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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q/A
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended March 31, 2005
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from _____________ to ______________
Commission File Number: 001-12155
Farmstead Telephone Group, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 06-1205743
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
22 Prestige Park Circle
East Hartford, CT 06108
(Address of principal executive offices) (Zip Code)
(860) 610-6000
(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if
changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of April 30, 2005, the registrant had 3,342,730 shares of its $0.001 par
value Common Stock outstanding.
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EXPLANATORY NOTE:
-----------------
This Form 10-Q/A to the Company's Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 2005, initially filed with the Securities
and Exchange Commission on May 16, 2005, amends Part I, Items 1 and 2 for the
three months ended March 31, 2005. This Form 10-Q/A continues to reflect
circumstances as of the date of the original filing of the Quarterly Report on
Form 10-Q for the quarterly period ended March 31, 2005 and we have not updated
the disclosures contained herein to reflect events that occurred at a later
date, except for items related to the restatement or where otherwise indicated.
The restatement pertains primarily to a correction in the accounting
for warrants issued to the Laurus Master Fund Ltd. ("Laurus") pursuant to a $3
million credit facility obtained effective March 31, 2005. See a more detailed
discussion of the restatement in Item 1, Note 1- "Restatement" to the Notes to
Consolidated Financial Statements.
We anticipate filing amended reports on Form 10-Q/A for the quarterly
periods ended June 30, 2005 and September 30, 2005 which will reflect a
continuation of corrections in the accounting for convertible notes and
warrants issued to Laurus during 2005. The consolidated financial statements
for the years ended December 31, 2005, 2004 and 2003 included in our Annual
Report on Form 10-K for the year ended December 31, 2005 should be relied upon.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Page
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
Consolidated Balance Sheets -- March 31, 2005 and
December 31, 2004 ............................................. 3
Consolidated Statements of Operations -- Three Months Ended
March 31, 2005 and 2004 ....................................... 4
Consolidated Statement of Changes in Stockholders' Equity --
Three Months Ended March 31, 2005. ............................ 4
Consolidated Statements of Cash Flows -- Three Months Ended
March 31, 2005 and 2004 ...................................... 5
Notes to Consolidated Financial Statements ...................... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ............................. 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ...... 17
ITEM 4. CONTROLS AND PROCEDURES ......................................... 17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS ............................................... 17
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS...... 17
ITEM 3. DEFAULTS UPON SENIOR SECURITIES ................................. 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 17
ITEM 5. OTHER INFORMATION ............................................... 17
ITEM 6. EXHIBITS ........................................................ 17
SIGNATURES .............................................................. 18
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
(In thousands) 2005 2004
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(Unaudited)
(As Restated)
ASSETS
Current assets:
Cash and cash equivalents $ 247 $ 217
Accounts receivable, net 1,544 1,453
Inventories, net 1,588 1,627
Other current assets 359 378
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Total Current Assets 3,738 3,675
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Property and equipment, net 281 268
Deferred financing costs (Note 6) 564 --
Other assets 104 107
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Total Assets $ 4,687 $ 4,050
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,656 $ 1,110
Accrued expenses and other current liabilities 609 242
Debt maturing within one year (Note 7) 153 187
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Total Current Liabilities 2,418 1,539
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Postretirement benefit obligation 624 593
Long-term debt (Note 7) 60 39
Derivative financial instruments (Note 6) 728 --
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Total Liabilities 3,830 2,171
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Commitments and contingencies (Note 11)
Stockholders' Equity:
Preferred stock, $0.001 par value; 2,000,000 shares authorized;
no shares issued and outstanding -- --
Common stock, $0.001 par value; 30,000,000 shares authorized;
3,342,730 and 3,322,182 shares issued and outstanding at
March 31, 2005 and December 31, 2004, respectively 3 3
Additional paid-in capital 12,327 12,320
Accumulated deficit (11,452) (10,420)
Accumulated other comprehensive loss (21) (24)
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Total Stockholders' Equity 857 1,879
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Total Liabilities and Stockholders' Equity $ 4,687 $ 4,050
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See accompanying notes to consolidated financial statements.
