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Farmstead Telephone Group
Farmstead Telephone Group, Inc.
Farmstead Telephone Group, Inc. has been a publicly owned company since 1987 and trades on the American Stock Exchange under the symbol "FTG." We are engaged in the Customer Premise Equipment segment of the telecommunications industry as a reseller of new and refurbished Lucent Technologies business telephone parts and systems. We also provide telecommunications equipment installation, repair, refurbishing, short-term rental, inventory management, and other value added services. In both 1996 and 1997, we received Lucent's top customer satisfaction honors. We sell our products and services primarily to corporate end users, and since inception have provided over $80 million of equipment and services to over 5,000 customers across the U.S.
Our Mission:
" ... to be the premier reseller in the U.S. of Lucent Technologies' new, remanufactured and refurbished business communications products and services."
Farmstead has always enjoyed a close and mutually profitable relationship first with AT&T and, since 1995, with newly-formed Lucent Technologies Inc. (formerly the communications equipment business unit of AT&T). Farmstead and Lucent have joined forces in several areas to bring high-quality communications products and services to the global business community.
Supplier of Lucent Technologies Business Communications Products
At the inception of the secondary market industry in 1985, Farmstead became one of the first companies in the United States to be appointed an Authorized Secondary Market Dealer by AT&T. Following AT&T's 1995 restructuring, Farmstead has enjoyed an ever expanding role with Lucent Technologies.
Classic Lucent is used equipment, purchased by Farmstead from Lucent, leasing companies and end users; refurbished to specific Lucent quality standards; then resold throughout the U.S. to our extensive end user customer base. Classic Lucent equipment is eligible for installation by Lucent technicians at standard costs and can be included on Lucent maintenance contracts. It also is warranted by Lucent or Farmstead for a full year.
Following is a listing of the Company's officers and directors, including a brief listing of their principal occupation for at least the past five years and other major affiliations as of January 1, 1999.
Officers:
George J. Taylor, Jr. , Chairman of the Board of Directors and Chief Executive Officer of the Company (including its predecessors) since 1984, and President since 1989. Member of the Compensation Committee of the Board of Directors until February 24, 1998. Director of the Company's affiliate, Beijing Antai Communication Equipment Company, Ltd. ("ATC"). President of Lease Solutions, Inc. (formerly Farmstead Leasing, Inc.) from 1981 to 1993. Vice President - Marketing and Sales for National Telephone Company from 1977 to 1981. Mr. Taylor, Jr. was one of the founders of the National Association of Telecommunication Dealers, has been a member of, or advisor to, its Board of Directors since its inception in 1986, and for two years served as its President and Chairman. Brother of Mr. Hugh M. Taylor.
Robert G. LaVigne, Director of the Company since 1988. Executive Vice President since July 1997. Chief Financial Officer, Corporate Secretary and Treasurer since 1988. Vice President-Finance & Administration from 1988 until July 1997. General Manager of the domestic telephone equipment division from January 1994 until October 1994. Controller of Economy Electric Supply, Inc., a distributor of electrical supplies and fixtures, from 1985 to 1988. Corporate Controller of Hi-G, Inc., a manufacturer of electronic and electromechanical components, from 1982 to 1985. Certified Public Accountant. Director of
ATC.
Alexander E. Capo, Vice President - Sales since July 1997. Vice President - Sales & Marketing from 1987 until July 1997. Director of Sales for The Farmstead Group, Inc. from 1985 to 1987. Sales Manager for the National Telephone Company from 1972 to 1983.
Joseph A. Novak, Jr., Vice President - Operations since 1993. General Manager of Farmstead Asset Management Services, LLC from 1996 to 1997. Prior to 1990, he was employed by AT&T for 28 years, serving in various operational and sales management capacities. Vice General Manager and a Director of
ATC.
Neil R. Sullivan, Vice President - Accounting & Administration since July 1997. Vice President and General Manager of the domestic telephone equipment division from August 1996 to July 1997. Corporate Controller from October 1994 to August 1996. Assistant Corporate Secretary since 1994. From 1981 to 1994 he was employed by Zero Corporation ("Zero"), a manufacturer of cabinets, cooling equipment and containers for the electronics industry. Mr. Sullivan was Controller of various divisions of Zero from 1981 to 1991, and was Vice President/General Manager of the Zero-East division from 1991 to 1994.
