedded derivative instruments, such as
conversion options, which in certain circumstances may be required to be
bifurcated from the associated host instrument and accounted for separately
as a derivative instrument liability.

The identification of, and accounting for, derivative instruments is
complex. Our derivative instrument liabilities are revalued at the end of
each reporting period, with changes in the fair value of the derivative
liability recorded as charges or credits to income in the period in which
the changes occur. For warrants and bifurcated conversion options that are
accounted for as derivative instrument liabilities, we determine the fair
value of these instruments using the Black-Scholes option pricing model.
That model requires assumptions related to the remaining term of the
instruments and risk-free rates of return, our current common stock price
and expected dividend yield, and the expected volatility of our common
stock price over the life of the conversion option. We estimate the future
volatility of our common stock price based on several factors, including
the history of our stock price and the experience of other entities
considered comparable to us. The identification of, and accounting for,
derivative instruments and the assumptions used to value them can
significantly affect our financial position and results of operations.

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 2005, 2004 and 2003 represented sufficient evidence to require
a full valuation allowance against our deferred tax assets as of December
31 of each year.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest rate risk: We are 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 $980,000 (which amount approximated the average amount
borrowed under the revolving portion of our credit facilities during the
year ended December 31, 2005), each 1 percentage point increase in the
Prime Rate would have resulted in $9,800 of additional annual interest
charges, which was not material to our operating results or cash flows for
2005. However, as our borrowing levels increase, fluctuations in interest
rates could materially impact our operating results and cash flows. We do
not currently use interest rate derivative instruments to manage exposure
to interest rate changes.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See the Index to Financial Statements and Financial Statement
Schedule in Item 15.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

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-
15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the "Exchange Act")) as of the end of the period covered by 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 Control over Financial Reporting. There were no
significant changes in our internal controls over financial reporting that
occurred during our fourth fiscal quarter of 2005 that has materially
affected, or is reasonably likely to materially affect, our internal
control over financial reporting.

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The executive officers and directors of the Company are as follows
(age as of January 1, 2006):

Name Age Position(s)
---------------------------- --- ----------------------------------------------------------------

Executive Officers:

Mr. Jean-Marc Stiegemeier 60 President & Chief Executive Officer, Chairman of the Board of
Directors

Mr. Robert G. LaVigne 54 Executive Vice President, Chief Financial Officer, Secretary and
Treasurer

Mr. Alfred G. Stein 61 Executive Vice President

Mr. Nevelle R. Johnson 48 Executive Vice President

Frederick E. Robertson, Jr., 47 Vice President- Operations

Directors:

Mr. Jean-Marc Stiegemeier 60 President & Chief Executive Officer, Chairman of the Board of
Directors

Mr. George J. Taylor, Jr. 63 Director, Special Advisor to the CEO

Mr. Harold L. Hansen 75 Director

Mr. Joseph J. Kelley 66 Director

Mr. Ronald P. Pettirossi 62 Director

Mr. Hugh M. Taylor 61 Director

Jean-Marc Stiegemeier, Chairman of the Board of Directors since May
12, 2005; our President and Chief Executive Officer, and a Director, since
October 1, 2004. From August 16, 2004 to October 1, 2004, he provided
business consulting services to the Company. Mr. Stiegemeier has extensive
executive management experience in the telecommunications industry. From
2002 to 2004 he was a business consultant, advising companies on strategic
redirections and turnarounds. He also served on the board of directors for
certain of these companies. From 1997-2001, he served in various capacities
including President, Founder and Director of Exp@nets Inc., a voice and
data solutions provider. Prior thereto, Mr. Stiegemeier served as Chairman
and CEO of Franklin Industries Inc., Lucht, Inc., Ships Entertainment, Inc,
California-Telamerica Inc., Morrow Optical, Inc., and Telamerica, Inc. He
was also the President of Honeywell-Telamerica.

Robert G. LaVigne, Executive Vice President since July 1997, and our
Chief Financial Officer, Corporate Secretary and Treasurer since 1988. Mr.
LaVigne was a Director of the Company from 1988 to 2001. He was the
Controller of Economy Electric Supply, Inc., a distributor of electrical
supplies and fixtures, from 1985 to 1988 and the Corporate Controller of
Hi-G, Inc., a manufacturer of electronic and electromechanical components,
from 1982 to 1985. Mr. LaVigne is a Certified Public Accountant.

Alfred G. Stein, Executive Vice President of our Company since
January 15, 2005. Mr. Stein was initially engaged by the Company in
September 2004 as an outside business consultant to assist management in
the development of a strategic re-direction of the Company's sales
organization and product offerings. Mr. Stein has extensive experience in
the telecommunications industry. Since 2002 he served as founder and
President of Matthews & Wolf, LLC, a small business consulting firm. From
1998 to 2002 he served as Vice President - Business Process Development for
Exp@nets, Inc. a voice and data solutions provider with over $1 billion in
revenues. From 1983 to 1998, he was President of Eagle Intercommunications,
Inc. a New York based telecommunications solution provider selling Toshiba,
NYNEX and Avaya products and services. Eagle was acquired by Exp@nets in
May of 1998.

Nevelle R. Johnson has been an Executive Vice President of our
Company since March 1, 2005. Mr. Johnson's responsibilities include the re-
direction and growth of our national sales organization, as well as the
implementation of new product and service offerings. Mr. Johnson has
extensive experience in the telecommunications industry. From November 2003
to March 2005 he was a Vice President of sales and services within Avaya
Inc. From 2000 to 2003 he was the Executive Vice President of sales and
services for Exp@nets, Inc. a voice and data solutions provider. From 1983
to 2000 he held various sales and executive positions with AT&T and Lucent
Technologies.

Frederick E. Robertson, Jr., Vice President- Operations of our
Company since January 2003, and our Director of Provisioning from March
2001 to January 2003. Mr. Robertson, Jr. was Senior Director of
Merchandising for Staples Communications, Inc. from 1999 to 2001, Director
of Corporate Purchasing and Logistics for Claricom, Inc. from 1998 to 1999,
and Corporate Manager, Cost Control and Purchasing for Executone
Information Systems, Inc. from 1996 to 1998.

George J. Taylor, Jr., Director of the Company since May 12, 2005;
Special Advisor to the CEO since October 1, 2004; Chairman of the Board of
Directors from 1984 until May 12, 2005; our Chief Executive Officer from
1984 until October 1, 2004, and our President from 1989 until October 1,
2004. Mr. Taylor, Jr. was President of Lease Solutions, Inc. (formerly
Farmstead Leasing, Inc.), a business product and automobile leasing
company, from 1981 to 1993 and 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
1986, and for two years served as its President and Chairman. He is the
brother of Mr. Hugh M. Taylor, a Director of the Company.

Harold L. Hansen, Director of the Company since 1992. An independent
management consultant since January 1997. A member of the Audit Committee
(Chairman until January 2, 2003) and the Compensation Committee. President
of Hansen Associates, a management and financial consulting firm from 1995
to 1997. President of H2O Environmental, Inc., an environmental and
geotechnical services company, from 1994 to 1995. President of Hansen
Associates from 1993 to 1994. Prior to 1993, Mr. Hansen served in various
corporate executive capacities including Executive Vice President and Chief
Operating Officer of Gestetner Corporation, Vice President and General
Manager of the Office Products Division of Royal Business Machines and Vice
President and General Manager of the Business Products Group of Saxon
Industries.

Joseph J. Kelley, Director of the Company since April 1995. Chairman
of the Compensation Committee and a member of the Audit Committee.
Currently an Executive-in-Residence at the Olin Graduate School of Business
at Babson College, Wellesley, Massachusetts. President of East Haven
Associates, a telecommunications consulting firm located in Wellesley,
Massachusetts, from 1995 to 2001. Group Vice President of NYNEX, in 1994,
responsible for the State of Massachusetts operations. From 1985 to 1994 he
served in various executive level positions with NYNEX, or associated
companies including Vice President - Operations of New England Telephone
(1991 - 1993), Vice President - New England Telephone, Network Department
(1990 - 1991), Corporate Director of Business Development, NYNEX Marketing
(1988 - 1990) and Vice President of New England Telephone - Maine (1985 -
1988). Mr. Kelley has been involved in the telecommunications industry
since 1963.

Ronald P. Pettirossi, Director of the Company since January 3, 2003.
Chairman of the Audit Committee. President of ER Ltd., a consulting company
since 1995. Mr. Pettirossi is a former audit partner of Ernst & Young, LLP,
who worked with public and privately held companies for 31 years. Mr.
Pettirossi is a member of the Board of Directors of Magellan Petroleum
Corporation and Magellan Petroleum Australia Limited.

Hugh M. Taylor, Director of the Company since 1993. Managing Director
of Newbury, Piret & Company, Inc., an investment banking firm located in
Boston, MA since 1994. CEO, President and a director of the Berlin City
Bank, Berlin, New Hampshire, from 1993 to 1994. Executive Vice President of
Fleet Bank of Massachusetts from 1992 to 1993. Executive Vice President and
Chief Operating Officer of Fleet Bank of Boston from 1990 to 1992. From
1973 to 1990 he was employed by the New England Merchants Bank, later the
Bank of New England, where he held various executive management positions
within the Commercial Banking Division, and the bank's venture capital
subsidiary. Brother of Mr. George J. Taylor, Jr.

Compliance with Section 16 (a) of the Exchange Act:

Section 16 of the Securities Exchange Act of 1934 requires directors
and executive officers and persons, if any, owning more than ten percent of
a class of the Company's equity securities to file with the Securities and
Exchange Commission initial reports of ownership and reports of changes in
ownership of the Company's equity and equity derivative securities. Except
as set forth below, and based solely upon the Company's review of copies of
such reports furnished to the Company, or written representations from such
persons that no other reports were required during 2005, the Company
believes that all Section 16(a) filing requirements applicable to the
Company's executive officers, directors and greater than 10% beneficial
owners were complied with.

Robert G. LaVigne, the Company's Executive Vice President, Chief
Financial Officer, Secretary and Treasurer filed late a Form 4 to report
the February 1, 2005 grant of 20,000 stock options, and a Form 4 to report
the April 12, 2005 grant of 40,000 stock options. Mr. LaVigne subsequently
filed these reports with the SEC on February 17, 2005 and April 19, 2005,
respectively. Frederick E. Robertson, Jr., the Company's Vice President-
Operations, filed late a Form 4 to report the June 29, 2005 grant of 40,000
stock options. Mr. Robertson subsequently filed this report with the SEC on
July 22, 2005.

Code of Ethical Conduct

The Company has adopted a Code of Ethical Conduct that applies to its
executive officers, directors and employees. A copy of this Code is
maintained on Farmstead's website at www.farmstead.com, in the Corporate
Governance section, and was previously filed with the Securities and
Exchange Commission. Stockholders may obtain copies of these documents,
free of charge, by sending a written request to our principal executive
office at 22 Prestige Park Circle, East Hartford, CT 06108, Attention:
Corporate Secretary.

ITEM 11. EXECUTIVE COMPENSATION

Compensation of Officers and Directors

The following table sets forth all compensation paid or accrued by
the Company to the Chief Executive Officer ("CEO") and to the next four
most highly compensated executive officers whose annual compensation
exceeded $100,000 for 2005 for services rendered to the Company during the
three years ended December 31, 2005.

Summary Compensation Table

Long-term
Annual Compensation (1) Compensation
--------------------------------------- Awards (1)
Other Annual ------------ All Other
Bonus Compensation Options Compen-
Name and Principal Position Year Salary ($) ($) ($) (#) sation ($)
-----------------------------------------------------------------------------------------------------------------

CEO:
Jean-Marc Stiegemeier 2005 350,002 - 1,325(6) - -
President, CEO and Director 2004 76,000 37,500(5) - 1,000,000(4) -
(from October 1, 2004)

Named Executive Officers:

Alfred G. Stein 2005 168,269 - - 250,000(4) 5,000(8)
Executive Vice President
(from January 15, 2005)

Nevelle R. Johnson 2005 168,476 - 250,000(4) 55,000(7)
Executive Vice President
(from March 1, 2005)

Robert G. LaVigne 2005 140,517 - - 60,000 15,212(3)
Executive Vice President, Chief 2004 112,000 - - 20,000 20,899(3)
Financial Officer, Secretary and 2003 112,000 - 6,570(2) 20,000 4,565(3)
Treasurer

Frederick E. Robertson, Jr. 2005 100,000 - - 40,000 -
Vice President- Operations 2004 100,000 - - - -
2003 100,000 - 1,346(2) 15,000 -

The Company did not grant any restricted stock awards or stock
appreciation rights ("SARS") or make any long-term incentive plan
payments during the fiscal years presented.

Includes payouts of unused vacation and/or sick time of $6,570 in
2003 for Mr. LaVigne and $1,346 in 2003 for Mr. Robertson.

