not good but liveable:
August 13, 1997
FARMSTEAD TELEPHONE GROUP INC (FTG)
Quarterly Report (SEC form 10QSB)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations Net Loss The Company recorded a net loss of $835,000 for the three months ended June 30, 1997, as compared to net income of $202,000 for the comparable 1996 period. The decline in earnings was attributable to several factors. Due to the unprofitable operations of the Company's foreign affiliates, ATC and TeleSolutions, the Company established a full valuation reserve in the current period against all associated assets, including inventory located overseas. The combination of these operating losses and one-time, non-cash asset write-downs negatively impacted operating results by approximately $411,000. The net loss for the current period was also attributable to the unprofitable operations of the Cobotyx voice processing products division and Farmstead Asset Management Services, LLC ("FAMS"), due to lower revenues from the comparable prior year period. In addition, the Company recorded approximately $310,000 more income in 1996 from the AT&T coupon rebate program than it did in 1997. This rebate program ended effective May 31, 1997. The Company recorded a net loss of $1,215,000 for the six months ended June 30, 1997, as compared to net income of $534,000 for the comparable 1996 period. The combination of the operating losses of the foreign affiliates and the above mentioned asset write-downs negatively impacted year to date operating results by approximately $444,000. The net loss for the current six month period was also attributable to the unprofitable operations of the Cobotyx voice processing products division and FAMS, due to lower revenues from the comparable prior year period. In addition, the Company recorded approximately $600,000 more income in 1996 from the AT&T coupon rebate program than it did in 1997. Revenues Revenues for the three months ended June 30, 1997 were $6,062,000, an increase of $1,414,000 or 30% from the comparable 1996 period. The increase was attributable to the Company's telephone equipment products and services, which were up by 44% over the comparable prior year period, due to sales of new products under the Company's Platinum Dealer Program with Lucent Technologies, increased secondary market equipment sales, and increased service revenues. Voice processing product revenues decreased by 14% from the comparable prior year period as a result of lower dealer and international sales. Revenues from FAMS decreased by 46% from the comparable prior year period due to lower consignment sales revenue. Revenues from telephone equipment sales and services accounted for 90% of consolidated revenues for the three months ended June 30, 1997 (81% in the comparable 1996 period), while revenues from voice processing product sales and services accounted for 6% of consolidated revenues in 1997 (10% in 1996). FAMS accounted for 4% of consolidated second quarter 1997 revenues (9% in the comparable 1996 period). Revenues for the six months ended June 30, 1997 were $11,164,000, an increase of $2,394,000 or 27% from the comparable 1996 period. The increase was attributable to the Company's telephone equipment products and services, which were up by 37% over the comparable prior year period, due to sales of new products under the Company's Platinum Dealer Program with Lucent Technologies, increased secondary market equipment sales, and increased service revenues. Voice processing product revenues decreased by 26% from the comparable prior year period as a result of lower dealer and international sales. Revenues from FAMS decreased by 2% from the comparable prior year period due to lower consignment sales revenue. Revenues from telephone equipment sales and services accounted for 89% of consolidated revenues for the six months ended June 30, 1997 (82% in the comparable 1996 period), while revenues from voice processing product sales and services accounted for 7% of consolidated revenues in 1997 (13% in 1996). Revenues from FAMS, which commenced operations at the end of February 1996, accounted for 4% of consolidated year to date 1997 revenues (5% in the comparable 1996 period). Cost of Revenues and Gross Profit Cost of revenues for the three months ended June 30, 1997 were $4,644,000, an increase of $1,475,000 or 47% from the comparable 1996 period. The gross profit margin was 23% of revenues during 1997, as compared to 32% of revenues for the comparable 1996 period. The decrease was attributable principally to (i) product sales mix, particularly increased sales of new equipment to end users and to the Company's associate dealers at lower profit margins than the Company realizes from sales of secondary market equipment, (ii) lower profit margins on service revenues and (iii) lower product purchase rebates earned from the utilization of AT&T coupons during the current period, which accounted for 5 percentage points of the difference in gross profit margin between the two periods. Cost of revenues for the six months ended June 30, 1997 were $8,395,000, an increase of $2,310,000 or 38% from the comparable 1996 period. The gross profit margin was 25% of revenues during 1997, as compared to 31% of revenues for the comparable 1996 period. The decrease was attributable principally to (i) product sales mix, particularly increased sales of new equipment to end users and to the Company's associate dealers at lower profit margins than the Company realizes from sales of secondary market equipment, (ii) lower profit margins on service revenues and (iii) lower product purchase rebates earned from the utilization of AT&T coupons during the period, which accounted for 4 percentage points of the difference in gross profit margin between the two periods. On May 31, 1997, the AT&T coupon redemption program expired, however this will not have a material effect on future profit margins. The Company is not currently aware of any other market conditions which would cause gross profit margins to significantly fluctuate from current levels. Operating