U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(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, 2004
|_| Transition report under Section 13 or 15(d) of the Exchange Act of 1934
For the transition period from __________ to __________
Commission file number 1-9224
CNE GROUP, INC.
(Exact Name of Small Business Issuer as Specified in Its Charter)
DELAWARE 56-2346563
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
200 West 57th Street, Suite 507, New York, N.Y. 10019
(Address of Principal Executive Offices)
212-977-2200
(Issuer's Telephone Number, Including Area Code)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 |_|
The number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
Class Outstanding at April 30, 2004
----- -----------------------------
Common stock - par value $.00001 10,640,915 shares
PART I
FINANCIAL INFORMATION
Item l. Financial Statements.
The following consolidated financial statements of CNE Group, Inc. and
subsidiaries (collectively referred to as the "Company," unless the
context requires otherwise) are prepared in accordance with the rules and
regulations of the Securities and Exchange Commission for Form 10-QSB and
reflect all adjustments (consisting of normal recurring accruals) and
disclosures which, in the opinion of management, are necessary for a fair
statement of results for the interim periods presented. It is suggested
that these financial statements be read in conjunction with the financial
statements and notes thereto included in the Company's Annual Report on
Form 10-KSB for the year ended December 31, 2003, which was filed with the
Securities and Exchange Commission.
The results of operations for the three-months ended March 31, 2004 are
not necessarily indicative of the results to be expected for the entire
fiscal year.
1
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
March 31, December 31,
2004 2003
------------ ------------
(Unaudited)
ASSETS
Current:
Cash and cash equivalents $ 193,201 $ 460,832
Accounts receivable, net of allowance for doubtful
accounts of $58,500 in 2004 and $51,500 in 2003 630,935 208,358
Inventory 293,282 246,719
Other 46,490 27,840
------------ ------------
Total current assets 1,163,908 943,749
Fixed assets, net 429,570 447,579
Intellectual property rights, net 1,446,846 1,475,145
Goodwill 7,285,894 7,285,894
Other assets 18,961 18,961
------------ ------------
Total assets $ 10,345,179 $ 10,171,328
============ ============
LIABILITIES
Current:
Accounts payable and accrued expenses $ 990,594 $ 940,253
Interest payable 73,428 89,950
Short-term credit arrangements 50,795 45,779
Lines of credit 163,699 164,314
Notes payable 37,502 146,988
Debenture payable 100,000 100,000
------------ ------------
Total current liabilities 1,416,018 1,487,284
Notes payable, net of current portion 320,680 326,045
Subordinated notes payable 1,891,821 1,767,000
Deferred revenue 32,115 23,620
Deferred grant revenue 300,000 300,000
------------ ------------
Total liabilities 3,960,634 3,903,949
------------ ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock (Notes A and E) 124 124
Common stock (Notes A and F) 119 101
Paid-in surplus 28,849,197 28,258,215
Accumulated deficit (19,591,795) (19,117,961)
------------ ------------
9,257,645 9,140,479
Less treasury stock, at cost - 1,238,656 shares in 2004 and 2003 (2,873,100) (2,873,100)
------------ ------------
Total stockholders' equity 6,384,545 6,267,379
------------ ------------
Total liabilities and stockholders' equity $ 10,345,179 $ 10,171,328
============ ============
See Notes to Consolidated Financial Statements.
2
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Three Months
Ended March 31,
------------------------------
2004 2003
------------ -----------
(Unaudited) (Unaudited)
Revenues:
Product sales $ 631,438 $ --
Service fee income 320,135 --
Internet related income 31,369 45,039
------------ -----------
982,962 45,039
Costs of goods sold 503,699 --
------------ -----------
Gross profit 479,263 45,039
Other expenses:
Advertising 24,720 --
Compensation and related costs 368,562 90,231
General and administrative 300,216 98,988
Product development 6,241 --
Depreciation and amortization 47,499 11,083
------------ -----------
747,238 200,302
------------ -----------
Loss before other income (expenses) (267,975) (155,263)
Other income (expenses):
Amortization of debt discount (124,821) --
Interest expense (81,182) (87,942)
Interest income 144 282
------------ -----------
Loss before provision for income taxes (473,834) (242,923)
Provision for income tax provision, net of valuation allowance -- --
------------ -----------
Net loss $ (473,834) $ (242,923)
============ ===========
Loss per common share - basic and diluted: $ (.05) $ (.04)
============ ===========
Weighted average number of common
shares outstanding - basic and diluted: 10,057,582 5,590,944
============ ===========
See Notes to Consolidated Financial Statements.