Includes insurance premiums paid under a Company-owned split-dollar
life insurance policy of $3,660 in 2005, $3,187 in 2004, and $0 in
2003. The cash surrender value of the policy vests to Mr. LaVigne's
benefit at the rate of 10% per year over a ten-year period. Also
included is $10,845, $17,712, and $4,565, respectively, representing
the increase in the vested policy cash surrender value during 2005,
2004 and 2003. Upon termination of employment, the unvested portion
of the policy cash surrender value remains with the Company.

Includes warrants issued to Messrs. Stiegemeier, Stein and Johnson in
connection with their employment agreements in the amount of 400,000,
250,000 and 250,000 shares, respectively. Mr. Stiegemeier also
received an option to purchase 600,000 shares of common stock.

Represents a one-time signing bonus per Mr. Stiegemeier's employment
agreement.

Consists of the imputed value for the personal use of a Company-owned
vehicle.

Consists of $5,000 in car allowances, and $50,000 in life insurance
premiums paid by the Company on a personally-owned policy.

Consists of consulting fees earned in 2005 prior to his employment
with the Company.

Supplemental Executive Retirement Plan ("SERP"). The Company
maintains a Supplemental Executive Retirement Plan ("SERP") for the benefit
of Mr. Taylor, Jr. The SERP was initially structured to provide the funding
for Mr. Taylor's annual retirement benefit of $100,000 payable over 15
years beginning at age 65. The SERP is an unfunded plan; however, it was
initially informally funded through a Company-owned life insurance policy
with an annual premium payment of $50,000 for ten years. No premium payment
was made in 2005 or 2004, and during 2004 the Company borrowed $275,000
against the policy's cash value. The policy provides a $1.2 million death
benefit.

Liability Insurance. Farmstead currently provides liability insurance
for its directors and officers. AIG is the principal underwriter of the
current coverage which extends until September 13, 2006. The annual cost of
this coverage is approximately $62,000.

Perquisites. The Company provides certain of our senior executive
officers with perquisites that we believe are reasonable, competitive and
consistent with the Company's overall compensation program. These
perquisites include: use of a car leased by the Company, financial
counseling and tax preparation services; housing for executives who reside
outside of the Greater Hartford area for a transitional period, and
telephonic equipment. We believe these costs described in this paragraph
are legitimate business expenses but we also recognize that all of these
costs can be viewed as personal benefits for these executives and have
reported them as required in the "Other Annual Compensation" column or in
the footnotes to the table set forth above. No senior executive officer
received perquisites greater than $50,000 for the year ended December 31,
2005. The SEC is currently promulgating new rules regarding perquisites
including lowering the threshold to $10,000 per senior executive officer.
The Company does not anticipate that such new rules will have a significant
impact on the perquisites currently provided to its senior executive
officers.

Option/Warrant/SAR Grants in Last Fiscal Year

The following table sets forth information concerning individual
grants of options and warrants to purchase shares of the Company's Common
Stock made during the year ended December 31, 2005 to each of the
individuals listed in the Summary Compensation Table.

Number of % of Total
Securities Options/Warrants Exercise Potential
Underlying Granted to or Realizable Value(1)
Options/warrants Employees in Base Price Expiration -------------------
Name Granted (#) Fiscal Year ($/SH) Date 5% ($) 10% ($)
----------------------------------------------------------------------------------------------------------------------

Alfred G. Stein 250,000 26.5% .67 1/15/2010 46,250 102,250
Nevelle R. Johnson 250,000 26.5% 1.10 3/1/2010 75,000 167,500
Robert G. LaVigne 20,000 2.12% .70 2/1/2015 8,805 22,312
Robert G. LaVigne 40,000 4.24% 1.17 4/12/2015 29,432 74,587
Frederick E. Robertson, Jr. 40,000 4.24% 1.03 6/29/2015 25,910 65,662

(1) In accordance with the rules and regulations of the Securities and
Exchange Commission, such gains are based on assumed rates of annual
compound stock appreciation of 5% and 10% from the date on which the
options were granted over the full term of the options. The rates do
not represent our estimate or projection of our common stock prices,
and no assurance can be given that these rates of annual compound
stock appreciation will occur.

Aggregated Option and Warrant Exercises in Last Fiscal Year and Fiscal
Year-End Option and Warrant Values

No. of Securities Underlying Value of Unexercised
Unexercised Options and In-the-Money Options and
Shares Warrants at 12/31/05 (#) Warrants at 12/31/05 ($)
Acquired on Value ---------------------------- ----------------------------
Name Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
---------------------------------------------------------------------------------------------------------------------------

Jean-Marc Stiegemeier - - 1,000,000 - $860,000 -
Alfred G. Stein - - 250,000 - 145,000 -
Nevelle R. Johnson - - 250,000 - 37,500 -
Robert G. LaVigne - - 285,500 40,000 48,600 3,200
Frederick E. Robertson, Jr. - - 15,500 51,500 6,540 17,770

Long-Term Incentive Plans - Awards in Last Fiscal Year: None.

Compensation of Directors

During 2005, each non-employee director received a $5,000 annual
retainer, $1,000 for each board meeting attended and $500 for each
committee meeting attended. The Chairman of the Audit Committee also
received a $4,000 annual retainer. The directors are also reimbursed for
their expenses in attending each meeting.

For each year of service on the board, non-employee directors receive
a non-qualified option to purchase 5,000 shares of Common Stock, at an
exercise price equal to the closing market price of the Common Stock on the
date of grant. The options are exercisable on their date of grant and have
a ten year term.

Employment Contracts and Termination of Employment And Change-in-Control
Arrangements

Mr. Jean-Marc Stiegemeier, the Company's Chairman, Chief Executive
Officer and President, (the "Executive") has an employment agreement with
the Company dated October 1, 2004 and as amended October 13, 2005 (the
"Agreement"). The Agreement expires December 31, 2009. The Agreement
includes the following key provisions: (i) an annual base salary of
$500,000, which may be increased by the Board in its discretion or
decreased by the Board under certain defined circumstances; (ii) a one-time
special bonus of $37,500, $25,000 of which was paid October 1, 2004, with
the balance paid in January 2005; (iii) an annual bonus of up to 100% of
Executive's base salary based upon the attainment of a Board-approved
earnings target for that year; (iv) use of a Company-leased residential
house in Connecticut through October 2006; and (v) as an incentive to
reduce the Company's "acquisition" costs, Executive would receive an
"acquisition incentive bonus" equal to one percent (1%) of the Purchase
Price, as defined in the Agreement for each acquisition that is concluded
during the term of this Agreement without any obligation by the Company to
pay any fees, commissions or any other cash or equity-based compensation to
any third party(ies) for or in connection with (a) the identification of
the entity that is the subject of the acquisition; (b) the valuation of the
acquisition or (c) the negotiation of the purchase price and other key
business terms of the acquisition with the selling party or its
representatives. Concurrent with the initial effective date of the
Agreement, Executive was issued a Warrant to purchase up to Four Hundred
Thousand (400,000) shares of common stock at fair market value. The Warrant
was exercisable immediately and expires five years from the date of grant.
The Executive was also granted an option to purchase up to Six Hundred
Thousand (600,000) shares of common stock under the 2002 Stock Option Plan
at an exercise price equal to the fair market value of the common stock on
the grant date. The option became exercisable in full on October 1, 2005.
The options expire ten years after the grant date.

The Agreement also provides severance pay for the Executive during
the term of the Agreement under certain circumstances. Should the Company
terminate the Agreement without "cause", or if the Executive terminates the
Agreement "for good reason", or in the event the Executive resigns after a
"change in control", as all are defined in the Agreement, then severance
pay will equal three times the "Executive Compensation Amount" as defined.
The Executive will not, however, be entitled to any severance or other
compensation if he voluntarily terminates his employment or if the Company
terminates the Agreement "for cause", as defined.

$175,000; (ii) an annual bonus of up to 100% of base salary based upon
attaining earnings targets approved by the Board of Directors; and (iii)
the grant of a five-year warrant to purchase up to 250,000 shares of common
stock at an exercise price of $.67 per share, which was equal to the
closing price of the common stock on his date of hire.

Mr. Johnson has an employment agreement expiring December 31, 2008
which includes the following key provisions: (i) an initial annual base
salary of $200,000; (ii) an annual bonus of up to 50% of base salary based
upon attaining earnings targets approved by the Board of Directors; (iii)
the grant of a five-year warrant to purchase up to 250,000 shares of common
stock at an exercise price of $1.10 per share, which was equal to the
closing price of the common stock on his date of hire; and (iv) payment by
the Company of life insurance premiums not exceeding $5,000 per month.

Both Mr. Stein's and Mr. Johnson's employment agreements provide
severance pay should they terminate their agreements for "good cause", as
defined, or should the Company terminate their agreements without cause, or
in the event of a change in control of the Company, as defined. Severance
pay would amount to three times the amount of the then-current base salary
and the average bonus paid during the three most recent calendar years.
These individuals would not be entitled to any severance or other
compensation if they voluntarily terminate their employment or if they are
terminated by the Company "for cause", as defined. Their agreements also
contain non-compete stipulations.

Mr. George J. Taylor, Jr. has an employment agreement with the
Company dated January 1, 1998 and as amended at various times between
August 1, 2001 and October 1, 2004. The agreement expires December 31,
2007, and contains the following major provisions: (i) a base salary of
$200,000 for 2005, increasing to $250,000 on January 1, 2006 and $300,000
on January 1, 2007; (ii) an annual bonus of up to 100% of his base salary
based upon the attainment of a Board-approved EBITDA target for that year,
provided the amount of any bonus earned shall be all or that portion of the
bonus so determined which the Compensation Committee of the Board of
Directors of the Company in its sole discretion determines to be
attributable to the efforts of Executive; (iii) an annual retirement
benefit of $100,000 payable over 15 years beginning at age 65; and (iv) an
"acquisition incentive bonus" as described above for Mr. Stiegemeier. Mr.
Taylor's agreement provides severance pay should he terminate the Agreement
for "good cause", as defined, or should the Company terminate his agreement
without cause, or in the event of a change in control of the Company, as
defined. 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. He will not be entitled to any severance or other
compensation if he voluntarily terminates his employment or if the Company
terminates the Agreement "for cause", as defined. No bonus was paid in
2005.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

The following table sets forth certain information regarding the
beneficial ownership of the Company's Common Stock, $.001 par value, as of
March 24, 2006 by (i) each person known by the Company to own beneficially
more than five percent of the Company's outstanding shares of Common Stock,
(ii) each of the individuals listed in the "Summary Compensation Table" in
Item 11 above (iii) all directors of the Company, and (iv) all directors
and officers as a group. In addition to being a beneficial owner of more
than five percent of the Company's outstanding shares of Common Stock, Mr.
George J. Taylor, Jr. and Mr. Jean-Marc Stiegemeier are directors of the
Company.

Beneficial ownership is determined in accordance with the rules of
the SEC for computing the number of shares of Common Stock beneficially
owned by a person and the percentage ownership of that person. Shares of
common stock subject to options or warrants currently exercisable or
exercisable within 60 days after January 31, 2006 are considered
outstanding for the purpose of computing the percentage ownership of the
person holding such options, but are not considered outstanding when
computing the percentage ownership of each other person. Except as
otherwise indicated, the Company believes each person named in the table
has sole voting and investment power with respect to all shares
beneficially owned by him. Information with respect to beneficial ownership
is based upon information furnished by such stockholder.

Percentage of
Number of Shares Outstanding
Name and Address of Beneficial Owner (1) Beneficially Owned Common Stock
---------------------------------------- ------------------ -------------

Five Percent Stockholders:
George J. Taylor, Jr. 1,132,884(2) 23.5%
Jean-Marc Stiegemeier 1,000,000(4) 20.3%
Robert G. LaVigne 312,500(3) 7.4%
Alfred G. Stein 275,000(6) 6.5%
Nevelle R. Johnson 260,000(7) 6.2%

Other Directors:
Harold L. Hansen 54,229(4) 1.4%
Hugh M. Taylor 60,703(5) 1.5%
Joseph J. Kelley 43,229(4) 1.1%
Ronald P. Pettirossi 17,500(4) *

Other Officer:
Frederick E. Robertson, Jr. 26,930(8) *

All Directors and Officers as a Group
(10 persons) 3,182,975(9) 46.5%

--------------------
* Less than 1%.
Unless otherwise indicated, the address of each named beneficial
owner is c/o the Company, 22 Prestige Park Circle, East Hartford, CT
06108.
Includes 885,782 shares issuable upon exercise of currently
exercisable stock options. Also includes 27,020 shares held by his
children.
Includes 305,500 shares issuable upon exercise of currently
exercisable stock options.
Consists of shares issuable upon exercise of currently exercisable
stock options and warrants.
Includes 57,316 shares issuable upon exercise of currently
exercisable stock options and 2,000 shares held by his children.
Consists of Includes 250,000 shares issuable upon the exercise of
warrants and $25,000 shares issuable upon exercise of currently
exercisable stock options.
Includes 250,000 shares issuable upon the exercise of warrants.
Includes 21,000 shares issuable upon exercise of currently
exercisable stock options.
Includes 2,009,556 shares issuable upon exercise of currently
exercisable stock options and 900,000 shares issuable upon exercise
of currently exercisable warrants.