Robert L. Saelens, Vice President - Marketing since June 1997. Director of Marketing from May 1996 through May 1997. President of Saelens & Associates, a marketing consulting firm, from 1989 to 1997. President of Baker, Bateson &
Saelens, Inc., a marketing consulting firm, from 1982 to 1989. Prior thereto, Mr. Saelens served for ten years in the Creative and Strategic planning departments of the J. Walter Thompson Corporation.
Outside Directors:
Harold L. Hansen, Director of the Company since 1992. An independent management consultant since January 1997. Chairman of the Audit Committee, member of 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 1983 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.
Hugh M. Taylor, Director of the Company since 1993. A member of the Audit and Compensation Committees. Managing Director of Newbury, Piret & Co., 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 to1994. 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.
Joseph J. Kelley, Director of the Company since April 1995. Chairman of the Compensation Committee and a member of the Audit Committee. President of East Haven Associates of Wellesley, in Wellesley, Massachusetts, from 1995 to the present. This company provides executive and technical support for European and Asian based communication companies seeking to expand market share in the U.S., as well as for U.S. companies seeking to expand internationally. 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.
The Company is principally engaged as
(i) a secondary market reseller, and authorized Lucent Dealer of remanufactured and refurbished Lucent Technologies, Inc. ("Lucent") telecommunications parts and systems, and (ii) as an authorized Lucent dealer for certain new telecommunications products. These Lucent products are primarily customer premises-based private switching systems and peripheral products, including voice processing systems. The Company also provides telecommunications equipment repair and refurbishing, rental, inventory management, and related value-added services. The Company sells its products and services primarily to both large and small end-user businesses, government agencies, and other secondary market dealers.
The Company operates in a highly competitive marketplace. Telephone equipment product competitors currently include Lucent and other new equipment manufacturers such as Northern Telecom Limited, other new equipment distributors, as well as other secondary market equipment resellers, of which the Company estimates there are over 100 nationwide. In the sale of Classic Lucent products, the Company competes with the other Lucent-designated ARS Dealers. The Company believes that key competitive factors in its market are timeliness of delivery, service support, price and product reliability. The Company also considers its working relationships with its customers to be an important and integral competitive factor. The Company anticipates intensified competition from larger companies having substantially greater technical, financial and marketing resources, as well as larger customer bases and name recognition than the Company. As the industry further develops CTI ("Computer Telephony Integration" - the actual hardware and
software that attaches to both telephone systems and computers) products, the Company anticipates that it will encounter a broader variety of competitors, including new entrants from related computer and communication industries.
- Management Discussion and Analysis
Revenues
Revenues from continuing operations for the three months ended September 30, 1999 were $10,177,000, an increase of $1,171,000 or 13% from $9,006,000 recorded in the comparable 1998 period. End user equipment sales revenues increased by 41% over the prior year period due to expansion of the Company's remote sales offices, increased sales to Lucent Technologies and to the start up of a call center operation. The end user revenue gains were partially offset by the discontinuance of the Company's dealer channel at the end of February 1999. As a part of its agreement with Lucent in becoming an Authorized Remarketing Supplier of Classic
Lucent(TM) telephone equipment ("ARS"), the Company transferred its new key system dealer base to another Lucent distributor. Revenues from this channel amounted to $1,016,000 ( 11% of revenues) for the three months ended September 30, 1998. Service revenues were 61% lower than in the comparable 1998 period primarily due to decreases in short-term equipment rentals,
installation and other services. Equipment sales revenues comprised 96% of consolidated revenues from continuing operations for the three months ended September 30, 1999 (88% in the comparable 1998 period), while service revenues accounted for 4% of consolidated revenues from continuing operations in 1999 (12% in 1998).
Revenues from continuing operations for the nine months ended September 30, 1999 were $23,623,000, an increase of $1,864,000 or 8.5% from $21,759,000 recorded in the comparable 1998 period. End user equipment sales revenues increased by 21% over the prior year period due to expansion of the Company's remote sales offices, increased sales to Lucent Technologies and to the start up of a call center operation. The end user revenue gains were partially offset by the discontinuance of the Company's dealer channel as noted above. Revenues from the dealer channel amounted to $476,000 for the current nine-month period, as compared to $2,211,000 in 1998. Service revenues were 13% lower than in the comparable 1998 period primarily due to decreases in short-term equipment rentals, installation and other services. Equipment sales revenues comprised 94% of consolidated revenues from continuing operations for the nine months ended September 30, 1999 (92% in the comparable 1998 period), while service revenues accounted
for 6% of consolidated revenues from continuing operations in 1999 (8% in 1998).