3
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
March 31,
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(In thousands, except per share amounts) 2005 2004
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(As Restated)
Revenues:
Equipment $ 1,965 $ 2,922
Services and other revenue 444 484
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Net revenues 2,409 3,406
Cost of revenues:
Equipment 1,319 2,046
Services and other revenue 234 272
Other cost of revenues 102 211
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Total cost of revenues 1,655 2,529
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Gross profit 754 877
Selling, general and administrative expenses 1,384 1,210
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Operating loss (630) (333)
Other income (expense):
Interest expense (8) (6)
Derivative instrument expense (393) --
Other income 3 1
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Total other income (expense) (398) (5)
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Loss before income taxes (1,028) (338)
Provision for income taxes 4 3
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Net loss $(1,032) $ (341)
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Basic and diluted net loss per common share $ (.31) $ (.10)
Weighted average common shares outstanding:
Basic and diluted 3,328 3,313
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FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENT OF CHANGES
IN STOCKHOLDERS' EQUITY (UNAUDITED)
Three Months ended March 31, 2005 (As Restated)
Accumulated
Additional Other
Common Stock Paid-in Accumulated Comprehensive
(In thousands) Shares Amount Capital Deficit Loss Total
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Balance at December 31, 2004 3,322 $3 $12,320 $(10,420) $(24) $1,879
Net loss - - - (1,032) - (1,032)
Amortization of pension liability
adjustment 3 3
Comprehensive loss (1,029)
Issuance of common stock 21 - 7 - - 7
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Balance at March 31, 2005 3,343 $3 $12,327 $(11,452) $(21) $ 857
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See accompanying notes to consolidated financial statements.
4
FARMSTEAD TELEPHONE GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended
March 31,
----------------------
(In thousands) 2005 2004
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(As Restated)
Cash flows from operating activities:
Net loss $ (1,032) $ (341)
Adjustments to reconcile net loss to net cash flows
provided by (used in) operating activities:
Provision for doubtful accounts receivable 9 9
Provision for losses on inventories 8 9
Depreciation and amortization 25 36
Derivative instruments expense 393 --
Decrease in accumulated other comprehensive loss 3 2
Increase in accrued postretirement benefit obligation 31 29
Changes in operating assets and liabilities:
Increase in accounts receivable (100) (485)
(Increase) decrease in inventories 31 (380)
Decrease (increase) in other assets 22 (36)
Increase in accounts payable 546 265
Increase in accrued expenses and other current liabilities 367 119
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Net cash provided by (used in) operating activities 303 (773)
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Cash flows from investing activities:
Purchases of property and equipment (3) (12)
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Net cash used in investing activities (3) (12)
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Cash flows from financing activities:
(Repayments) borrowings under revolving credit line (46) 305
Increase in deferred financing costs (229) --
Proceeds from issuance of common stock 7 2
Repayments of long-term debt and capital lease obligations (2) --
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Net cash (used in) provided by financing activities (270) 307
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Net increase (decrease) in cash and cash equivalents 30 (478)
Cash and cash equivalents at beginning of period 217 827
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Cash and cash equivalents at end of period $ 247 $ 349
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Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 8 $ 6
Income taxes 2 4
Non-cash financing and investing activities:
Purchase of equipment under capital lease 36 --
Discount on warrants issued to Laurus 335 --
See accompanying notes to consolidated financial statements
5
FARMSTEAD TELEPHONE GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION, BUSINESS OPERATIONS, AND SIGNIFICANT ACCOUNTING
POLICIES
Basis of Presentation
The consolidated financial statements presented herein consist of the
accounts of Farmstead Telephone Group, Inc. and its wholly owned subsidiaries,
FTG Venture Corporation (inactive) and InfiNet Systems, LLC (inactive). The
accompanying consolidated financial statements as of March 31, 2005 and for the
three months ended March 31, 2005 and 2004 have been prepared in accordance
with accounting principles generally accepted in the United States of America
and the rules and regulations of the Securities and Exchange Commission for
interim financial statements. In the Company's opinion, the unaudited interim
consolidated financial statements and accompanying notes reflect all
adjustments, consisting of normal and recurring adjustments, which are
necessary for a fair presentation of its financial position and operating
results for the interim periods presented. The results of operations for the
three months ended March 31, 2005 are not necessarily indicative of the results
that may be expected for the entire fiscal year. This Form 10-Q should be read
in conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2004.