Equity Compensation Plan Information

The following table discloses certain information about the warrants
issued, and the options issued and available for issuance under all Company
stock option plans as of December 31, 2005:

(a) (b) (c)
Number of securities
Number of remaining available for
securities to be Weighted-average future issuance under
issued upon exercise price of equity compensation
exercise of outstanding plans (excluding
outstanding options, options, warrants securities reflected in
Plan Category warrants and rights and rights column (a))
-------------------------------------------------------------------------------------------------

Equity compensation plans
approved by security holders 2,684,619 $1.45 1,080,500

Equity compensation plans
not approved by security
holders 900,000 .67 -
-------------------------------------------------------------------------------------------------
Total 3,584,619 $1.25 1,080,500
=================================================================================================

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The following is a summary of fees billed to Farmstead by Carlin,
Charron & Rosen LLP ("CCR") for professional services rendered during the
years ended December 31, 2005 and 2004:

Fee Category 2005 2004
----------------------------------------

Audit Fees $61,500 $43,875
Audit-Related Fees - -
Tax Fees 11,400 9,250
All Other Fees 12,110 1,554
------- -------
Total Fees $85,010 $54,679
======= =======

Audit Fees. Consists of fees billed for professional services
rendered for the audit of Farmstead's consolidated financial statements and
reviews of interim consolidated financial statements included in quarterly
reports filed with the Securities and Exchange Commission. The contractual
fees for the audit of Farmstead's consolidated financial statements for its
fiscal years ended December 31, 2005 and 2004 were $50,100 and $48,000,
respectively.

Audit-Related Fees. There were no audit-related fees billed during
2005 and 2004.

Tax Fees. Consists of fees billed for professional services rendered
for the preparation of federal and state tax returns.

All Other Fees. For 2005, consisted of reviews of Registration
Statements filed with the Securities and Exchange Commission, research on
state tax matters, and for representation at the 2005 Annual Meeting of
Stockholders. For 2004, consisted of fees in connection with discussions
related to Section 404 of the Sarbanes-Oxley Act of 2002, and for
representation at the 2004 Annual Meeting of Stockholders.

The Audit Committee reviews and approves an engagement letter
received from CCR which details the scope and cost of services to be
provided the Company during the following fiscal year in connection with
the audit of the Company's financial statements, reviews of quarterly
financial statements and the preparation of tax returns. All other services
to be performed by the auditors that are not included in the approved
engagement letter are submitted to the Audit Committee for approval.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a) Index to Financial Statements and Financial Statement Schedule

Page
----

Financial Statements:
Report of Carlin, Charron & Rosen LLP 40
Consolidated Balance Sheets - December 31, 2005 and 2004 41
Consolidated Statements of Operations -
Years Ended December 31, 2005, 2004 and 2003 42
Consolidated Statements of Changes in Stockholders' Equity (Deficiency)-
Years Ended December 31, 2005, 2004, and 2003 43
Consolidated Statements of Cash Flows -
Years Ended December 31, 2005, 2004, and 2003 44
Notes to Consolidated Financial Statements 45

Financial Statement Schedule: Page
----
Report of Carlin, Charron & Rosen LLP 66
Schedule II - Valuation and Qualifying Accounts 67

(b) Exhibits: See Index to Exhibits on page 68.

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 April
7, 2006.

FARMSTEAD TELEPHONE GROUP, INC.

By: /s/ Jean-Marc Stiegemeier
--------------------------------
Jean-Marc Stiegemeier
President, Chief Executive
Officer and Director

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 April 7, 2006.

Signature Title(s)
--------- --------

/s/ Jean-Marc Stiegemeier President, Chief Executive Officer,
----------------------------- Chairman of the Board of Directors
Jean-Marc Stiegemeier (Principal Executive Officer)

/s/ Robert G. LaVigne Executive Vice President, Chief Financial Officer,
----------------------------- Secretary and Treasurer
Robert G. LaVigne (Principal Financial and Accounting Officer)

/s/ George J. Taylor, Jr. Director
-----------------------------
George J. Taylor, Jr.

/s/ Harold L. Hansen Director
-----------------------------
Harold L. Hansen

/s/ Joseph J. Kelley Director
-----------------------------
Joseph J. Kelley

/s/ Ronald P. Pettirossi Director
-----------------------------
Ronald P. Pettirossi

/s/ Hugh M. Taylor Director
-----------------------------
Hugh M. Taylor

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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, 2005 and 2004, and
the related consolidated statements of operations, changes in stockholders'
equity (deficiency), and cash flows for each of the years in the three-year
period ended December 31, 2005. 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 the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the consolidated financial statements are free of material
misstatement. The Company is not required to have, nor were we engaged to
perform, an audit of its internal control over financial reporting. Our
audit included consideration of internal control over financial reporting
as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Company's internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements, assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, 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, 2005 and 2004, and the
results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 2005 in conformity with accounting
principles generally accepted in the United States of America.

/s/ CARLIN, CHARRON & ROSEN, LLP
Glastonbury, Connecticut
April 4, 2006

FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2005 and 2004

(In thousands, except share amounts) 2005 2004
-------------------------------------------------------------------------------------------

ASSETS
Current assets:
Cash and cash equivalents $ 222 $ 217
Accounts receivable, net 3,125 1,453
Inventories, net 723 1,627
Other current assets (Note 10) 281 378
-------------------------------------------------------------------------------------------
Total Current Assets 4,351 3,675
-------------------------------------------------------------------------------------------
Property and equipment, net 615 268
Deferred financing costs (Note 6) 535 -
Other assets 103 107
-------------------------------------------------------------------------------------------
Total Assets $ 5,604 $ 4,050
===========================================================================================

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 3,105 $ 1,110
Accrued expenses and other current liabilities 539 242
Current portion of convertible debt, net of unamortized
discount of $549 (Note 6) 860 -
Revolving credit facility note (Note 6) - 179
Derivative financial instruments (Note 7) 385 -
Current portion of long-term debt (Note 8) 30 8
-------------------------------------------------------------------------------------------
Total Current Liabilities 4,919 1,539
-------------------------------------------------------------------------------------------
Postretirement benefit obligation (Note 13) 719 593
Convertible debt, net of unamortized discount of $415 (Note 6) 8 -
Derivative financial instruments (Note 7) 406 -
Long-term debt (Note 8) 49 39
-------------------------------------------------------------------------------------------
Total Liabilities 6,101 2,171
-------------------------------------------------------------------------------------------

Commitments and contingencies (Note 10)

Stockholders' Equity (Deficiency):
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;
3,817,132 and 3,322,182 shares issued and outstanding
at December 31, 2005 and 2004, respectively 4 3
Additional paid-in capital 13,249 12,320
Accumulated deficit (13,734) (10,420)
Accumulated other comprehensive loss (16) (24)
-------------------------------------------------------------------------------------------
Total Stockholders' Equity (Deficiency) (497) 1,879
-------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity (Deficiency) $ 5,604 $ 4,050
===========================================================================================

See accompanying notes to consolidated financial statements.

FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2005, 2004 and 2003

(In thousands, except per share amounts) 2005 2004 2003
------------------------------------------------------------------------------------------------

Revenues:
Equipment $12,080 $10,964 $12,928
Services and other revenue 3,123 1,380 1,981
------------------------------------------------------------------------------------------------
Net revenues 15,203 12,344 14,909
------------------------------------------------------------------------------------------------

Cost of revenues:
Equipment 9,186 7,987 8,886
Services and other revenue 1,847 846 1,310
Other cost of revenues 401 618 827
------------------------------------------------------------------------------------------------
Total cost of revenues 11,434 9,451 11,023
------------------------------------------------------------------------------------------------
Gross profit 3,769 2,893 3,886
Selling, general and administrative expenses 7,253 4,295 4,561
------------------------------------------------------------------------------------------------
Operating loss (3,484) (1,402) (675)
Other income (expense):
Interest expense (168) (28) (28)
Derivative instrument income, net 339 - -
Other income 10 6 7
------------------------------------------------------------------------------------------------
Total other income (expense) 181 (22) (21)
------------------------------------------------------------------------------------------------
Loss before income taxes (3,303) (1,424) (696)
Provision for income taxes 11 - 13
------------------------------------------------------------------------------------------------
Net loss $(3,314) $(1,424) $ (709)
------------------------------------------------------------------------------------------------

Basic and diluted net loss per common share $ (.95) $ (.43) $ (.21)

Basic and diluted weighted average common shares outstanding 3,491 3,317 3,305
------------------------------------------------------------------------------------------------

See accompanying notes to consolidated financial statements.

FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS' EQUITY (DEFICIENCY)
Years Ended December 31, 2005, 2004, and 2003

Accumulated
Common Stock Additional Accum- Other
----------------- Paid-in ulated Comprehensive
(In thousands) Shares Amount Capital Deficit Loss Total
-----------------------------------------------------------------------------------------------------------------

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
Net loss - - - (1,424) - (1,424)
Amortization of pension liability
adjustment - - - - 8 8
Comprehensive loss - - - - - (1,416)
Issuance of common stock 11 - 4 - - 4
-----------------------------------------------------------------------------------------------------------------
Balance at December 31, 2004 3,322 3 12,320 (10,420) (24) 1,879
Net loss - - - (3,314) - (3,314)
Amortization of pension liability
adjustment - - - - 8 8
Comprehensive loss - - - - - (3,306)
Shares issued upon conversion of
convertible debt 375 1 801 - - 802
Common stock issued upon exercise
of stock options 55 - 66 - - 66
Common stock issued under employee
stock purchase plan 45 - 30 - - 30
Restricted stock issued for services 20 - 32 - - 32
-----------------------------------------------------------------------------------------------------------------
Balance at December 31, 2005 3,817 $4 $13,249 $(13,734) $(16) $(497)
-----------------------------------------------------------------------------------------------------------------

See accompanying notes to consolidated financial statements.

FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2005, 2004 and 2003

(In thousands) 2005 2004 2003
---------------------------------------------------------------------------------------------

Operating Activities:
Net loss $(3,314) $(1,424) $(709)
Adjustments to reconcile net loss to net cash
used in operating activities:
Provision for doubtful accounts receivable 36 18 75
Provision for losses on inventories 392 106 28
Depreciation and amortization of property and equipment 121 123 164
Amortization of deferred financing costs 71 - -
Amortization of discounts on convertible debt 57 - -
Unrealized gain on derivative instruments (339) - -
Decrease in accumulated other comprehensive loss 8 8 -
Value of common stock issued for services 32 - -
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (1,708) (63) 386
Decrease in inventories 512 236 312
Decrease (increase) in other assets 101 14 (467)
Increase (decrease) in accounts payable 1,995 (240) 137
Increase (decrease) in accrued expenses and other
current liabilities 297 70 (111)
Increase in postretirement benefit obligation 126 115 98
---------------------------------------------------------------------------------------------
Net cash used in operating activities (1,613) (1,037) (87)
---------------------------------------------------------------------------------------------
Investing Activities:
Purchases of property and equipment (412) (29) (83)
---------------------------------------------------------------------------------------------
Net cash used in investing activities (412) (29) (83)
---------------------------------------------------------------------------------------------
Financing Activities:
(Repayments) borrowings under BACC credit facility (179) 179 -
Borrowings under convertible debt facility 2,409 - -
Deferred financing costs (272) - -
Repayment of long-term debt and capital lease obligations (24) (2) -
Borrowing against cash value of insurance policy - 275 -
Proceeds from exercise of stock options and employee
stock purchases 96 4 3
---------------------------------------------------------------------------------------------
Net cash provided by financing activities 2,030 456 3
---------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 5 (610) (167)
Cash and cash equivalents at beginning of year 217 827 994
---------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 222 $ 217 $ 827
=============================================================================================

(In thousands) 2005 2004 2003
---------------------------------------------------------------------------------------------

Supplemental disclosures of cash flow information:
Cash paid during the year for: Interest $ 64 $ 26 $ 26
Income taxes 2 5 5
Non-cash financing and investing activities:
Purchase of equipment under capital lease 56 - -
Common stock issued upon conversion of debt 802 - -
Discount on warrants issued to Laurus 335 - -
Discounts on issuances of convertible debt 1,389 - -
Acquisition of vehicle for debt - 49 -
Increase in accrued benefit obligation recorded in
Stockholders' Equity (Deficiency) - - 32

See accompanying notes to consolidated financial statements.