3
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Three Months Ended March 31,
----------------------------
2004 2003
--------- ---------
(Unaudited) (Unaudited)
Cash flows from operating activities:
Net loss $(473,834) $(242,923)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 47,499 11,083
Provision for doubtful accounts 7,000 --
Amortization of debt discount 124,821 --
Changes in:
Accounts receivable (429,577) 70,609
Inventory (46,563) --
Prepaid expenses and other assets (18,650) --
Accrued expenses and other liabilities 66,715 74,778
--------- ---------
Net cash used in operating activities (722,589) (86,453)
--------- ---------
Cash flows from investing activities:
Purchase of furniture and equipment (1,191) --
--------- ---------
Net cash used in investing activities (1,191) --
--------- ---------
Cash flows from financing activities:
Net proceeds from issuance of 1,750,000 shares of common stock 571,000 --
Principal repayments on notes payable (114,851) --
--------- ---------
Net cash provided by financing activities 456,149 --
--------- ---------
Decrease in cash and cash equivalents (267,631) (86,453)
Cash and cash equivalents at beginning of period 460,832 183,200
--------- ---------
Cash and cash equivalents at end of period $ 193,201 $ 96,747
========= =========
Supplemental disclosures of cash flow information related to
continuing operations:
Cash paid during the period for:
Interest $ 77,776 $ --
Income taxes $ -- $ --
Non-cash financing activities relating to forgiveness of interest
indebtedness to an officer and an employee of the Company:
Interest payable 20,000 --
Paid in surplus (20,000) --
See Notes to Consolidated Financial Statements.
4
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE A - THE COMPANY
Business
CNE Group, Inc. (the "Company" or "CNE") is a holding company whose primary
operating subsidiary is SRC Technologies, Inc. ("SRC"). SRC, also a holding
company, is the parent of Connectivity, Inc. ("Connectivity"), Econo-Comm, Inc.
("ECI") (d/b/a Mobile Communications), and U.S. Commlink, Ltd. ("USCL").
Connectivity, ECI and USCL market, manufacture, repair and maintain remote radio
and cellular-based emergency response products to a variety of federal, state
and local government institutions, and other vertical markets throughout the
United States. SRC has intellectual property rights to certain key elements of
these products - specifically, certain communication, data entry and telemetry
devices.
The Company also generates revenue from its subsidiary, CareerEngine, Inc.,
which is engaged in the business of e-recruiting. This segment is not
significant to the operations of the Company.
Going Concern
The Company has incurred substantial losses, sustained substantial operating
cash outflows and has a working capital deficit at both March 31, 2004 and
December 31, 2003. The above factors raise substantial doubt about the Company's
ability to continue as a going concern. The Company's continued existence
depends on its ability to obtain additional equity and/or debt financing to fund
its operations and ultimately to achieve profitable operations. The Company is
continuously in the process of raising additional financing and has initiated a
cost reduction strategy. At March 31, 2004, management believes that the working
capital deficit, losses and negative cash flow will ultimately be improved by
(i) the acquisitions of SRC and ECI and (ii) cost reduction strategies initiated
in January 2004. There is no assurance that the Company can obtain additional
financing or achieve profitable operations or generate positive cash flow. The
2004 and 2003 financial statements do not include any adjustments relating to
the recoverability or classification of recorded asset amounts or the amount and
classification of liabilities that might be necessary as a result of this going
concern uncertainty.
American Stock Exchange Listing
On January 2, 2004, the Company received a notice dated December 31, 2003 from
the American Stock Exchange Staff indicating that the Company had demonstrated
compliance with the requirements necessary for continued listing on the American
Stock Exchange.
As is the case for all listed issuers, the Company's continued listing
eligibility will be assessed on an ongoing basis; however, during the year
ending December 31, 2004, the Company will be subject to additional scrutiny (as
set forth in Section 1009(h) of the AMEX Company Guide) as is the case for any
listed company that has regained compliance.
Corporate Matters
On April 17, 2003, pursuant to the terms of Section 251(g) of the Delaware
General Corporation Law, CareerEngine Network, Inc. ("CareerEngine") became a
wholly-owned subsidiary of the Company. Pursuant to this transaction, the
Company acquired all of the assets of CareerEngine and all former stockholders
of CareerEngine became the stockholders of the Company, which is the entity that
is now publicly traded on the American Stock Exchange under the symbol "CNE." As
a successor entity to CareerEngine, the Company's shares are deemed to be
registered under Section 12(g) of the Securities
See Notes to Consolidated Financial Statements.