Restatement
The accompanying consolidated financial statements as and for the
three months ended March 31, 2005 (the " 2005 Financial Statements") have been
restated to correct an error pertaining to the accounting for warrants issued
to the Laurus Master Fund Ltd. (the "Laurus Warrants") in connection with the
execution of a three-year Secured Revolving Note agreement dated March 31,
2005. Specifically, the Company has adjusted its 2005 Financial Statements in
order to revalue the fair market value of the Laurus Warrants as of March 31,
2005 and apply the accounting methodology required under EITF Issue 00-19,
"Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company's Own Stock". Applying this methodology resulted in the
recording of a derivative financial instrument liability attributable to the
Laurus Warrants in the amount of $728,000 as of March 31, 2005, and a non-cash
expense in the amount of $393,000. The effect of the foregoing on the 2005
Financial Statements is as follows:
Three Months Ended March 31, 2005
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As Previously
(in thousands, except per share amounts) Reported As Restated
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Consolidated Balance Sheet:
Total assets $4,538 $4,687
Total liabilities 3,102 3,830
Stockholders' equity 1,436 857
Consolidated Results of Operations:
Operating loss (630) (630)
Net loss (639) (1,032)
Net loss per common share $(.19) $(.31)
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Business Operations
As presented in the consolidated financial statements contained in
this report, the Company incurred a net loss of $1,032,000 for the quarter
ended March 31, 2005. This net loss includes a non-cash derivative instrument
expense of $393,000 arising from the valuation of common stock purchase
warrants issued to the Laurus Master Fund, Ltd. ("Laurus") in connection with a
three-year convertible revolving credit facility entered into effective March
31, 2006, as more fully described in Note 6 - Convertible Debt. In addition,
the Company has incurred substantial losses in each of the past four fiscal
years. These losses have been primarily the result of significant declines in
revenues over these periods. As further described in the Company's Annual
Report on Form 10-K for the year ended December 31, 2004, the Company has taken
several measures to turnaround its operating performance. The turnaround
strategy 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, such as through installation and maintenance
services. As a part of the turnaround plan, the Company hired a new President
and CEO in October 2004, and two Executive Vice Presidents -- one
6
responsible for operations (hired in January 2005) and one responsible for
sales (hired in March 2005). In March, the Company significantly expanded its
sales infrastructure and opportunities, first by the hiring of twenty three
sales and sales support professionals formerly employed by Avaya Inc., and
second by entering into a trial agreement with Avaya to provide products and
services to the SMB ("small-to-medium sized business") market which commenced
in March with the launch of a nationwide SMB sales program. At the end of March
2005, the Company's direct sales force was 83% larger than in March 2004, and
March 2005 bookings and revenues were significantly higher than in recent
months. The Company intends to hire additional sales professionals during 2005
as required to meet its SMB revenue expectations. In May 2005, the Company
formed a wholly-owned subsidiary named "One IP Voice" which, when operational,
will offer carrier-based hosted IP telephony services along with network
services. Its primary target will be the SMB market.
In order to finance its business expansion plans, effective March 31,
2005 the Company entered into a $3 million credit arrangement with Laurus,
replacing a $1.7 million credit facility with Business Alliance Capital
Corporation. For additional information, refer to Note 6- Convertible Debt,
contained herein.
Significant Accounting Policies
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.
7
2. RECLASSIFICATIONS
Certain amounts in prior years' financial statements have been reclassified to
conform to the 2005 presentation.
3. ACCOUNTS RECEIVABLE, NET
March 31, December 31,
(In thousands) 2005 2004
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Trade accounts receivable $1,383 $1,379
Less: allowance for doubtful accounts (69) (60)
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Trade accounts receivable, net 1,314 1,319
Other receivables 230 134
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Accounts receivable, net $1,544 $1,453
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Other receivables consist of commissions, rebates and other dealer
incentives due from Avaya Inc., and are recorded in the consolidated financial
statements when earned. Refer to Note 1- Accounting for Manufacturer
Incentives, in the Company's Annual Report on Form 10-K for the year ended
December 31, 2004.
4. INVENTORIES, NET
March 31, December 31,
(In thousands) 2005 2004
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Finished goods and spare parts $1,292 $1,341
Work in process (a) 296 352
Rental equipment 42 52
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1,630 1,745
Less: reserves for excess and obsolete
inventories (42) (118)
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Inventories, net $1,588 $1,627
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(a) Work in process inventories consist of used equipment requiring
repair or refurbishing.
5. PROPERTY AND EQUIPMENT, NET
Estimated
Useful Lives March 31, December 31,
(In Thousands) (Yrs.) 2005 2004
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Computer and office equipment 3 - 5 $1,073 $1,071
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 36 -
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1,716 1,678
Less: accumulated depreciation and
amortization (1,435) (1,410)
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Property and equipment, net $ 281 $ 268
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Leased equipment under capital lease consists of computer equipment.
6. CONVERTIBLE DEBT
On March 31, 2005, the Company entered into a financing transaction
with 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 was set at $500,000, the proceeds of which were advanced to the
Company on April 4, 2005. 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. The Company also issued Laurus a five-year warrant (the "Warrant") to
purchase an aggregate of 500,000 shares of common stock of the Company 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
8
from registration under Section 4(2) of the Securities Act of 1933, as amended.
There were no borrowings under the Laurus Notes as of March 31, 2005.
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 will additionally be 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.
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 fixed conversion price 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. If the registration statement is not timely filed, or declared
effective the Company will be subject to certain penalties.