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. 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 year ended December 31, 2005 one
customer accounted for 11.8% of revenues. During the years ended December
31, 2004 and 2003, no single customer accounted for more than 10% of
revenues.

In May, 2005, the Company formed a wholly-owned subsidiary named One
IP Voice, Inc. ("OIPV"). OIPV was formed to provide carrier-based VoIP
telephony solutions along with network services. Its primary target market
is the small-to-medium sized business ("SMB") market, which the Company
believes is the fastest growing segment of the telecommunications systems
business. OIPV's product offerings include Hosted IP Centrex and IP
Trunking services, bundled with private OIPV "last mile" connectivity on a
national basis, long distance calling, On Net calling, local area calling,
911 capabilities and Wide Area Network ("WAN") voice and data connectivity.
In January 2006, the Company launched the national marketing of OIPV's
products and services.

Financial Results and Liquidity
The Company has incurred losses of $3,314,000, $1,424,000 and
$709,000 in 2005, 2004 and 2003, respectively, on revenues of $15,203,000,
$12,344,000 and $14,909,000, respectively. As of December 31, 2005 the
Company has a working capital deficiency of $568,000, and a stockholders'
equity deficiency of $497,000. With the exception of 2005, the Company has
experienced declining revenues in its sales of telecommunications equipment
for several years, partly attributable to reduced capital equipment
spending from the Company's customer base. This has particularly been the
case in the aftermarket parts business in which the Company has
additionally experienced intensified competition and resulting sales price
erosion, as aftermarket parts have become more of a commodity and subject
to "price shopping" by customers. Since joining the Company in October
2004, the new Chief Executive Officer, along with the rest of the Company's
management team, has been developing and implementing a new operational
strategy to grow revenues and turnaround the Company's operating
performance.

The turnaround strategy is based upon growing its revenue base
principally through building a larger and more highly qualified sales
force, and diversifying the Company's product offerings and targeted
customers. The current business strategy is to transition to a full
communications solutions provider, becoming less dependent on equipment
sales, and developing more sources of recurring revenues, such as through
installation and maintenance services,

and by providing VoIP products and services. In March 2005, the Company
implemented measures to increase revenues from its legacy telecommunication
equipment business by increasing its sales force and targeting the SMB
market. In May 2005, the Company took steps to further diversify its
product offerings through the formation of OIPV. The Company made
significant progress during 2005 in implementing these strategies as
evidenced by a 23% increase over 2004 in telecommunications equipment and
service revenues, and by the national launch of OIPV's product offerings in
January 2006.

Despite a negative cash flow from operations in 2005, the Company has
been able to secure financing to support its operations to date. In March
2005, the Company obtained a $3 million credit facility from the Laurus
Master Fund, Ltd., replacing a $1.7 million credit facility with Business
Alliance Capital Corporation. Between January 30, 2006 and March 17, 2006
the Company raised approximately $3 million through various offerings of
convertible debt and convertible preferred stock to unaffiliated private
investors. The Company believes that the capital raised, along with its
current credit facilities, will be sufficient to support its 2006 liquidity
requirements, depending upon operating results. The growth of the OPIV
business from current levels will, however, require additional financing.
Going forward, the Company plans to raise significant amounts of additional
cash through private and public equity offerings in order to support the
expansion of OIPV's business. No assurance can be given, however, that
funding in the amounts required by the Company will be available, which may
impact management's growth plans for this new business.

Principles of Consolidation
The consolidated financial statements presented herein consist of the
accounts of Farmstead Telephone Group, Inc. and its wholly-owned
subsidiaries. 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,
depreciation, taxes and contingencies, among others. Estimates include the
identification and valuation of derivative instruments, the amortization
periods for debt issuance costs, and the amortization of discounts on
convertible securities arising from bifurcated derivative instruments.
Estimates are also used in determining product sales returns, which are
reflected as reductions to revenues. 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
The Company records revenues from the sale of equipment (including
parts, complete systems and system upgrades), the sale of installation
services (in connection with the sale of systems, as well as on a time-and-
materials basis), the sale of Avaya maintenance contracts, and the
provision of other value-added services such as the provision of short-term
equipment rentals and the repair of customer-owned equipment. In general,
revenue from sales of equipment is recognized when persuasive evidence of
an agreement exists, shipment has occurred (FOB shipping point), the sales
price is fixed and determinable, and collection of the resulting receivable
is probable. The Company typically sells systems or system upgrades under
single contracts to provide the equipment and the installation service
(although customers may choose to provide their own installation). These
contracts separately price the installation and any associated professional
services based on the current market value for such services. The Company
outsources installation services to third party vendors under subcontract
arrangements which include project bids. The Company recognizes revenue on
the sale of systems and system upgrades using the guidelines contained in
Emerging Issues Task Force ("EITF") Issue No. 00-21 "Revenue Arrangements
with Multiple Deliverables" ("EITF 00-21"). EITF 00-21 addresses accounting
methodologies for a vendor in arrangements with multiple revenue-generating
elements, such as those including products with installation requirements.
Under EITF 00-21, revenue is recognized for each element of the transaction
based on its relative fair value. The revenue associated with each
delivered element should be recognized separately provided (i) it has
stand-alone value; (ii) there is objective and reliable evidence of the
fair value of each element; (iii) delivery of the undelivered element is
probable and substantially controlled by the vendor, and performance of the
undelivered element is not essential to the functionality of the delivered
element. Under these guidelines, the Company recognizes revenue on
equipment sales upon shipment of the equipment and installation sales
revenues upon completion of the installation of the equipment.

The Company recognizes commission revenues from sales of Avaya
maintenance contracts upon customer execution of the contract. Once the
contract is executed, the Company receives a one-time commission, and all
future service obligations are borne entirely by Avaya. Revenues from
short-term equipment rentals are recognized ratably over the term of the
rental agreement. Revenues from the provision of customer equipment repair
services, and on other provided services, are recognized upon completion of
the service. Reductions to revenues are recorded for estimated product
returns, based on historical experience.

Accounting for Manufacturer Incentives
The Company receives various forms of incentive payments, rebates,
and negotiated price discounts from Avaya and its designated master
distributors. Rebates and negotiated price discounts directly related to
specific customer sales are recorded as a reduction in the cost of goods
sold on those product sales. Rebates that are based on purchasing certain
product lines exclusively from one manufacturer ("loyalty rebates") are
also recorded as a reduction in cost of goods sold when the products are
purchased. Incentive payments designed to offset marketing expenses and
certain growth initiatives supported by Avaya are recorded as a contra
expense to the related expenditure. All incentive payments are recorded
when earned under the specific rules of the incentive plan.

Shipping and Handling Fees
In accordance with Emerging Issues Task Force Issue 00-10,
"Accounting for Shipping and Handling Fees and Costs," freight billed to
customers is included in net sales and service revenues in the consolidated
statements of operations, while freight billed by vendors is included in
cost of sales in the consolidated statements of operations.

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 the associated accumulated depreciation is removed
from the accounts and any resulting gain or loss is recorded.

Derivative financial instruments
We do not use derivative instruments to hedge exposures to cash flow,
market, or foreign currency risks.

We review the terms of convertible debt and equity instruments we
issue to determine whether there are embedded derivative instruments,
including the embedded conversion option, that are required to be
bifurcated and accounted for separately as a derivative financial
instrument. In circumstances where the convertible instrument contains more
than one embedded derivative instrument, including the conversion option,
that is required to be bifurcated, the bifurcated derivative instruments
are accounted for as a single, compound derivative instrument. Also, in
connection with the sale of convertible debt and equity instruments, we may
issue freestanding warrants that may, depending on their terms, be
accounted for as derivative instrument liabilities, rather than as equity.
We may also issue options or warrants to non-employees in connection with
consulting or other services they provide.

Certain instruments, including convertible debt and equity
instruments and the freestanding options and warrants issued in connection
with those convertible instruments, may be subject to registration rights
agreements, which impose penalties for failure to register the underlying
common stock by a defined date. The existence of the potential cash
penalties under the related registration rights agreement requires that the
embedded conversion option be accounted for as a derivative instrument
liability. Similarly, the potential cash penalties under the related
registration rights agreement may require us to account for the
freestanding options and warrants as derivative financial instrument
liabilities, rather than as equity. In addition, when the ability to
physical or net-share settle the conversion option or the exercise of the
freestanding options or warrants is deemed to not be within the control of

the Company, the embedded conversion option or freestanding options or
warrants may be required to be accounted for as a derivative financial
instrument liability.

Derivative financial instruments are measured at their fair value.
For derivative financial instruments that are accounted for as liabilities,
the derivative instrument is initially recorded at its fair value and is
then revalued at each reporting date, with changes in the fair value
reported as charges or credits to income. For option-based derivative
financial instruments, we use the Black-Scholes option pricing model to
value the derivative instruments. When the convertible debt or equity
instruments contain embedded derivative instruments that are to be
bifurcated and accounted for as liabilities, the total proceeds allocated
to the convertible host instruments are first allocated to the fair value
of all the bifurcated derivative instruments. The remaining proceeds, if
any, are then allocated to the convertible instruments themselves, usually
resulting in those instruments being recorded at a discount from their face
amount.

To the extent that the fair values of any freestanding and/or
bifurcated derivative instrument liabilities exceed the total proceeds
received, an immediate charge to income is recognized, in order to
initially record the derivative instrument liabilities at their fair value.
The discount from the face value of the convertible debt, together with the
stated interest on the instrument, is amortized over the life of the
instrument through periodic charges to income, usually using the effective
interest method.

The classification of derivative instruments, including whether such
instruments should be recorded as liabilities or as equity, is reassessed
periodically, including at the end of each reporting period. If
reclassification is required, the fair value of the derivative instrument,
as of the determination date, is reclassified. Any previous charges or
credits to income for changes in the fair value of the derivative
instrument are not reversed. Derivative instrument liabilities are
classified in the balance sheet as current or non-current based on whether
or not net-cash settlement of the derivative instrument could be required
within 12 months of the balance sheet date.

Stock Compensation Plans
The Company accounts for stock option and warrant 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 and
warrant awards to officers, directors and employees 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,
-------------------------------
2005 2004 2003
-------------------------------------------------------------------------------------

Net loss, as reported $(3,314) $(1,424) $(709)
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (392) (149) (78)
-------------------------------------------------------------------------------------
Pro forma net loss $(3,706) $(1,573) $(787)
=====================================================================================

Loss per share:
As reported $ (.95) $ (.43) $(.21)
Pro forma $ (1.06) $ (.47) $(.24)
=====================================================================================

The weighted-average fair value of options and warrants granted
during 2005, 2004 and 2003 was $.67, $.15, and $.27, respectively. The fair
value of stock options and warrants 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:

2005 2004 2003
---- ---- ----

Dividend yield 0% 0% 0%
Average risk-free rate 3.88 - 4.36% 3.1 - 3.3% 2.93%
Expected volatility 65% 50% 103%
Expected option holding period (yrs.) 3.6 - 4.0 3.0 - 3.5 4.7

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 is 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 is
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 (using
the "treasury stock" method), and convertible debt (using the "as-
converted" method), 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.

(In thousands) 2005 2004 2003
---------------------------------------------------------------------------------

Stock Options 2,685 2,388 1,871
Warrants issued to employees 900 - -
Convertible notes and warrants issued to lender (a) 1,439 - -
---------------------------------------------------------------------------------
Total 5,024 2,388 1,871
=================================================================================

(a) potential shares of common stock issuable assuming conversion rates
in effect at December 31, 2005.

Segment Information
Prior to 2005, the Company operated in one industry segment, that
being the resale of telecommunications equipment. Since the formation of
the Company's wholly-owned subsidiary, One IP Voice, the company is
additionally operating in a new business segment: Network services. For
additional information of the Company's business segments, refer to Note
17.

Fair Value of Financial Instruments
The carrying amounts of Farmstead's financial instruments, including
cash and cash equivalents, accounts receivable, accounts payable, accrued
expenses, long-term debt and convertible debt obligations approximate fair
value.

Reclassifications
Certain amounts in prior years' financial statements and related
notes have been reclassified to conform to the 2005 presentation.

2. CASH AND CASH EQUIVALENTS

Cash and cash equivalents totaled $221,992 and $217,126 at December
31, 2005 and 2004, respectively. Included in each period are investments in
a money market mutual fund consisting of high quality short term
instruments, principally U.S. Government and Agency issues and commercial
paper.