Gross Profit
The gross profit from continuing operations for the three months ended September 30, 1999 was $2,401,000, an increase of $78,000 or 3% over the $2,323,000 recorded in the comparable prior year period. The gross profit margin was approximately 24% of revenues in the current three-month period as compared to approximately 26% in the comparable prior year period. The gross profit from continuing operations for the nine months ended September 30, 1999 was $5,706,000, an increase of $200,000 or 3.6% over the $5,506,000 recorded in the comparable prior year period. The gross profit margin was approximately 24% of revenues in the current nine-month period as compared to approximately 25% in the comparable prior year period.
In both the current year three and nine month periods, the Company recorded higher gross profit margins on equipment sales revenues, due principally to equipment sold through the new call center and the discontinuance of the low margin dealer sales channel. However, license fees paid in the 1999 period to Lucent for ARS program and call center equipment sales, and higher labor and other overhead costs had the effect of reducing the overall gross profit margin from the prior year level. The higher labor and overhead costs were primarily attributable to the third quarter 1999 start up of a separate equipment repair and refurbishing operation in connection with a contract to repair certain telephone equipment for Lucent, and in connection with the current ARS program.
Selling, General and Administrative ("SG&A") Expenses
SG&A expenses from continuing operations for the three months ended September 30, 1999 were $1,888,000, an increase of $101,000 or 6% over the comparable 1998 period. SG&A expenses were 19% of revenues in the current period as compared to 20% of revenues in the comparable 1998 period. SG&A expenses from continuing operations for the nine months ended September 30, 1999 were $5,073,000, an increase of $407,000 or 9% over the comparable 1998 period. SG&A expenses were 21% of revenues in both the current and prior year nine-month periods.
In both the current year three and nine month periods, the increase in SG&A expenses was primarily attributable to increased sales and sales support personnel, and associated compensation and travel expenses, as the Company opened additional sales offices and started up a call center sales operation. Higher employment levels overall from a year ago have also resulted in increased insurance expense, office expense, depreciation on computer and office equipment, and higher telephone expense. These additional expenses were partially offset by reduced marketing expenses due to the availability of co-op advertising programs sponsored by Lucent, and in 1998 the Company recorded an $80,000 charge to reduce the carrying value of a note receivable from
FAMS, LLC.
Interest Expense and Other Income
Interest expense for the three months ended September 30, 1999 was $91,000, as compared to $80,000 for the comparable 1998 period. Interest expense for the nine months ended September 30, 1999 was $219,000, as compared to $192,000 for the comparable 1998 period. The increase in each period was attributable to higher average borrowings under the Company's credit facilities.
Other income for the nine months ended September 30, 1999 was $27,000, as compared to $58,000 for the comparable 1998 period. Other income in each period consisted principally of interest earned on invested cash, and has declined from the prior year due to a lower invested cash balance.
(Benefit) Provision for Income Taxes
The $6,000 income tax benefit recorded for the nine months ended September 30, 1999 reflected a $19,000 credit arising from the overpayment of prior year state taxes.
Liquidity and Capital Resources
Working capital at September 30, 1999 was $10,468,000, a 42% increase from $7,399,000 at December 31, 1998. The working capital ratio was 3.0 to 1 at September 30, 1999, as compared with 2.4 to 1 at December 31, 1998. The working capital improvement was primarily due to an increase in accounts receivable attributable to higher sales volume, and to an increase in inventories.
Operating activities used $1,108,000 during the nine months ended September 30, 1999 principally due to an increase in accounts receivable and inventories only partially offset by an increase in accounts payable.
Investing activities used $146,000 during the nine months ended September 30, 1999 from the purchase of fixed assets, principally computer equipment.