Since the secured convertible notes are not considered to be
conventional convertible debt, as the Company incurs borrowings under the
credit facility, any embedded conversion options in the secured convertible
notes will be subject to the requirements of EITF Issue 00-19. The Company will
also be required to bifurcate the embedded conversion option and account for it
as a derivative instrument liability because of the potential penalties that
the Company 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
the Company issues 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, will have to be considered for
bifurcation and accounted for, together with the embedded conversion option, as
a single compound derivative instrument. This derivative instrument liability
would be initially
9
recorded at its fair value and 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 will be the embedded conversion option, which will be
revalued using the Black-Scholes option pricing model.
The 500,000 warrants issued to Laurus were initially valued at
$335,000, 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 the Company 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 was adjusted to fair value (using the Black-Scholes option pricing
model) at the end of the reporting period, and the resulting $393,000 change in
fair value was expensed. 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 $335,000 has been recorded as a
deferred financing cost, and is being amortized to interest expense over the
term of the facility using an effective interest method.
Also included in deferred financing costs on the balance sheet at
March 31, 2005 is $229,000 of fees and expenses incurred by the Company in
connection with the Laurus facility, including a $117,000 prepaid facility fee,
a $50,000 broker fee, and $62,000 of legal and other direct costs incurred.
These fees will be charged to expense on a pro-rata basis over the term of the
facility.
7. DEBT OBLIGATIONS
Long-term debt obligations consisted of the following at March 31:
March, 31, December, 31,
(In thousands) 2005 2004
----------------------------------------------------------------------
BACC revolving credit facility note $133 $179
Installment purchase note 46 47
Obligations under capital lease 34 -
----------------------------------------------------------------------
213 226
Less: debt maturing within one year (153) (187)
----------------------------------------------------------------------
Long-term debt obligations $60 $39
----------------------------------------------------------------------
BACC revolving credit facility note:
------------------------------------
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. The average and highest amounts borrowed under the BACC facility during
the three months ended March 31, 2005 were approximately $223,000 and $447,000,
respectively. This facility was replaced by the Laurus credit facility as more
fully described in Note 6 -- Convertible Debt..
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
March 31, 2005 was $45,980, of which $8,154 was classified under debt maturing
within one year.
Obligations under Capital Lease:
--------------------------------
In March 2005, the Company entered into non-cancelable lease agreement
to finance $36,112 of computer equipment. Monthly lease payments are $1,103
with a $1.00 purchase option at the end of 36 months. The effective interest
rate on the capitalized lease obligation is 10.38%. The note balance at March
31, 2005 was $34,257, of which $12,037 was classified under debt maturing
within one year.
10
8. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
March 31, December 31,
(in thousands) 2005 2004
----------------------------------------------------------------------
Salaries, commissions and benefits $257 $167
Accrued deferred financing costs 200 -
Other 152 75
----------------------------------------------------------------------
Accrued expenses and other current liabilities $609 $242
----------------------------------------------------------------------
Refer to Note 6 -- Convertible Debt for information on the nature of
the deferred financing costs. Other accrued expenses include a one-time $68,000
fee for the early termination of the BACC credit facility.
9. RECENTLY ADOPTED 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,". This statement clarifies the accounting
for abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage). It also requires that these items be recognized as
current-period charges regardless of whether they meet the criterion of "so
abnormal". 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 will adopt this
standard in its third quarter of fiscal 2005. The Company has not determined
the impact, if any, that this statement will have on its consolidated financial
position or results of operations.
10. STOCK OPTIONS
The Company applies the disclosure only provisions of Financial
Accounting Standards Board Statement ("SFAS") No. 123, "Accounting for
Stock-based Compensation" ("SFAS 123") and SFAS No. 148, "Accounting for
Stock-based Compensation -- Transition and Disclosure" ("SFAS 148") for
employee stock option and warrant awards. Had compensation cost for the
Company's stock option plan and issued warrants 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 (in thousands except per share amounts):
Three Months Ended
March 31,
--------------------
2005 2004
----------------------------------------------------------------------
Net loss, as reported $(1,032) $(341)
Add: Total stock-based employee
compensation expense determined under
fair value based method for all
awards, net of related tax effects (202) (21)
----------------------------------------------------------------------
Pro forma net loss $(1,234) $(362)
Pro forma net loss per share:
Basic and diluted $ (.37) $ (.11)
----------------------------------------------------------------------
11
The weighted-average fair value of options and warrants granted during
the three months ended March 31, 2005 and 2004 was $.35 and $.56, 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: dividend yield of 0% for 2005 and 2004; expected volatility of 55%
for 2005 and 109% for 2004; average risk-free interest rate of 3.8% for 2005
and 3.02 % for 2004; and an expected option holding period of 3.5 years for
2005 and 4.7 years for 2004.