3. ACCOUNTS RECEIVABLE, NET

As of December 31, the components of accounts receivable, net were as
follows (in thousands):

2005 2004
-----------------------------------------------------------

Trade accounts receivable $2,815 $1,379
Less: allowance for doubtful accounts (75) (60)
-----------------------------------------------------------
Trade accounts receivable, net 2,740 1,319
Other receivables 385 134
-----------------------------------------------------------
Accounts receivable, net $3,125 $1,453
===========================================================

Other receivables consist of commissions, rebates and other dealer
incentives due from Avaya, Inc. Refer to Note 1, Accounting for
Manufacturer Incentives.

4. INVENTORIES, NET

As of December 31, the components of inventories, net were as follows
(in thousands):

2005 2004
------------------------------------------------------------------------

Finished goods and spare parts $ 947 $1,341
Work in process 202 352
Rental equipment 12 52
------------------------------------------------------------------------
1,161 1,745
Less: reserves for excess and obsolete inventories (438) (118)
------------------------------------------------------------------------
Inventories, net $ 723 $1,627
========================================================================

Work in process inventories consists of used equipment requiring
repair or refurbishing.

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.) 2005 2004
-----------------------------------------------------------------------------------------------

Computer and office equipment 3 - 5 $ 1,065 $ 1,071
Network equipment and licenses 3 - 5 391 -
Furniture and fixtures 5 - 10 288 288
Leasehold improvements 10 171 171
Capitalized software development costs 5 98 98
Automobile 5 50 50
Leased equipment under capital lease 3 56 -
-----------------------------------------------------------------------------------------------
2,119 1,678
Less: accumulated depreciation and amortization (1,504) (1,410)
-----------------------------------------------------------------------------------------------
Property and equipment, net $ 615 $ 268
===============================================================================================

The Company has capitalized software development costs incurred by
subcontract programmers in the development of on-line product catalogs and
ordering processes. Leased equipment under capital leases consists of
computer equipment. Depreciation and amortization expense was $121,437,
$123,306, and $164,009 for the years ended December 31, 2005, 2004, and
2003, respectively.

6. CONVERTIBLE DEBT

Convertible debt obligations consisted of the following as of
December 31 (in thousands):

2005 2004
----------------------------------------------------------------------------

Borrowing under secured revolving credit facility note $1,409 $ -
Secured convertible Minimum Borrowing Note 423 -
Less: unamortized discount attributable to the revolving
credit facility note (549) -
Less: unamortized discount attributable to the
Minimum Borrowing Note (415) -
------ ----
Convertible Debt, net of unamortized discounts 868
Less:current portion (860)
------ ----
Convertible Debt, net of unamortized discounts $ 8 $ -
============================================================================

On March 31, 2005, the Company terminated its $1.7 million revolving
credit facility with Business Alliance Capital Corporation ("BACC"),
repaying the outstanding balance and an early-termination fee of $68,000 on
April 1, 2005. On March 31, 2005, the Company entered into a financing
transaction with Laurus Master Fund, Ltd., ("Laurus"), providing for a
three-year, $3 million ("Capital Availability Amount") revolving loan
credit facility which includes a Secured Revolving Note (the "Revolving
Note") and a Secured Convertible Minimum Borrowing Note (together with the
Revolving Note, the "Laurus Notes"). The initial Minimum Borrowing Note
("MBN") was set at $500,000, the proceeds of which were advanced to the
Company on April 4, 2005. Upon conversion of the MBN, and provided there
are outstanding borrowings under the revolving note of a minimum of
$300,000, such amount may be transferred from the revolving loan balance to
create a new MBN. Amounts outstanding under the Laurus Notes will either be
paid in cash at their March 31, 2008 maturity date or, at Laurus' option,
by converting such amounts into shares of the Company's common stock from
time to time. As further consideration for providing the credit facility,
the Company also issued Laurus a five-year warrant (the "Warrant") to
purchase an aggregate of 500,000 shares of common stock at an exercise
price of $1.82 per share. The warrant exercise price was set at 130% of the
average closing price of the Company's common stock over the ten trading
days preceding the execution of the agreement, and is subject to anti-
dilution protection adjustments. This transaction was completed in a
private offering pursuant to an exemption from registration under Section
4(2) of the Securities Act of 1933, as amended.

The following describes certain of the material terms of the
financing transaction with Laurus. The description below is not a complete
description of the material terms of the financing transaction and is
qualified in its entirety by reference to the agreements entered into in
connection with the financing which were included as exhibits to the
Company's Annual Report on Form 10-K for the year ended December 31, 2004:

Principal Borrowing Terms and Prepayment: Borrowings are advanced
pursuant to a formula consisting of (i) 90% of eligible accounts
receivable, as defined (primarily receivables that are less than 90 days
old), and (ii) 30% of eligible inventory, as defined (primarily inventory
classified as "finished goods"), up to a maximum inventory advance of
$600,000, less any reserves required by Laurus. Interest on the outstanding
borrowings is charged at the per annum rate of two percentage points (2%)
above the prime rate, but not less than 6%. The interest rate charged,
however, will be decreased by 2% (or 200 basis points) for every 25%
increase in the market price of the Company's common stock above the fixed
conversion price, down to a minimum interest charge of 0.0%. The Company is
additionally charged a fee equal to 0.25% of the unused portion of the
facility. Should the Company terminate the financing agreement with Laurus
prior to the maturity date, the Company will incur an early payment fee
equal to 4%, 3% and 2% of the Capital Availability Amount if terminated in
the first, second or third year, respectively, of the term. As of December
31, 2005 the interest rate charged under the Laurus Notes was 9.25%.

Security and Events of Default: Borrowings under the Laurus Notes are
secured by a lien on substantially all of the Company's assets. The
Security 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 or there are material
liens or attachments levied against the Company's assets; (iv) the
Company's common stock ceases to be publicly traded; and (v) the Company
fails to comply with the terms, representations and conditions of the
agreement. Upon the occurrence of an Event of Default, the interest rate
charged will be increased by 1-1/2 % per month until the default is cured;
should the default continue beyond any applicable grace period, Laurus
could require the Company to repay 120% of any principal and interest
outstanding under the agreement.

Conversion Rights and Limitation: All or a portion of the outstanding
principal and interest due under the Laurus Notes may be converted, at the
option of the Holder, into shares of the Company's common stock, at the

Fixed Conversion Price ("FCP") of $1.54. The FCP was originally set at 110%
of the average closing price of the Company's common stock over the ten
trading days preceding the execution of the agreement, and is subject to
anti-dilution protection adjustments. The FCP will be reset once $1.5
million of debt has been converted. The Laurus Notes contain a mandatory
conversion feature such that, if the average closing price of the common
stock as reported by Bloomberg, L.P. on the Principal Market for five (5)
consecutive trading days in any calendar month shall be greater than 115%
of the FCP, the Holder shall convert into shares of common stock such
portion of the principal amount outstanding under any Minimum Borrowing
Note (together with accrued interest and fees in respect thereof) on such
date equal to ten percent (10%) of the aggregate dollar trading volume of
the common stock for the period of twenty-two (22) trading days preceding
the date of the mandatory conversion. The Holder shall not be required
under any circumstances to make more than one (1) mandatory conversion in
any calendar month. By agreement between the parties, Laurus will not own
greater than 4.99% of the outstanding shares of the Company's common stock
except that (i) upon the occurrence and during the continuance of an Event
of Default, or (ii) upon 75 days prior notice to the Company, their
ownership could increase to 19.99%. Upon receipt of a conversion notice
from the Holder, the Company can elect to pay cash to the Holder in lieu of
issuing shares of common stock, at a price per share equal to the intraday
high price of the stock.

Registration Rights: Pursuant to the terms of a Registration Rights
Agreement, the Company is obligated to file and obtain effectiveness for a
registration statement registering the resale of shares of the Company's
common stock issuable upon conversion of the Laurus Notes and the exercise
of the Warrant. In the event that the Company is unable to obtain
effectiveness on a timely basis, it would be subject to a penalty of 2% per
month, or any portion thereof, of the then outstanding balance of any
Minimum Borrowing Note. As of December 31, 2005, the Company had timely
registered all underlying shares that it was required to register

As of December31, 2005, the amount of available borrowings under the
revolving portion of the credit facility, pursuant to borrowing formulas,
were as follows (dollars in thousands):

Available borrowings supported by collateral base $ 2,155
Less: amount borrowed under revolving credit facility (1,409)
Less: amount borrowed under Minimum Borrowing Note (423)
-------
Available to borrow $ 323
=======

The average and highest amounts borrowed under all credit facilities
during the year ended December 31, 2005 were approximately $985,000 and
$2,199,000, respectively. The Company was in compliance with the provisions
of its loan agreement as of December 31, 2005. Future required principal
repayments under the MBN as of December 31, 2005 are: 2006 - $0; 2007 - $0;
and 2008 - $423,000.

Since the secured convertible notes are not considered to be
conventional convertible debt, the embedded conversion option in the
secured convertible notes is subject to the requirements of EITF Issue 00-
19. The Company is also required to bifurcate the embedded conversion
option and account for it as a derivative instrument liability because of
the potential penalties that we may have to pay Laurus under the
Registration Rights Agreement, together with the fact that the conversion
price of the debt can be adjusted if we issue common stock at a lower
price. In addition, other embedded derivative instruments in the secured
convertible notes, including the interest rate reset feature and Laurus'
right to put the debt back to us with a 20% premium upon certain Events of
Default, have been bifurcated and accounted for, together with the embedded
conversion option, as a single compound derivative instrument. This
derivative instrument liability was initially recorded at its fair value
and is then adjusted to fair value at the end of each subsequent period,
with any changes in the fair value charged or credited to income in the
period of change. The most significant component of this compound
derivative instrument is the embedded conversion option, which is revalued
using the Black-Scholes option pricing model.

The proceeds received from Laurus under the Minimum Borrowing Notes
("MBNs") issued during 2005 were first allocated to the fair value of the
bifurcated embedded derivative instruments included in the convertible
notes, with the remaining proceeds allocated to the MBN, resulting in the
their being recorded at a significant discount from their face amounts.
This discount, together with the stated interest on the MBN, is being
amortized using an effective interest method over the term of the MBN.
Since there are frequent borrowings and repayments under the revolving
note, the value of the embedded derivative instruments is calculated upon
advances, and the discount is recognized as the advances are repaid, with
the stated interest recognized currently.

The 500,000 warrants issued to Laurus were initially valued at
$334,000, using the Black-Scholes option pricing model and the following
assumptions: market price - $1.31; exercise price - $1.82; expected term -
5 years; volatility - 65%; interest rate - 4.18%; and dividends - 0. Since
there are potential penalties that we may have to pay Laurus under the
Registration Rights Agreement, the warrants have been recorded as a
derivative instrument liability, rather than as equity. This derivative
instrument liability is adjusted to fair value (using the Black-Scholes
option pricing model) at the end of each subsequent reporting period, and
any changes in the fair value are charged or credited to income in the
period of change. Since the nature of the Laurus credit facility is
revolving, with continuous advances and repayments expected over its term,
and with an indeterminate amount of Minimum Borrowing Notes which can be
created and converted, it is not practical to allocate the warrant value to
the initial proceeds of the borrowings under the facility or to any one
Minimum Borrowing Note. As such, the initial valuation of $334,000 has been
recorded as a deferred financing cost, and is being amortized to expense
over the term of the facility using an effective interest method.

7. DERIVATIVE FINANCIAL INSTRUMENTS

The following derivative liabilities related to warrants and embedded
derivative instruments were outstanding as of December 31, 2005 (dollars in
thousands). There were no such instruments or derivative liabilities
outstanding as of December 31, 2004.

Instrument:

Revolving note $ 385
Minimum Borrowing Note 135
-----
Fair value of bifurcated embedded derivative instrument liabilities 520

500,000 warrants issued to Laurus 271
-----
Total derivative financial instruments at December 31, 2005 791
Less: amount attributable to the Revolving note, reported in
current liabilities (385)
-----
Derivative financial instruments recorded in non-current liabilities $ 406
=====

The Company uses the Black-Scholes option pricing model to value
warrants, and the embedded conversion option components of any bifurcated
embedded derivative instruments that are recorded as derivative
liabilities. See Note 6 Convertible Debt. In valuing the warrants and the
embedded conversion option components of the bifurcated embedded derivative
instruments, at the time they were issued and at December 31, 2005, we used
the following assumptions: market price of our common stock on the date of
valuation; an expected dividend yield of 0%; an expected life equal to
either the remaining period to the expiration date of the warrants or
maturity date of the convertible debt instruments; expected volatility of
65% based on historical experience; and a risk-free rate of return ranging
from 3.67-4.35%, based on constant maturity rates published by the U.S.
Federal Reserve, applicable to the remaining life of the instruments.