5
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE A - THE COMPANY (CONTINUED)
Exchange Act of 1934 and Rule 12g-3 promulgated thereunder. The shares were
issued without registration in reliance upon exemptions provided in Section
3(a)(9) of the Securities Act of 1933 and Rule 145 promulgated thereunder.
In addition, the officers and directors of CareerEngine became the officers and
directors of the Company. On April 23, 2003, three directors of the Company
resigned (Kevin J. Benoit, Edward A. Martino and James J. Murtha) and their
replacements were appointed (Michael J. Gutowski, Larry M. Reid and Carol L.
Gutowski). Ms. Gutowski is the wife of Michael J. Gutowski. Messrs. Gutowski and
Reid were also appointed the President and Chief Operating Officer and the
Executive Vice President of the Company, respectively. See "Acquisition of all
of the outstanding stock of SRC and ECI" below.
In addition, on April 23, 2003, the Board of Directors and a majority of the
stockholders approved the reorganization of the Company and pursuant to
Accounting Standards ARB 43 which increased the authorized number of shares of
common stock to 40,000,000 shares with a par value of $0.00001 per share and
increased the authorized number of shares of preferred stock to 25,000,000
shares with a par value of $0.00001 per share. The preferred stock may be issued
in one or more series at the discretion of the Board of Directors.
Acquisition of all of the outstanding stock of SRC and ECI
On April 23, 2003 the Company issued (i) 899,971 shares of its common stock,
(ii) 1,697,966 shares of its non-voting Series A Preferred Stock and an equal
number of ten year Class A Warrants, (iii) 4,400 shares of its Series B
Preferred Stock, and (iv) 9,735,875 shares of its non-voting Series C Preferred
Stock and a like number of ten year Class C Warrants, each to purchase one share
of the Company's Common Stock at a $1.00 per share, for 100% ownership of SRC
and ECI. In addition, ECI's sellers retained certain of ECI's trade receivables
aggregating approximately $100,000. The Company also acquired a patent related
to the operation of ECI's business in exchange for notes aggregating $2,000,000
bearing 8% interest. The consolidated financial statements include the operating
results of SRC and ECI from the date of acquisition. The details of such
transactions are set forth below.
SRC
On April 23, 2003, the Company issued to Mr. and Mrs. Gutowski, the former
principal common stockholders of SRC, an aggregate of 4,867,937 shares of
its non-voting Series C Preferred Stock and an equal number of ten year
Class C Warrants, each to purchase one share of its Common Stock at $1.00
per share. The Class C Warrants are not exercisable and are not detachable
from the Series C Preferred Stock prior to 66 months after their issuance.
See Note E.
The Company issued to the other former common stockholders of SRC,
including Mr. Reid, an aggregate of 899,971 shares of its Common Stock,
1,697,966 shares of its non-voting Series A Preferred Stock and a like
number of ten year non-detachable Class A Warrants, each to purchase one
share of its Common Stock at $1.00 per share. The Class A Warrants are not
exercisable and are not detachable from the Series A Preferred Stock prior
to 66 months after their issuance. See Note E.
The Company issued an aggregate of 4,400 shares of its Series B Preferred
Stock to the former holders of the SRC Series B Preferred Stock. See Note
E.
See Notes to Consolidated Financial Statements.
6
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE A - THE COMPANY (CONTINUED)
ECI
Also, on April 23, 2003, the Company issued to Gary L. Eichsteadt and
Thomas L. Sullivan, the former stockholders of ECI, an aggregate of
4,867,938 shares of its Series C Preferred Stock and an equal number of
Class C Warrants, each to purchase one share of its Common Stock at $1.00
per share. The Class C Warrants are not exercisable and are not detachable
from the Series C Preferred Stock prior to 66 months after their issuance
(see Note E). In addition, Messrs. Eichsteadt and Sullivan retained
certain of ECI's trade receivables aggregating approximately $100,000. The
Company also acquired a patent ("ECI Patent) related to the operation of
ECI's business from Mr. Eichsteadt for notes in the aggregate principal
amount of $2,000,000, bearing interest at the annual rate of 8%, payable
quarterly, and due on October 31, 2008. The notes are currently secured by
a certain Pledge Agreement - see Note D. Mr. Sullivan remained an
executive officer ECI. On July 31, 2003, the Company transferred all the
stock of ECI to SRC and ECI became a wholly-owned subsidiary of SRC. In
addition, the Company transferred its rights to the ECI Patent to SRC.