11. COMMITMENTS AND CONTINGENCIES
Employment agreements:
On January 15, 2005 the Company hired Mr. Alfred G. Stein for the
position of Executive Vice President. From September 13, 2004 to his date of
hire, Mr. Stein was a consultant to the Company, assisting management in the
development of a strategic re-direction of the Company's sales organization and
product offerings, for which he earned $40,000 in consulting fees. Mr. Stein
has an employment agreement expiring December 31, 2007 which includes the
following key provisions: (i) an annual base salary of $175,000, (ii) an annual
bonus of up to 100% of base salary based upon the attainment of a
Board-approved annual business plan which includes revenue and operating profit
targets and (iii) the grant of a five-year warrant to purchase up to 250,000
shares of common stock at an exercise price of $0.67 per share, which was equal
to the closing price of the common stock on the date of hire. The Company is
currently in the process of registering 150,000 of the shares underlying the
warrant, and has agreed to register the remaining 100,000 shares by January 15,
2007.
On March 1, 2005, the Company hired Mr. Nevelle R. Johnson to the
position of Executive Vice President. Mr. Johnson's responsibilities include
management of the Company's national sales organization, as well as the
development of new product and service offerings. 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 the date of hire;
and (iv) payment by the Company of life insurance premiums not exceeding $5,000
per month, provided that the Company attains at least 75% of targeted earnings.
The Company is currently in the process of registering 100,000 of the shares
underlying the warrant, and has agreed to register an additional 100,000 shares
by March 1, 2007 and the remaining 50,000 shares by March 1, 2008;
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.
12. EMPLOYEE BENEFIT PLANS
The components of the net periodic benefit cost included in the
results of operations for the three months ended March 31, 2005 and 2004 are as
follows:
(In thousands) 2005 2004
-----------------------------------------------
Service cost $22 $20
Interest cost 10 9
Recognized actuarial losses 2 2
-----------------------------------------------
Net expense $34 $31
-----------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
The discussions set forth below and elsewhere in this Quarterly Report
on Form 10-Q contain certain statements, based on current expectations,
estimates, forecasts and projections about the industry in which we operate and
management's beliefs and assumptions, which are not historical facts and are
considered forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 ("the Act"). Forward-looking
statements include, without limitation, any
12
statement that may predict, forecast, indicate, or imply future results,
performance, or achievements, and may contain the words "believe," "will be,"
"will continue," "will likely result," "anticipates," "seeks to," "estimates,"
"expects," "intends," "plans," "predicts," "projects," and similar words,
expressions or phrases of similar meaning. Our actual results could differ
materially from those projected in the forward-looking statements as a result
of certain risks, uncertainties and assumptions, which are difficult to
predict. Many of these risks and uncertainties are described under the heading
"Risks, Uncertainties and Other Factors That May Affect Future Results" below.
All forward-looking statements included in this document are based upon
information available to us on the date hereof. We undertake no obligation to
update publicly any forward-looking statements, whether as a result of new
information, future events or otherwise. In addition, other written or oral
statements made or incorporated by reference from time to time by us or our
representatives in this report, other reports, filings with the Securities and
Exchange Commission ("SEC"), press releases, conferences, or otherwise may be
forward-looking statements within the meaning of the Act.
RESULTS OF OPERATIONS
Overview
For the three months ended March 31, 2005, we reported a net loss of
$1,032,000 or $.31 per share on revenues of $2,409,000. This compares with a
net loss of $341,000 or $.10 per share on revenues of $3,406,000 recorded for
the three months ended March 31, 2004. The net loss for 2005 includes (i) a
one-time expenses aggregating $84,000 incurred in connection with the
termination of our credit facility with Business Alliance Capital Corporation;
and (ii) a non-cash derivative instrument expense of $393,000 arising from the
valuation of common stock purchase warrants issued to Laurus in connection with
a three-year convertible revolving credit facility entered into effective March
31, 2006, as more fully described in Note 6 - Convertible Debt. There are
several factors which have contributed to these results. First, there continues
to be intense competition in the market areas that we serve, particularly with
our larger, "Enterprise" customers. This has led to continued sales price
erosion and some loss of market share, particularly in the sale of parts, which
we believe has become more of a commodity and subject to "price shopping" by
customers. Our strategy to diversify our product offerings by selling complete
systems and system upgrades has not yet generated enough incremental revenues
to compensate for the decline in parts sales. Second, we recognize the need for
a larger and more effective sales force, particularly during these times.