8. LONG-TERM DEBT

Long-term debt obligations consisted of the following at December 31
(dollars in thousands):

2005 2004

Installment purchase note $ 40 $47
Obligations under capital lease 39 -
-----------------------------------------------------
79 47
Less: debt maturing within one year (30) (8)
-----------------------------------------------------
Long-term debt obligations $ 49 $39
=====================================================

Installment Purchase Note:
The Company is financing an automobile through a $50,056, 3.75% note
payable to a finance company. The note is payable in 38 monthly
installments of $799, with a final payment of $24,236 on January 7, 2008.
The note balance at December 31, 2005 was $39,864, of which $8,154 was
classified under debt maturing within one year.

Obligations under Capital Lease:
During 2005, the Company entered into non-cancelable lease agreements
to finance $56,000 of computer equipment with payment terms ranging from 24
to 36 months. Monthly lease payments aggregate $1,984 and the agreements
contain a $1.00 purchase option at the end of the lease term. The effective
interest rate on the lease obligations is 10.38 to 10.5%. The principal
balance of these obligations at December 31, 2005 was $38,900, of which
$21,681 was classified as current.

Scheduled principal repayments on long-term debt are as follows
(dollars in thousands): 2006 - $30; 2007 - $21; and 2008 - $28.

9. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

As of December 31, the components of accrued expenses and other
current liabilities were as follows (in thousands):

2005 2004
----------------------------------------------------------------

Salaries, commissions and benefits $296 $167
Legal fees and expenses 104 1
Income taxes 20 3
Property taxes 16 16
Customer deposits and unearned revenue 30 -
Employee Stock Purchase Plan deposits 28 -
Other 45 55
----------------------------------------------------------------
Accrued expenses and other current liabilities $539 $242
----------------------------------------------------------------

10. COMMITMENTS AND CONTINGENCIES

Lease Agreements. The Company leases 25,051 square feet at 22
Prestige Park Circle, East Hartford, CT for its corporate offices and
equipment distribution center under an agreement 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 is $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 $1.22 per square foot, subject to a
2% annual increase.

The Company leases approximately 1,700 square feet of office space in
New York, NY under a non-cancelable lease expiring May 31, 2007, with a
monthly rental of $4,893 to $5,040 over the remaining term. The Company
leases a house for the benefit of its Chief Executive Officer at a rental
payment of $5,000 per month expiring October 2006 and an apartment for
occasional use by the Company's non-resident employees at a rental payment
of $1,395 per month expiring October, 2006.

The Company leases 2,684 square feet of office space in Denver,
Colorado for OIPV's national operations center, under a 26 month agreement
dated December 1, 2005 and expiring January 31, 2008. The annual rental is
$45,628 for 2/1/06 - 1/31/07, and $46,970 for 2/1/07 - 1/31/08.

As of December 31, 2005, aggregate future minimum annual rental
payments under the initial terms of the above property leases are as
follows: $322,387 for 2006, $228,628 for 2007, $160,483 for 2008, $156,569
for 2009 and $162,831 for 2010. Rent expense was $280,633 in 2005, $254,581
in 2004 and $313,692 in 2003.

Service-provider Commitments and Agreements:

OIPV has a "Master Service Partner Agreement" with an unaffiliated
third party for the provision of wholesale and bundled IP
telecommunications products and services, including telephone number
assignment and portability, as well as wholesale local and long distance
calling plans. This agreement, dated September 7, 2005, has a two year
term. Under this agreement, OIPV has a minimum purchase commitment of
$45,600 during the first 12 months of service (billed monthly at varying
"ramp-up" rates), and a $120,000 minimum purchase commitment ($10,000 per
month) during months 13-24.

OIPV has several agreements in effect with an unaffiliated third-
party for the provision of customer billing and support services, and for
licenses to use various products of the vendor. The terms of these
agreements range from

one to three years. The agreements, which contain fees that are based on a
percentage of revenues and/or usage, are also subject to a minimum fee
commitment. The annual minimum fee commitment aggregates approximately
$69,000 for 2006, $30,000 for 2007 and $30,000 for 2008.

OIPV has a two-year Private Label Resale Agreement with a
communications company pursuant to which OIPV can purchase for resale
various bandwidths ("circuits") at wholesale rates. Under the agreement,
installed circuits carry a one-year payment commitment. This agreement is
non-exclusive. As of December 31, 2005, this commitment approximated
$60,000.

OIPV has a Master Service Agreement with a communications company
pursuant to which it currently is committed on colocation space and
connectivity to the public switched telephone network for a 1-year period
expiring August 2006. Its monthly commitment is approximately $3,885 per
month.

Employment Agreements:

Mr. Alfred G. Stein, Executive Vice President, has an employment
agreement dated March 1, 2005 and expiring December 31, 2008 which includes
the following key provisions: (i) an initial annual base salary of
$175,000; (ii) an annual bonus of up to 100% of base salary based upon
attaining earnings targets approved by the Board of Directors; and (iii)
the grant of a five-year warrant to purchase up to 250,000 shares of common
stock at an exercise price of $.67 per share, which was equal to the
closing price of the common stock on his date of hire.

Mr. Nevelle R. Johnson, Executive Vice President, has an employment
agreement expiring December 31, 2008 which includes the following key
provisions: (i) an initial annual base salary of $200,000; (ii) an annual
bonus of up to 50% of base salary based upon attaining earnings targets
approved by the Board of Directors; (iii) the grant of a five-year warrant
to purchase up to 250,000 shares of common stock at an exercise price of
$1.10 per share, which was equal to the closing price of the common stock
on his date of hire; and (iv) payment by the Company of life insurance
premiums not exceeding $5,000 per month.

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 could 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 was secured by
cash, and since this cash was 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, 2004. The LC expired in March
2005.

11. STOCK OPTIONS AND WARRANTS

Stock Options:

The Company has outstanding options granted under the following
plans: (i) the Farmstead Telephone Group, Inc. 2002 Stock Option Plan (the
"2002 Plan") and (ii) the Farmstead Telephone Group, Inc. 1992 Stock Option
Plan (the "1992 Plan"). The 1992 Stock Option Plan terminated in May 2002,
however options previously granted under the 1992 Plan 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, is 2,300,000. Options currently granted expire on various dates
through 2015. A summary of stock option transactions for each of the three
years in the period ended December 31, 2005 is as follows:

Weighted
Average
Number Exercise Exercise
of Shares Price Range Price
----------------------------------------------------------------------------

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
Granted 656,000 .34 - .76 .41
Exercised - - -
Canceled or expired (138,587) .28 - 7.30 1.86
----------------------------------------------------------------------------
Outstanding at December 31, 2004 2,388,119 $.28 - 2.50 $1.36
Granted 443,500 .70 - 3.09 1.83
Exercised (55,000) .28 - 1.50 1.20
Canceled or expired (92,000) .28 - 1.51 1.10
----------------------------------------------------------------------------
Outstanding at December 31, 2005 2,684,619 $.28 - 3.09 $1.45
============================================================================
As of December 31, 2005:
Exercisable 2,242,619 $.28 - 2.50 $1.39
Available for future grant 1,080,500

The following summarizes information about stock options outstanding
and exercisable as of December 31, 2005:

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
--------------- --------------------------------------------------------- ------------------------------

$ .00 - 0.50 712,500 8.5 $ .39 683,250 $ .39
$0.51 - 1.00 148,000 6.9 .75 117,000 .75
$1.01 - 1.50 233,650 7.6 1.27 123,400 1.43
$1.51 - 2.00 1,453,469 2.8 1.94 1,308,469 1.96
$2.01 - 2.50 137,000 9.1 2.89 10,500 2.32
----------------------------------------------------------------------------------------------------------------
Total 2,684,619 5.3 $1.45 2,242,619 $1.39
================================================================================================================

Warrants:
---------

Warrants to purchase shares of Common Stock were issued to certain
officers of the Company in connection with their employment agreements. The
exercise price of these warrants represented the fair market value of the
Company's common stock on the date of grant. The warrants were exercisable
on the date of grant, and expire five years from the date of grant. The
following summarizes information about outstanding warrants as of December
31, 2005:

Date of Number Exercise
Employee grant Outstanding Price
--------------------------------------------------------------

12. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

(Revised 2004) requires an entity to measure the cost of employee services
received in exchange for an award of equity instruments based on the grant-
date fair value of the award (with limited exceptions). That cost will be
recognized over the period during which an employee is required to provide
service in exchange for the award. Accounting for share-based compensation
transactions using the intrinsic method supplemented by pro forma
disclosures will no longer be permissible. This statement is effective as
of the beginning of the first quarter of 2006. The adoption of this
standard will have an impact on the Company's 2006 results of operations as
it will be required to expense the fair value of all share based payments;
however the Company has not yet determined whether or not this impact will
be significant.

In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4," ("SFAS 151") which clarifies the types
of costs that should be expensed rather than capitalized as inventory. This
statement also clarifies the circumstances under which fixed overhead costs
associated with operating facilities involved in inventory processing
should be capitalized. The provisions of SFAS 151 are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005.
The adoption of SFAS 151 is not material to the Company's consolidated
financial position or results of operations.

13. EMPLOYEE BENEFIT PLANS

Supplemental Executive Retirement Plan. The Company maintains a
Supplemental Executive Retirement Plan ("SERP") for the benefit of Mr.
Taylor , initially established to provide him with an annual retirement
benefit of $100,000 per year, payable over 15 years beginning at age 65. In
2003, the Company recognized expense using a 7% discount rate, which it
lowered to 6.25% at year-end. During 2004 and 2005, the Company utilized a
6.25% discount rate for both expense and disclosure purposes. The amount of
the unrecognized actuarial loss of $15,952 at December 31, 2005, $23,929 at
December 31, 2004 and $31,906 at December 31, 2003 has been recorded in
Accumulated Other Comprehensive Loss as a component of Stockholders' Equity
(Deficiency).

The components of the net periodic benefit cost included in the
results of operations for the three years ended December 31, 2005 are set
forth as follows (in thousands):

2005 2004 2003
---------------------------------------------------------

Service cost $ 84 $ 80 $69
Interest cost 42 35 29
Amortization of actuarial loss 8 8 -
---------------------------------------------------------
Net expense $134 $123 $98
=========================================================

The following information summarizes activity in the SERP for the two
years ended December 31, 2005 (in thousands):

2005 2004
--------------------------------------------------------------------------------

Changes in Accumulated Benefit Obligation:
Accumulated Benefit obligation at beginning of year $ 593 $ 478
Service cost 84 80
Interest cost 42 35
--------------------------------------------------------------------------------
Accumulated Benefit obligation at end of year $ 719 $ 593
================================================================================

Fair Value of Plan Assets $ - $ -
================================================================================

Reconciliation of Funded Status:
Funded status $(719) $(593)
Unrecognized actuarial loss 16 24
--------------------------------------------------------------------------------
Accrued net periodic pension cost $(703) $(569)
================================================================================

Amounts Recognized in the Consolidated Balance Sheets:
Accrued accumulated benefit obligation $(719) $(593)
Accumulated other comprehensive loss 16 24
--------------------------------------------------------------------------------
Net liability reflected in the consolidated balance sheets $(703) $(569)
================================================================================

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 (2006), $100,000 (2007), $100,000 (2008),
$100,000 (2009), $100,000 (2010) and $500,000 (2011 - 2015).

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 have since been added to the ESPP. The ESPP covers all
employees working more than 20 hours per week, excluding employees owning
5% or more of the combined voting power of all classes of shares of the
Company or its subsidiary corporations. The ESPP provides for six-month
"offering periods" beginning September 14, 2001, with a final offering
period beginning March 1, 2011, and during such periods employees can
participate through payroll deductions of up to 10% of their earnings. At
the end of each offering period, 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.
Effective beginning with the September 2005 offering period, the ESPP was
amended to reduce the discount offered to employees to a 5% discount to the
market price of Company stock at the end of the offering period. Shares
purchased through the ESPP cannot exceed $25,000 in fair market value per
person per calendar year. During the two years ended December 31, 2005, the
Company issued 45,275 and 10,581 shares, respectively, of Common Stock.

401(K) Plan. The Company offers its employees a 401(K) plan, pursuant
to which it may make discretionary contributions. The Company made no
contributions in 2005 or 2004, and contributed $5,300 in 2003.