Financing activities provided $1,001,000 during the nine months ended September 30, 1999, principally from increased borrowings under the Company's credit facilities. On June 14, 1999, the Company entered into a two-year, $10 million business financing agreement (the "Credit Agreement") with
DFS, replacing a $6 million revolving credit line with First Union National Bank and a $4 million inventory credit line with
Finova. The Credit Agreement contains the following credit sublimits: (i) a $10 million accounts receivable-based credit line, (ii) a $10 million inventory floorplan credit line to finance products purchased directly from Lucent or an approved Lucent distributor, and (iii) a $1.5 million supplemental inventory-based credit line. Borrowings under the accounts receivable line are advanced at 80% of eligible receivables (primarily receivables that are less than 90 days old), while borrowings under the supplemental inventory-based line are advanced at 50% of the cost of eligible refurbished
inventory, and between 50-100% of the cost of new equipment purchased from Lucent or an approved Lucent distributor through DFS's floorplan financing program. These borrowings are at prime plus 1/2% (8.75% at September 30, 1999). Borrowings under the $10 million inventory-based credit line, which totaled $1,508,000 at September 30, 1999, are repayable, interest-free in either two or three equal monthly installments depending upon the product purchased. The facility calls for a commitment fee, payable annually, of .09% of the aggregate credit line. Since it is the Company's intent to maintain the DFS facility for longer than one year, borrowings are classified as long-term debt, except for borrowings under the inventory floorplan portion of the credit line which are classified as current.
The Credit Agreement restricts the Company from the payment of dividends without the consent of
DFS, and requires the Company to maintain a minimum tangible net worth of $5.5 million through December 30, 1999 and $5.75 million thereafter. The Credit Agreement also contains covenants requiring the Company to maintain certain debt-to-equity, interest coverage and current asset ratios, and minimum profitability levels, all of which the Company was in compliance with at September 30, 1999. As of September 30, 1999, the unused portion of the DFS facility aggregated approximately $4.2 million, of which approximately $2.04 million was available under various borrowing formulas. Borrowings are dependent upon the continuing generation of collateral, subject to the aggregate $10 million credit limit. The weighted average interest rate on the Company's credit facilities (excluding floorplan borrowings repayable under interest-free installments) was approximately 9% and 8.5% for the three and nine months ended
September 30, 1999, respectively.
The Company believes that it has sufficient capital resources, in the form of cash and available credit lines, to satisfy its current working capital requirements. The Company does not have any material commitments for capital expenditures.
The Company primarily sells remanufactured, refurbished (by the Company or other equipment
refurbishers) and new telecommunications parts and systems manufactured by Lucent (See "Relationship with Lucent Technologies" for further information on Lucent). These products are primarily private switching systems, generally PBXs and key systems, located at the customers premises, that permit a number of local telephones or terminals to communicate with one another, with or without use of the public telephone network. Key systems are generally used by small businesses, and are characterized by telephones which have multiple buttons permitting the user to select outgoing or incoming telephone lines directly. PBXs are private telephone switching systems usually located on a customer's premises, with an attendant console, and are designed for use by larger businesses. A PBX normally has more memory capacity and therefore can provide more features and flexibility than a key system. The Company sells both telecommunication
system parts and complete systems, however the Company's revenues are predominantly from the sale of parts. Parts sold include both digital and analog telephone sets and circuit packs, and other system accessories and related products such as headsets, consoles, speakerphones, paging systems and voice processing products offered by Lucent. Lucent key systems sold by the Company, in both piece parts and complete systems, include:
Merlin(R) and Merlin Legend(R), Spirit(R) and Partner(R). Lucent PBX equipment sold by the Company, primarily in parts, include
Definity(R), System 75 and System 85. Equipment sales revenues accounted for approximately 94% of consolidated revenues from continuing operations in 1998 (93% in 1997), while service revenues comprised 6% of consolidated revenues from continuing operations in 1998 (7% in 1997). Sales of PBX equipment and associated telephones and peripherals comprised approximately 81% of equipment sales in 1998 (85% in 1997), while key equipment and other equipment sales comprised 19% (15% in 1997).