Revenue growth is dependent upon a highly trained sales force. Third, we
continue to believe that corporations are still cautious about capital
equipment spending. Although there have been some signs of improvement in our
industry, and we are experiencing increased sales quotation activities, our
overall order flow has been below our expectations.
As further described in our Annual Report on Form 10-K for the year
ended December 31, 2004, we have taken several measures to turnaround our
operating performance. The turnaround strategy is principally based upon
building a larger and more highly qualified sales force, and diversifying our
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, such as
through installation and maintenance services. As a part of the turnaround
plan, we 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 March, we significantly
expanded our sales infrastructure and opportunities, first by the hiring of
twenty three sales and sales support professionals formerly employed by Avaya
Inc., and second by entering into a trial agreement with Avaya to provide
products and services to the SMB ("small-to-medium sized business") market
which commenced in March with the launch of a nationwide SMB sales program. At
the end of March 2005, our direct sales force was 83% larger than in March
2004, and March 2005 revenues were significantly higher than in recent months.
We intend to hire additional sales professionals during 2005 as required to
meet our SMB revenue expectations. In May 2005, the Company formed a
wholly-owned subsidiary named "One IP Voice" which, when operational, will
offer carrier-based hosted IP telephony services along with network services.
Its primary target will be the SMB market.
In order to finance our business expansion plans, effective March 31,
2005 we entered into a $3 million credit arrangement with a new lender,
replacing a $1.7 million credit facility with Business Alliance Capital
Corporation. For additional information on our financial resources, refer to
Note 6 - Convertible Debt, and the "Liquidity and Capital Resources" section
which follows.
Additional information on our results of operations and financial
condition for the three months ended March 31, 2005 follows below.
13
Revenues
Three Months Ended March 31,
----------------------------
(Dollars in thousands) 2005 % 2004 %
-----------------------------------------------------------------
End-user equipment sales $1,875 78 $2,763 81
Equipment sales to resellers 90 4 159 5
-----------------------------------------------------------------
Total equipment sales 1,965 82 2,922 86
-----------------------------------------------------------------
Services 287 12 367 11
Other revenue 157 6 117 3
-----------------------------------------------------------------
Total services and other revenue 444 18 484 14
-----------------------------------------------------------------
Consolidated revenues $2,409 100 $3,406 100
-----------------------------------------------------------------
Equipment Sales
---------------
Equipment Sales. Total equipment sales for the three months ended
March 31, 2005 were $1,965,000, down $957,000 or 33% from the comparable 2004
period. The decrease consisted of declines in both end-user sales and sales to
resellers. 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 2005 have previously been described in the
"Overview" section above. During 2005, we continued a strategy of diversifying
our product offerings by marketing the sale of complete telecommunications
systems to our customer base. In addition, in March 2005, through the
significant expansion of our sales force, we began targeting the SMB
marketplace, which is primarily oriented towards systems sales.
Equipment sales to resellers ("wholesale sales") decreased by $69,000
or 43% from the comparable 2004 period. Wholesale sales have been impacted by
the same factors noted above that have impacted end-user sales.
Services and Other Revenues
---------------------------
Three Months Ended March 31,
----------------------------
(Dollars in thousands) 2005 2004
-----------------------------------------------------
Services:
Installations $258 $331
Rentals and repair 29 36
Other revenues 157 117
-----------------------------------------------------
Services and other revenues $444 $484
-----------------------------------------------------
Service revenues for the three months ended March 31, 2005 were
$287,000, down $80,000 or 22% from the comparable 2004 period. The decrease was
primarily attributable to lower installation revenues, due to the decline in
our parts sales resulting in lower move, add and change billings, and a decline
in systems sales requiring our installation services. 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.
Other revenue for the three months ended March 31, 2005 was $157,000,
up $40,000 or 34% from the comparable 2004 period. The increase was
attributable to higher commissions earned on Avaya maintenance contract sales,
partly offset by lower freight billed to customers on product shipments due to
lower sales volume. In the sale of Avaya maintenance contracts, all of the
equipment service obligations are borne entirely by Avaya.
Cost of Revenues and Gross Profit. Total cost of revenues for the
three months ended March 31, 2005 was $1,655,000, down $874,000 or 35% from the
comparable 2004 period. The gross profit for the three months ended March 31,
2005 was $754,000, down $123,000 or 14% from the comparable 2004 period. As a
percentage of revenue, the overall gross profit margin was 31% for 2005,
compared to 26% 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) excess capacity --
as sales volume falls, overhead costs, consisting primarily of product handling,
purchasing, and facility costs, become a
14
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 three months ended
March 31, 2005, the gross profit margin on equipment sales increased to 33%
from 30% in 2004. The increase was attributable to higher profit margins on
system sales, as the Company increased its sales of smaller, "non-PBX" systems.