14. 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):

2005 2004 2003
------------------------------------------------------

Federal income tax expense:
Current $ - $ - $ -
Deferred - - -
State income tax expense:
Current 11 - 13
Deferred - - -
------------------------------------------------------
Provision for income taxes $11 $ - $13
======================================================

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):

2005 2004 2003
-----------------------------------------------------------------------------------------------

Income tax benefit at statutory rate $(1,123) $(484) $(237)
Increase (reduction) in income taxes
resulting from:
Change in state tax benefits (51) (102) (71)
State and local income taxes, net of federal
income tax benefit (7) - (9)
Non-recognizable Income from derivative financial instruments (115) - -
Non-deductible life insurance 7 9 (8)
Non-deductible meals and entertainment 7 8 7
Increase in valuation allowance 1,293 569 331
-----------------------------------------------------------------------------------------------
Provision for income taxes $ 11 $ - $ 13
===============================================================================================

The tax effects of temporary differences that give rise to
significant portions of deferred tax assets and liabilities at December 31,
2005 and 2004 are as follows (in thousands):

2005 2004
------------------------------------------------------------------

Deferred tax assets:
Allowance for doubtful accounts $ 25 $ 20
Inventory allowances 213 38
Accrued retirement obligation 239 193
Property and equipment 23 19
Other 30 16
Net operating loss and other carryforwards 3,879 2,830
------------------------------------------------------------------
Total gross deferred tax assets 4,409 3,116
Less: valuation allowance (4,409) (3,116)
------------------------------------------------------------------
Net deferred tax assets $ - $ -
==================================================================

The Company has federal net operating loss carryforwards of
approximately $9,951,000 that expire through 2025. In 2005 and 2004, the
valuation allowance was increased by $1,293,000 and $569,000 to fully
offset the Company's deferred tax assets as of December 31, 2005 and 2004,
respectively. Management believes that the present valuation allowance is
prudent due to the net losses sustained during the three years ended
December 31, 2005 and the unpredictability of future earnings.

15. STOCKHOLDERS' EQUITY (DEFICIENCY)

On December 30, 2005, the Company's common stock ceased trading on
the AMEX; however on the same date the Company obtained quotation of its
securities on the Over-the-Counter Bulletin Board (the "OTCBB") and its
Common Stock is listed under the symbol "FTGP".

On December 16, 2005, the Company held a Special Meeting of the
Stockholders, and received shareholder approval for (i) the issuance of
more than 20% of the Company's outstanding shares of common stock which may
arise in connection with the Laurus revolving credit facility as more fully
described in Note 6; (ii) the issuance of more than 20% of the Company's
outstanding shares of common stock in any one or series or combinations of
private offerings sales and issuances to investors of the Company's
securities, and a secondary offering sale and issuance to the public of
Common Stock, in an approximate amount in the range of $6,000,000 to
$26,000,000 (exclusive of any securities which may be sold upon exercise of
any over allotment options and (iii) an amendment to the 2002 Plan to
increase the number of shares of Common Stock available for grants and
awards under the 2002 Plan by 1,000,000 shares, from 1,300,000 to
2,300,000. See Note 18, Subsequent Events-Financing Transactions.

16. 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, 2005, one

customer accounted for 12% of accounts receivable. As of December 31, 2004,
one customer accounted for 17% 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,
2005. During the year ended December 31, 2005, one customer accounted for
11.8% of revenue. During the two years ended December 31, 2004, 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 money market funds 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.

17. SEGMENT INFORMATION

Historically, the Company has operated in a single business segment,
selling telecommunications equipment to businesses. During 2005, the
Company commenced activities related to the development of a new business
segment which became operational in January 2006, and provides hosted
carrier-based Voice over IP products and related network services to the
small-to-medium business marketplace. During the year ended December 31,
2005 this new business segment was in its development stage and did not
generate any revenues. Summarized financial information for the Company's
reportable business segments for the year ended December 31, 2005 is
presented below. Geographic information is not presented because the
Company does not operate outside of the United States. Corporate operating
expenses consist primarily of compensation and benefits, costs associated
with corporate governance and compliance, investor relations, and other
shared general expenses not allocated to the business segments.

Business segment information as of and for the year ended December
31, 2005 is as follows:

Telecom- IP
munication Telephony
(In thousands) Equipment Services Corporate Consol.
---------------------------------------------------------------------------------------

Revenues $15,203 $ - $ - $15,203
Operating loss (1,220) (1,091) (1,173) (3,484)
Depreciation and amortization of
property and equipment 91 19 11 121
Identifiable assets 4,624 445 535(a) 5,604
Capital expenditures 77 391 - 468
=======================================================================================

(a) Consists of deferred financing costs not allocated to the operating
segments.

The following table reconciles the totals reported for the operating
loss of the segments to the Company's reported loss before income taxes:

Year ended
(In thousands) December 31, 2005
----------------------------------------------------------------------------------

Total segment operating losses $(2,311)
Unallocated amounts:
Corporate expenses (1,173)
Interest expense (105)
Amortization of discounts on convertible debt and warrants (63)
Derivative instrument income, net 339
Other income 10
----------------------------------------------------------------------------------
Consolidated loss before income taxes $(3,303)
==================================================================================

18. INTEREST EXPENSE

Interest expense for the years ended December 31, 2005, 2004 and 2003
was comprised of the following components:

(In thousands) 2005 2004 2003
-----------------------------------------------------------------------------

Interest on outstanding borrowings $ 76 $ 28 $ 28
Amortization of deferred financing costs (1) 35 - -
Amortization of discounts on convertible notes (2) 57 - -
-----------------------------------------------------------------------------
Interest expense $168 $28 $28
=============================================================================

Amortization of deferred financing costs consists of $6,000
amortization of an imputed discount on warrants issued to the Laurus
Master Fund LTD ("Laurus") and $29,000 of amortization of a prepaid
facility fee of $117,000 in connection with a revolving credit
facility entered into with Laurus on March 31, 2005. These costs are
included in deferred financing costs on the Consolidated Balance
Sheet, and are being amortized to interest expense over the three-
year term of the facility. See Note 6.

Discounts imputed in accounting for the Company's convertible notes
issued to the Laurus Master Fund pursuant to this credit facility,
are being amortized to interest expense over their term using the
effective interest method. See Note 6.

19. SUBSEQUENT EVENTS - FINANCING TRANSACTIONS

During 2006, the Company has entered into several private placements
of debt and equity securities in order to raise capital for use in its
current business and the working capital requirements of its start-up IP
telephony business. These transactions are summarized below.

Convertible Debt Issuances
--------------------------

On January 30, 2006, the Company issued a $400,000 Convertible
Promissory Note and a Warrant to purchase 22,047 shares of common stock to
Christopher P. Baker, pursuant to a Convertible Promissory Note and
Purchase Agreement. The Convertible Promissory Note was subsequently repaid
in full, with interest, on February 8, 2006 and the note was cancelled. The
warrants expire ten years from the date of issue, and are exercisable at
$1.27 per share. In lieu of exercising the warrant with cash, the Holder
may elect to receive that number of shares of common stock equal to the
value of the warrant (or that portion being exercised) at the time of
exercise.

On February 8, 2006, the Company issued a $1,000,000 Principal Amount
Convertible Promissory Note (the "Sotomar Note") to Sotomar -
Empreendimentos Industriais e Imobiliarios, SA (the "Holder") pursuant to a
Convertible Note and Warrant Purchase Agreement (the "Purchase Agreement").
The proceeds received by the Company, net of placement agent fees and
expenses, amounted to approximately $913,000.

The following describes certain of the material terms of this
transaction. The description below is not a complete description of the
terms of the financing transaction and is qualified in its entirety by
reference to the specific agreements entered into in connection therewith
which are included as exhibits to this Annual Report on Form 10-K.

Convertible Promissory Note. The outstanding principal amount under
the Sotomar Note, plus any accrued but unpaid interest thereon, shall
automatically convert into the shares of Series A Preferred Stock of the
Company sold by the Company upon the sale of Series A Preferred Stock and
warrants to purchase Common Stock to accredited investors in a private
placement transaction pursuant to Regulation D (collectively, "Offered
Securities") which produces at least $500,000 of aggregate gross proceeds
to the Company (a "Preferred Offering"). The conversion price of the
Sotomar Note into Series A Preferred Stock upon an automatic conversion
pursuant to this Section shall be equal to the price paid per unit of
Offered Securities by investors in the Preferred Offering. In the event a
Preferred Offering does not occur by 90 days from the issuance of the
Sotomar Note (the "Maturity Date"), all of the outstanding Principal Amount
under the Sotomar Note, plus any accrued but unpaid interest thereon, shall
be, at Holder's sole discretion, (i) converted into shares of the Company's
Common Stock, $.001 par value per share, at a conversion price equal to
110% of the average of the closing bid prices of the Company's Common Stock
reported

for the last ten (10) trading days immediately prior to the Maturity Date
(the "Conversion Price"); (ii) paid in cash to Holder; or (iii) paid in any
combination of (i) and (ii). Moreover, the conversion rights outlined above
shall apply to the Sotomar Note in the event of a merger or consolidation
with or into any other entity or a sale, transfer, lease, conveyance or
exclusively license all or substantially all of the Company's assets. Upon
conversion of the Sotomar Note into any securities of the Company, the
Holder shall be entitled to the same rights, privileges and preferences as
the other holders of such securities.

Interest on the Sotomar Note accrues at the per annum rate of 10%. If
this note is subject to an Event of Acceleration, the interest rate shall
increase to 18% per annum (or such lesser amount as may not be prohibited
by applicable law) until such principal amount plus accrued but unpaid
interest is paid in full.

The Company has the right to prepay the principal amount and any
accrued interest thereon in whole or in part without penalty or premium at
any time. Prior to making an optional prepayment, the Company shall give
Holder five days' prior written notice of its intention to make a
prepayment. Upon any notice of prepayment, Holder shall have the option to
convert all but not less than all of the principal amount then outstanding
under this Note, plus any accrued but unpaid interest thereon, into shares
of Series A Preferred Stock. Any prepayment amount shall be applied first
to any accrued but unpaid interest, and then to the principal amount.

Warrant to Purchase Shares of Stock. In connection with the issuance
of the Sotomar Note, the Holder received a warrant to purchase up to an
aggregate 529,134 shares of the Company's common stock at an exercise price
of $1.27 per share. The warrant expires ten years from issuance. In lieu of
exercising the warrant with cash, the Holder may elect to receive that
number of shares of common stock equal to the value of the warrant (or that
portion being exercised) at the time of exercise.

In connection with the above transactions, the Company issued to its
placement agent a warrant (the "Placement Agent Warrant") to purchase up to
an aggregate 150,000 shares of the Company's common stock at an exercise
price of $1.27 per share. The Placement Agent Warrant expires five years
from issuance. In lieu of exercising this warrant with cash, the placement
agent may elect to receive that number of shares of common stock equal to
the value of the warrant (or that portion being exercised) at the time of
exercise.

The exercise price and the number of securities of the Company into
which the Sotomar Note and warrant, and the Placement Agent Warrant may be
converted shall be appropriately adjusted for any stock splits,
subdivisions, combinations, distributions and the like.

Series A Preferred Stock Issuances
----------------------------------

On February 17, 2006 the Company sold 44,117 Units to Meadowbrook
Opportunity Fund LLC at a price of $17.00 per Unit. On March 17, 2006 the
Company sold 91,433 Units to the following investors at a price of $17.00
per Unit: Sotomar - Empreendimentos Industriais e Imobiliarios, SA, William
A. Boyd, Suzy Ulrich, Richard J Cranmer, Watamar & Partners SA, Thomas
Barrett, Case Holdings Co., Inc., Allan Sorensen, Chuck & Joy Hartz, Hartz
Family Foundation, Barton Ferris, Jr. and William Harner (together with
Meadowbrook Opportunity Fund LLC the "Investors"). Each Unit consists of
(i) one share of the Company's Series A Preferred Stock, $.001 par value
per share, and (ii) a Warrant to purchase five shares of the Company's
Common Stock, par value $.001 per share, at an exercise price of $2.125 per
share (the Series A Preferred Stock and the Warrant together "Securities").
The Securities were not registered under the Securities Act of 1933, as
amended, or applicable state securities laws. The Securities are subject to
restrictions on transferability and resale and may not be transferred or
resold except as permitted under the Securities Act of 1933, as amended,
and applicable state securities laws, pursuant to registration or exemption
from those laws. The proceeds received by the Company, net of placement
agent fees and expenses, aggregated $2,095,958.

The following describes certain of the material terms of the Series A
Preferred Stock transactions. The description below is not a complete
description of the terms of the financing transaction and is qualified in
its entirety by reference to the specific agreements entered into in
connection therewith which are included as exhibits to this Annual Report
on Form 10-K.

Series A Preferred Stock. The Investors received certain rights in
connection with its purchase of the Series A Preferred Stock:

* The Investor shall be entitled to receive in preference to any
dividend on the Common Stock a cumulative non-compounding
dividend at the rate of 8% per annum of the original Preferred
A per share price.

* In the event of any liquidation or winding up of the Company,
the Investors shall be entitled to receive in preference to the
holders of the Common Stock an amount equal to two times the
original Preferred A per share price plus any declared but
unpaid dividends.