Expenses Operating expenses were 30% and 29% respectively, of revenues for the three months ended June 30, 1997 and 1996. Operating expenses were 31% and 28% respectively, of revenues for the six months ended June 30, 1997 and 1996. Selling, general & administrative ("SG&A") expenses for the three months ended June 30, 1997 were $1,757,000, an increase of $415,000 or 31% over the comparable 1996 period. SG&A expenses for the six months ended June 30, 1997 were $3,414,000, an increase of $987,000 or 41% over the comparable 1996 period. SG&A expense was 29% of revenues for both the three months ended June 30, 1997 and 1996, and was 31% and 28% respectively, of revenues in the six month periods ended June 30, 1997 and 1996. The increase in SG&A dollars was principally attributable to (i) higher levels of employment and associated employee costs, as the Company increased its sales, customer and technical support capabilities in connection with becoming a dealer and distributor for new Lucent products, and began developing a network of associate dealers, and (ii) higher facility occupancy costs, including increased depreciation expense from fixed assets acquired in connection with the Company's relocation to its new headquarters in East Hartford, Connecticut. Other Income and Expenses Other income for the three and six months ended June 30, 1997 was $20,000 and $57,000, respectively, as compared to $132,000 and $424,000 for the respective three and six month periods ended June 30, 1996. Other income in the current year periods consisted principally of interest earned on the Company's invested cash. Included in other income for the three and six months ended June 30, 1996 was $130,000 and $410,000, respectively of rebates from AT&T under a coupon redemption program. Liquidity and Capital Resources Working capital at June 30, 1997 was $7,585,000, a 10% increase from the $6,898,000 of working capital at December 31, 1996. The working capital ratio at June 30, 1997 was approximately 3.4 to 1 as compared to 2.4 to 1 at December 31, 1996. The increase in working capital was attributable to the reclassification to long-term liabilities from current liabilities of the Company's borrowings under its revolving credit facility which, in May 1997, was replaced with a two year loan agreement. Operating activities used $1,892,000 during the six months ended June 30, 1997, principally from an $887,000 increase in accounts receivable, a $346,000 increase in inventories, and as a result of the operating loss for the period. Investing activities used $150,000 during the six months ended June 30, 1997, principally in the purchase of property and equipment. During the current period, the Company purchased approximately $644,000 of office furniture and equipment, computer equipment, and leasehold improvements, principally in conjunction with the Company's relocation to its new headquarters in East Hartford, Connecticut. In May 1997, the Company entered into a five year, noncancelable lease agreement for the financing of $419,000 of these purchases. Under the lease agreement, which is being accounted for as a capital lease, monthly lease payments are $9,589, with a $1.00 buyout option at the end of the lease. Financing activities generated $345,000 during the six months ended June 30, 1997, principally from $322,000 of advances under an inventory finance agreement. On June 6, 1997, the Company entered into a $2 million line of credit agreement with AT&T Commercial Finance Corporation ("AT&T-CFC") which expires April 30, 1998. The credit line is used to finance the acquisition of inventory manufactured by Lucent Technologies, Inc. ("Lucent"), and borrowings are secured by all of the Company's inventories. Under the terms of this agreement, advances to finance products purchased directly from Lucent are repayable, interest-free, in either two or three equal monthly installments, depending upon the product purchased. Advances to finance Lucent products purchased from other vendors ("Other Eligible Inventory") are repayable in two equal monthly installments, bear interest at prime plus 1.5%, and are subject to a $500,000 borrowing limit. For products purchased directly from Lucent the ratio of total collateral available to AT&T-CFC after deduction of any senior liens, to total AT&T-CFC indebtedness must be at least 1.5 to 1. The ratio of Other Eligible Inventory to advances on Other Eligible Inventory must be at least 2 to 1. As of June 30, 1997, the Company's borrowings under this credit arrangement were $322,000. Effective May 30, 1997, the Company entered into a two year, $3.5 million revolving loan facility with First Union Bank of Connecticut ("First Union"), modifying and replacing its previous one year, $2.5 million facility with First Union. Under the new facility, borrowings are advanced at 80% of eligible accounts receivable, bear interest at First Union prime plus .5% (9% at June 30, 1997), and are secured by all of the Company's assets excluding inventories. The new loan agreement contains requirements as to a minimum amount of net worth, and maintenance of debt to net worth and debt service coverage ratios, all of which the Company is in compliance. In addition, the agreement restricts fixed asset purchases and does not allow the payment of cash dividends without the consent of the lender. There is no requirement to maintain compensating balances under the agreement. As of June 30, 1997, the unused portion of the credit facility was $1,559,000, of which approximately $523,000 was available under the borrowing formula. The average and highest amounts borrowed under these credit facilities during the six months ended June 30, 1997 were $1,655,000 and $2,282,000, respectively. Borrowing are dependent upon the continuing generation of collateral, subject to the credit limit. The Company believes that it has sufficient capital resources, in the form of cash and availability under its credit facilities, to satisfy its present working capital requirements.
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