This increase was partly offset by a 2 percentage point decrease in end-user
parts margins. The reduced parts 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, the Company was not subject to any license fees payable to
Avaya during 2005 due to that program's termination in June 2004. License fees
expensed in the comparable 2004 period accounted for a 2 percentage point
reduction of the 2004 gross profit margin. We expect continued pressure on our
equipment profit margins going forward, particularly in the sale of parts and
systems to our larger, "Enterprise" customers, due to continuing price
competition in our marketplace.
Gross Profit Margins on Services and Other Revenue. For the three
months ended March 31, 2005, the Company realized an overall 47% profit margin
on its combined service and other revenues, compared to 44% recorded in 2004.
The profit margin on the services component was 30% in 2005 compared to 35% in
2004; the decline being attributable to installation services. This result,
however, was more than offset by an increase in profit margins generated by
other sources of revenue. For the three months ended March 31, 2005, the
Company realized an 80% profit margin on other revenues, compared to 70%
recorded in 2004. This increase was attributable to higher commission revenues
from the sale of Avaya maintenance contracts, which generated a 100% profit
margin.
Other Cost of Revenues. Other cost of revenues consists of product
handling, purchasing and facility costs and expenses. For the three months
ended March 31, 2005, these expenses were 48% lower than 2004, and represented
approximately 5% of 2004 equipment sales revenues, compared to 7% of 2004
equipment sales revenues. The reduction in other cost of revenues primarily
resulted from lower personnel levels as well as lower facility costs and
expenses.
Selling, General and Administrative ("SG&A") Expenses. SG&A expenses
for the three months ended March 31, 2005 were $1,384,000, up $174,000 or 14%
from the comparable 2004 period. SG&A expenses for the three months ended March
31, 2005 were 57% of revenues, compared to 36% of revenues in 2004. Virtually
all of the increase was attributable to increased personnel levels and to
expenses associated with the termination of the BACC credit facility. 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, by March 2005, the Company's direct sales force was increased by 83%
from March 2004. In connection with the replacement of the BACC credit facility
with the Laurus credit facility, the Company incurred in March 2005 one-time
expenses totaling $84,000, which included a $68,000 early termination fee, and
the write-off of the remaining balance of its annual loan commitment fee with
BACC.
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 revenues by the end of 2005.
Other Income (Expense). Other income (expense) for the three months
ended March 31, 2005 was $(398,000), compared with $(5,000) for 2004. The
principal components of other income (expense) are as follows.
Interest expense. Interest expense on the principal balance of
outstanding borrowings for the three months ended March 31, 2005 was $8,000,
compared with $6,000 for 2004. The increase in interest expense was
attributable to higher borrowing levels and interest rates.
Derivative instrument expense. The Company recorded expense of
$393,000 during the three months ended March 31, 2005 from its derivative
instrument liability arising from the issuance of common stock purchase
warrants to Laurus. The current period charge resulted from an increase in the
calculated fair market value of the warrants due to an increase in the market
value of the Company's stock from that used in the initial valuation. The
Company is required to record "mark-to-market" adjustments to the value of its
derivative liabilities at the end of each reporting period. These
"mark-to-market" adjustments are non-cash, with no impact on liquidity. Refer
to Notes 1 and 6 in the Notes to Consolidated Financial Statements contained
herein for further discussion of the nature of the derivative financial
instruments and the Company's accounting policies.
Other income. Other income for both periods presented consisted of
interest earned on invested cash.
15
Provision for Income Taxes. The provision for income taxes represents
estimated minimum state taxes in all reported periods. We maintain a full
valuation allowance against our net deferred tax assets, which consist
primarily of net operating loss and capital loss carryforwards, and timing
differences between the book and tax treatment of inventory and other asset
valuations. Realization of these net deferred tax assets is dependent upon our
ability to generate future taxable income.
LIQUIDITY AND CAPITAL RESOURCES
Working capital, defined as current assets less current liabilities,
was $1,320,000 at March 31, 2005, a decrease of $816,000 or 38% from $2,136,000
at December 31, 2004. The working capital ratio was 1.5 to 1 at March 31, 2005,
compared to 2.4 to 1 at December 31, 2004. Operating activities provided
$303,000 during 2005, compared to the use of $773,000 in the comparable 2004
period. Net cash provided by operating activities in 2005 consisted of a net
loss of $1,032,000 less non-cash items of $469,000, and net cash generated by
changes in operating assets and liabilities of $866,000. Net cash generated by
changes in operating assets and liabilities was primarily attributable to an
increase in accounts payable and accrued expenses, as we lengthened our vendor
payment cycles in response to reduced availability under our credit facility
with Business Alliance Capital Corporation ("BACC") and lower sales than
anticipated during January and February 2005.