* The conversion price of the Series A Preferred Stock will be
subject to a weighted average adjustment (based on all deemed
outstanding shares of Common Stock and shares of Preferred
Stock) and to reduce dilution in the event that the Company
issues additional equity securities (other than the shares
reserved for issuance under or to Laurus Master Fund Ltd., the
Company's Stock Option Plan, the Company's Employee Stock
Purchase Plan, employees, officers, consultants and directors
of the Company, and under other currently existing options,
warrants and obligations to issue shares) at a purchase price
less than the Series A Preferred Stock conversion price. The
Series A Preferred Stock conversion price will also be subject
to proportional adjustment for stock splits, stock dividends,
recapitalizations and the like.

* The Series A Preferred Stock will vote together with the Common
Stock and not as a separate class except as required by law,
however, the Series A Preferred Stock, exclusively and as a
separate class, will be entitled to elect one (1) director of
the Corporation. Each share of Series A Preferred Stock shall
have a number of votes equal to the number of shares of Common
Stock then issuable upon conversion of such share of Series A
Preferred Stock .

Warrant to Purchase Shares of Stock. The Investors received warrants
to purchase up to an aggregate 677,750 shares of the Company's common stock
at an exercise price of $2.125 per share. The warrants expire five years
from issuance. In lieu of exercising the warrants with cash, the Holders
may elect to receive that number of shares of common stock equal to the
value of the warrant (or that portion being exercised) at the time of
exercise.

Registration rights. The Company agreed to use its best efforts to
register the common stock underlying the Securities for resale via a Form
S-3 or other appropriate registration statement ("Registration Statement")
within 90 days after the completion of the Series A Offering. The Company
agreed to respond to Securities and Exchange Commission Registration
Statement comments within 10 days and request effectiveness of the
Registration Statement within 3 days of "no review" or "no further
comments".

Pursuant to the terms of the Sotomar Note described above, and as a
result of the aforementioned sale of Series A Preferred Stock, on February
17, 2006 the Sotomar Note, together with interest accrued thereon,
converted into 58,970 shares of Series A Preferred Stock.

In connection with the above Series A Preferred Stock transactions,
the Company issued to its placement agent warrants (the "Placement Agent
Warrants") (i) to purchase up to an aggregate 101,660 shares of the
Company's common stock at an exercise price of $2.125 per share and (ii) to
purchase up to an aggregate 20,332 shares of the Company's Series A
Preferred Stock at an exercise price of $17.00 per share. The Placement
Agent Warrants expire ten years from issuance. In lieu of exercising the
warrants with cash, the placement agent may elect to receive that number of
shares of common stock or Series A Preferred Stock, as applicable, equal to
the value of the warrant (or that portion being exercised) at the time of
exercise.

20. RELATED PARTY TRANSACTIONS

As described in Note 10, on October 1, 2004, the Company entered into
an employment agreement with Mr. Jean-Marc Stiegemeier in connection with
his appointment as President and Chief Executive Officer of the Company.
From August 16, 2004 to October 1, 2004, he provided business consulting
services to the Company for which he earned $50,000 in fees. Prior to Mr.
Alfred Stein's employment with the Company, he provided business consulting
services to the Company for which he earned $40,000 in fees for the period
September 13, 2004 to January 15, 2005.

The Company has an agreement with Straitshot Communications, Inc., a
Washington corporation, ("Straitshot") for certain communications services
and equipment in connection with our OIPV offering. Our Chairman and CEO,
Mr. Stiegemeier, is currently a member of the Board of Directors of
Straitshot.

21. QUARTERLY FINANCIAL DATA (UNAUDITED)

Summarized quarterly financial data for 2005 and 2004 is as follows
(dollars in thousands except earnings (loss) per share):

Quarter
---------------------------------------------------------------------------------------------
2005 First Second Third Fourth (a)
---------------------------------------------------------------------------------------------

Revenues $ 2,409 $4,483 $ 4,807 $ 3,504
Gross Profit 754 1,336 1,239 440
Operating loss (630) (429) (646) (1,779)
Net loss (639) (474) (704) (1,497)
Loss per common share:
Basic and diluted $ (.19) $ (.14) (.20) (.40)
Weighted average common shares outstanding:
Basic and diluted 3,328 3,353 3,511 3,780
=============================================================================================

(a) Includes a $385,000 charge to increase reserves for inventory
obsolescence. Also includes a net credit of $415,000 to correct the
accounting for its financing transactions with the Laurus Master Fund
LTD as further described in Note 6. The effect of this correction of
accounting on previously reported quarters of 2005 is as follows:

Quarter
---------------------------------------------------------------------------------------------
2005 (as Restated) First Second Third Fourth
---------------------------------------------------------------------------------------------

Revenues $ 2,409 $4,483 $ 4,807 $ 3,504
Gross Profit 754 1,336 1,239 440
Operating loss (630) (429) (646) (1,779)
Net income (loss) (1,032) 202 (2,648) 164
Income (loss) per common share:
Basic $ (.31) $ .06 $ (.75) $ .04
Diluted $ (.31) $ .05 $ (.75) $ .03
Weighted average common shares outstanding:
Basic 3,328 3,353 3,511 3,780
Diluted 3,328 4,391 3,511 6,536
=============================================================================================

Quarter
---------------------------------------------------------------------------------------------
2004 First Second Third Fourth (b)
---------------------------------------------------------------------------------------------

Revenues $ 3,406 $2,889 $ 3,338 $ 2,711
Gross Profit 877 604 804 608
Operating loss (333) (406) (176) (487)
Net loss (341) (414) (175) (494)
Loss per common share:
Basic and diluted (.10) (.12) (.05) (.16)
Weighted average common shares outstanding:
Basic and diluted 3,313 3,316 3,317 3,322
=============================================================================================

(b) Includes a $26,000 credit to income from a reduction in the Company's
reserves for sales and product returns.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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, 2005 and 2004, and
for each of the years in the three-year period ended December 31, 2005, and
have issued our report thereon dated April 4, 2006. Our audit also
included the financial statement schedule of Farmstead Telephone Group,
Inc., 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 audits. In our opinion, such financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.

/s/ CARLIN, CHARRON & ROSEN, LLP
Glastonbury, Connecticut
April 4, 2006

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 2005
Allowance for doubtful accounts $ 60 $ 36 - $ 21* $ 75
Inventory valuation reserves 118 581 - 72* 627
Deferred tax asset valuation allowance 3,116 ** -

Year 2004
Allowance for doubtful accounts $ 80 $ 18 - $ 38* $ 60
Inventory valuation reserves 359 106 - 347* 118
Deferred tax asset valuation allowance 2,547 569** - - 3,116

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

* Represents write-offs of inventories and uncollectible accounts
receivable.
** Recorded to fully reserve for the increase in the Company's net
deferred tax assets.

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.

3.1 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)]
3.2 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)]
3.3 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]
3.4 Amended and Restated By-Laws [Exhibit 3(d) to the Annual
Report on Form 10-K for the year ended December 31, 2000]
3.5 Certificate of Designation to the Certificate of
Incorporation of Farmstead Telephone Group, Inc., dated
February 17, 2006 [Exhibit 99.1 to the Form 8-K Current
Report filed February 24, 2006]
4.1 Amended 1992 Stock Option Plan [Exhibit to the Proxy
Statement on Schedule 14A filed April 14, 1998 (File No.
001-12155)]
4.2 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]
4.3 Warrant to Purchase common stock of Farmstead Telephone
Group, Inc. issued to Jean-Marc Stiegemeier October 1, 2004
[Exhibit 4(a) to the Form 8-K Current Report filed October
6, 2004]
4.4 Warrant to Purchase common stock of Farmstead Telephone
Group, Inc. issued to Alfred G. Stein January 15, 2005*
4.5 Warrant to Purchase common stock of Farmstead Telephone
Group, Inc. issued to Nevelle R. Johnson March 1, 2005
[Exhibit 4(a) to the Form 8-K Current Report filed March
4, 2005]
4.6 Security Agreement dated March 31, 2005 by and among Laurus
Master Fund, Ltd. and Farmstead Telephone Group, Inc.
[Exhibit 99.1 to the Form 8-K Current Report filed April 5,
2005]
4.7 Secured Revolving Note dated as of March 31, 2005. [Exhibit
99.2 to the Form 8-K Current Report filed April 5, 2005]
4.8 Secured Convertible Minimum Borrowing Note dated as of March
31, 2005 [Exhibit 99.1 to the Form 8-K Current Report filed
April 5, 2005]
4.9 Common Stock Purchase Warrant dated as of March 31, 2005
[Exhibit 99.1 to the Form 8-K Current Report filed April 5,
2005]
4.10 Minimum Borrowing Note Registration Rights Agreement dated
as of March 31, 2005 [Exhibit 99.1 to the Form 8-K Current
Report filed April 5, 2005]
4.11 Convertible Promissory Note and Warrant Purchase Agreement,
dated February 8, 2006, entered into with Sotomar -
Empreendimentos Industriais e Imobiliarios, SA 2005 [Exhibit
99.1 to the Form 8-K Current Report filed February 14, 2006]
4.12 Convertible Promissory Note, dated February 8, 2006, issued
to Sotomar - Empreendimentos Industriais e Imobiliarios, SA
[Exhibit 99.2 to the Form 8-K Current Report filed February
14, 2006]
4.13 Warrant to Purchase Shares of Common Stock, dated February
8, 2006, issued to Sotomar - Empreendimentos Industriais e
Imobiliarios, SA SA [Exhibit 99.3 to the Form 8-K Current
Report filed February 14, 2006]
4.14 Warrant to Purchase Shares of Common Stock, dated February
8, 2006, issued to C.P. Baker Securities, Inc. SA [Exhibit
99.4 to the Form 8-K Current Report filed February 14, 2006]
4.15 Series A Preferred Stock and Warrant Purchase Agreement
dated February 17, 2006, entered into with Meadowbrook
Opportunity Fund LLC SA [Exhibit 99.1 to the Form 8-K
Current Report filed February 24, 2006]
4.16 Series A Preferred Stock and Warrant Purchase Agreement
dated March 17, 2006, entered into with Sotomar -
Empreendimentos Industriais e Imobiliarios, SA, William A.
Boyd, Suzy Ulrich, Richard J Cranmer, Watamar & Partners SA,
Thomas Barrett, Case Holdings Co., Inc., Allan Sorensen,
Chuck & Joy Hartz, Hartz Family Foundation, Barton Ferris,
Jr. and William Harner [Exhibit 99.1 to the Form 8-K Current
Report filed March 21, 2006]

10.1 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]
10.2 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]
10.3 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]
10.4 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]
10.5 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]
10.6 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]
10.7 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]
10.8 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]
10.9 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]
10.10 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]
10.11 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]
10.12 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]
10.13 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]
10.14 Revolving Credit Master Promissory Note dated February 19,
2004 between Business Alliance Capital Corporation and
Farmstead Telephone Group, Inc.
10.15 Modification Agreement dated February 19, 2004 between
Business Alliance Capital Corporation and Farmstead
Telephone Group, Inc.
10.16 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
10.17 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
10.18 Amendment to Reseller Master Terms and Conditions:
Authorized Remanufactured Supplier (ARS) Program Between
Avaya Inc. and Farmstead Telephone Group, Inc., dated
October 28, 2003
10.19 Employment Agreement dated October 1, 2004 between Farmstead
Telephone Group, Inc. and Jean-Marc Stiegemeier. [Exhibit
10(a) to the Form 8-K Current Report filed October 6, 2004]
10.20 Fourth 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; as
Further Amended by that Certain Second Addendum Dated as of
January 1, 2003; and as Further Amended by that Certain
Third Addendum Dated as of January 1, 2004. [Exhibit 10(b)
to the Form 8-K Current Report filed October 6, 2004]

10.21 Agreement between Farmstead Telephone Group, Inc. and Jean-
Marc Stiegemeier dated August 16, 2004 [Exhibit 10(c ) to
Form 10-Q for the quarter ended September 30, 2004].
10.22 Employment Agreement dated January 15, 2005 between
Farmstead Telephone Group, Inc. and Alfred G. Stein*
10.23 Employment Agreement dated March 1, 2005 between Farmstead
Telephone Group, Inc. and Nevelle R. Johnson [Exhibit 10(a)
to the Form 8-K Current Report filed March 4, 2005]
10.24 First Addendum to that Certain Employment Agreement Between
Farmstead Telephone Group, Inc. and Jean-Marc Stiegemeier,
Dated as of October 1, 2004 [Exhibit 99(a) to the Form 8-K
Current Report filed October 14, 2005]
21 Subsidiaries *
31.1 Certification of the Principal Executive Officer pursuant to
Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002. *
31.2 Certification of the Principal Financial Officer pursuant to
Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002. *
32.1 Certification of the Chief Executive Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002. *
32.2 Certification of the Chief Financial Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002. *

--------------------
* filed herewith.