Relationship with Lucent Technologies Prior to February 1, 1996, the business of Lucent was conducted as a part of the operations of AT&T Corp. ("AT&T"). On February 1, 1996, as a result of a decision to restructure the company, AT&T began the process of separating Lucent into a stand-alone company. AT&T completed an IPO of Lucent shares in April 1996 and the divestiture of Lucent was completed in October 1996 through the distribution of AT&T's shares in Lucent to AT&T shareholders. Lucent is comprised of the systems and technology units that were formerly part of AT&T. With 1998 consolidated revenues of $30.1 billion, Lucent is one of the world's leading designers, developers and manufacturers of telecommunications systems, software and products. Throughout this report, references to AT&T and Lucent will be referred to collectively as "Lucent Technologies" or "Lucent." Since 1985, Lucent has provided support to the secondary market by continuing to offer installation, maintenance,
repair, reconditioning and certification services for its products purchased by end-users through equipment resellers. Equipment resellers such as the Company may also, with various restrictions, utilize Lucent documentation, technical information and software. Lucent also generally provides up to a one-year warranty for products purchased from Lucent for resale. The installation and maintenance of Lucent equipment is generally provided by Lucent. The Company does, however, coordinate the installation scheduling directly with Lucent if requested to do so by its customer. The Company also has agreements with a number of installation and maintenance companies covering the New England and New York geographic areas who can also provide such services. Since February 1998, the Company has been operating under a Lucent- sponsored "Authorized Remarketing Supplier" ("ARS") program as an ARS Dealer, licensed under a three-year contract entered into in December 1998 (the "ARS Agreement") to sell "Classic
Lucent(TM)"
products to end users nationwide. Classic Lucent products are defined as used Lucent key system and PBX system parts, currently supported by Lucent, that have been refurbished by the Company under Lucent quality standards. This designation applies to substantially all of the used Lucent products which the Company now sells. The Company is currently one of four companies authorized to participate in this program. No company has been designated an exclusive sales territory.
The Company is committed to respond to its customers' service or project-oriented telecommunications needs. While each type of service is not material to the Company's operations as a whole, the Company believes they help differentiate the Company from its competitors, as well as contribute to longer-lasting customer relationships and incremental equipment sales. The Company provides the following services: Repair and Refurbishing: The Company performs fee-based repair and refurbishing services for its customers through its in-house facilities and use of subcontract repair shops. The in-house work includes cleaning, buffing and minor repairs. The Company out sources major repairs of circuit boards and digital telephone sets. Inventory Management: The Company provides inventory storage, accounting, and distribution services, acting as a centralized depot for its customers' idle telecommunications equipment. Equipment Rentals: The Company rents out equipment on a month-to- month basis, servicing those customers that have
temporary, short-term equipment needs. Other Services: The Company's technical staff currently provide engineering, configuration, technical "hot line" telephone support and limited on-site installation services. For customers in the television broadcast industry the Company provides telecommunications coordination services for broadcast sports and other events throughout the country. The Company's combined service revenues accounted for 6% of revenues from continuing operations in 1998 and 7% in 1997. No individual service category accounted for more than 5% of revenues from continuing operations.
No patent or trademark is considered material to the Company's continuing operations. Pursuant to agreements in effect with Lucent, the Company may utilize, during the term of these agreements, certain Lucent designated trademarks, insignia and symbols in the Company's advertising and promotion of Lucent products.
Corporate Headquarters:
Farmstead Telephone Group, Inc. is traded on the American Stock Exchange under the symbol "FTG."
22 Prestige Park Circle
East Hartford, CT 06108
Phone: 860.610.6000
Fax: 860.610.6001
1/31/00
Forward-Looking Statements
The Company's prospects are subject to certain uncertainties and risks. The discussions set forth in this Form 10-QSB contain certain statements which are not historical facts and are considered forward-looking statements within the meaning of the Federal Securities Laws. The Company's actual results could differ materially from those projected in the forward-looking statements as a result of, among other factors, general economic conditions, growth in the telecommunications industry, competitive factors and their effect on pricing, changes in product mix and product demand, dependence on third party suppliers, and other risk factors detailed in this report, described from time to time in the Company's other Securities and Exchange Commission filings, or discussed in the Company's press releases. In addition, other written or oral statements that constitute forward-looking statements may be made by or on behalf of the Company. All forward-looking statements included in this document are based upon
information available to the Company as of the date of this filing. The Company is under no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
This report was written by
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Company, within the meaning of Section 27A of the Securities Act of 1933 and Sections 21E of the Securities
Exchange Act of 1934, and are subject to the safe harbor created by these sections. Actual results may differ
materially from the Company's expectations and estimates.
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