Investing activities used $3,000 during 2005, compared to $12,000 in
2004. Net cash used by investing activities in 2005 and 2004 consisted of
capital expenditures. Capital expenditure requirements during the quarter ended
March 31, 2005 were principally for computer equipment to support our expanded
personnel levels, which were largely financed through capital leases. There are
currently no material commitments for capital expenditures, although we will
continue to purchase computer equipment as we continue the expansion of our
sales force. 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 used $270,000 during 2005 principally from net
repayments under our revolving credit facility and from financing costs
incurred in connection with the new Laurus credit facility. On March 31, 2005,
we terminated our $1.7 million revolving credit facility with BACC, repaying
the outstanding balance on April 1, 2005. The average and highest amounts
borrowed under the BACC facility during the three months year ended March 31,
2005 were approximately $223,000 and $447,000, respectively. On March 31, 2005,
we entered into a financing transaction with Laurus, providing for a
three-year, $3 million revolving loan credit facility. Our borrowing formulas
with Laurus are less restrictive than the formulas provided under the BACC
agreement, and they provided us with a calculated initial availability of
approximately $950,000 after the April 4, 2005 funding of the initial $500,000
minimum borrowing note. Refer to Note 6 - Convertible Debt, for further
information on the principal terms and conditions of this financing
transaction.
Our ability to provide cash to satisfy working capital requirements
continues to be dependent upon generating positive cash flow from operations
and upon formula borrowings under our revolving credit facility. Historically,
our working capital borrowings have increased during periods of revenue growth.
This is because our cash receipts cycle is longer than our cash disbursements
cycle. As our revenues from systems sales increases, as management expects, the
cash receipts cycle may lengthen, unless we can consistently negotiate up-front
deposits and progress payments under our systems sales contracts. No assurances
can be given that we will have sufficient cash resources to finance all of our
future growth plans, and it may become necessary to seek additional financing
sources for such purposes. In order to obtain additional financing, we may
first need to demonstrate improved operating performance.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion included in Item 7 of our Annual Report on Form 10-K
for the year ended December 31, 2004 under the subheading "Critical Accounting
Policies and Estimates" is still considered current and applicable, and is
hereby incorporated into this Quarterly Report on Form 10-Q.
RISKS, UNCERTAINTIES AND OTHER FACTORS THAT MAY AFFECT FUTURE RESULTS
The discussion included in Item 7 of our Annual Report on Form 10-K
for the year ended December 31, 2004 under the subheading "Risks, Uncertainties
and Other Factors That May Affect Future Results" is still considered current
and applicable, and is hereby incorporated into this Quarterly Report on Form
10-Q.
16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The discussion included in Item 7A of our Annual Report on Form 10-K for the
year ended December 31, 2004, "Quantitative and Qualitative Disclosures About
Market Risk", is still considered current and applicable, and is hereby
incorporated into this Quarterly Report on Form 10-Q.
ITEM 4. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures. We maintain
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"))
that are designed to ensure that information required to be disclosed in our
reports filed under the Exchange Act, is recorded, processed, summarized and
reported within the time periods specified in the Security and Exchange
Commission's rules and forms, and that such information is accumulated and
communicated to our management, including our Chief (principal) Executive
Officer and Chief (principal) Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and
management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures.
An evaluation was conducted by our Chief Executive Officer and Chief
Financial Officer of the effectiveness of the Company's disclosure controls and
procedures as of the end of the period covered by this report. Based on that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective to ensure that
information required to be disclosed in our reports filed under the Exchange
Act, is recorded, processed, summarized and reported within the time periods
specified in the Security and Exchange Commission's rules and forms.
(b) Changes in Internal Controls. There have been no changes in our
internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) during the most recently completed fiscal
quarter that materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
PART II. OTHER INFORMATION.
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Refer to the Company's Current Report on Form 8-K filed April 5, 2005.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS:
The following documents are filed as Exhibits to this Quarterly Report
on Form 10-Q:
31.1 Certification of the Chief Executive Officer, pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer, pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer, pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer, pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: May 12, 2006 FARMSTEAD TELEPHONE GROUP, INC.
/s/ Jean-Marc Stiegemeier
-------------------------------------
Jean-Marc Stiegemeier
Chief Executive Officer & President
Dated: May 12, 2006 /s/ Robert G. LaVigne
-------------------------------------
Robert G. LaVigne
Executive Vice President, Chief Financial Officer
18