On May 19, 2003, Mr. Eichsteadt assigned $1,500,000 of the aforementioned
8% notes equally to Mr. Sullivan, Mr. Gutowski and Mrs. Gutowski. Further
on August 31, 2003, Mr. and Mrs. Gutowski converted their notes
aggregating $1,000,000 into 1,000,000 shares of the Company's Series AA
Preferred Stock.
The Series A Preferred Stock has an aggregate liquidating preference over
all other CNE equity of $1,697,966 and the Series B Preferred Stock has an
aggregate liquidating preference over all other CNE equity except the
Series B Preferred Stock liquidating value of $440,000. The Series C
Preferred Stock has no liquidating preference.
The total consideration, including acquisition costs, was allocated based
on the estimated fair values of the net assets and liabilities acquired on
the acquisition date.
ECI SRC Total
----------- ----------- -----------
Tangible assets $ 588,492 $ 292,979 $ 881,471
Patents 1,379,789 170,820 1,550,609
Goodwill 2,766,233 4,519,661 7,285,894
Liabilities (2,144,771) (857,033) (3,001,804)
----------- ----------- -----------
Net asset value $ 2,589,743 $ 4,126,427 $ 6,716,170
=========== =========== ===========
There were no relationships between the Company or any of its affiliates
and any of the sellers of the assets (SRC and ECI) acquired by the Company
prior to the acquisition transactions.
Private Financings
On April 23, 2003, the Company also completed a private financing pursuant to
which it issued notes (the "Notes") in the aggregate principal amount of
$1,000,000, of which $650,000 was to the officers of the Company, and 4,165,800
ten year cashless Class B Warrants, each to purchase one share of its Common
Stock at $0.50 per share. The Notes bear interest at the annual rate of 10%
payable quarterly and are due on April 30, 2004. The aggregate number of shares
for which the Warrants may be exercised must equal 15% of the Company's
outstanding Common Stock on a fully-diluted basis. These Warrants are anti-
See Notes to Consolidated Financial Statements.
5
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE A - THE COMPANY (CONTINUED)
dilutive until the Notes have been repaid. The due date of the Notes may be
extended at the Company's option for an additional year in consideration for the
issuance of 10-year warrants to purchase an additional 4% of the Company's then
outstanding common stock at $0.50 per share. These Warrants would also be
anti-dilutive until the Notes have been repaid. In addition, the Company valued
the warrants, utilizing the Black-Scholes Pricing Model, at $699,000, which is
being accounted for as debt discount and is being amortized ratably over the
one-year term of the Notes.
On March 12, 2004, the Company notified the Class B Warrant holders that, to
satisfy the 15% non-dilutive provisions of their Warrants, these Warrants were
now exercisable for an aggregate of 5,245,200 shares of the Company's common
stock at approximately $0.40 per share. On this date, the Company also exercised
its option to extend the maturity date of the notes to April 30, 2005 and
satisfied the requirement for the additional 4% non-dilutive interest in the
Company by issuing to the noteholders Class B Warrants to purchase an additional
1,708,900 shares of the Company's common stock at $0.50 per share. The
non-dilutive provisions of the Warrants terminate when all of the notes have
been paid in full.
1. On September 17, 2003, the Company sold 1,250,000 shares of its
Common Stock at $0.40 per share to an existing noteholder and
stockholder of the Company.
2. On January 21, 2004, a secured factoring arrangement with an
individual, which amounted to $300,000 at December 31, 2003, was
restructured into a $300,000 unsecured Note Payable due February 10,
2005. The individual was also issued Class BB Warrants to purchase
150,000 shares of the Company's common stock at $0.50 per share.
3. On February 10, 2004, the Company sold 1,750,000 shares of its
Common Stock at $0.40 per share. The net proceeds of the transaction
amounted to $571,000. The Company is using the funds obtained from
this financing primarily for working capital purposes.
The Company is using the funds obtained from these financings primarily for
working capital purposes as well as to pay certain ECI notes payable. The
aforementioned financings were effected pursuant to the exemption from the
registration provisions of the Securities Act of 1993 provided by Section 4(2)
thereof.
Catastrophe on September 11, 2001
On September 11, 2001 the Company's headquarters were located at Suite 2112 of
Two World Trade Center in New York City. The catastrophe of September 11, 2001
involved no injury to any of the Company's employees. However, with the complete
destruction of the building, all of the Company's leasehold improvements,
furniture and fixtures, and office and computer equipment located at this site
were also destroyed. Since the attack through the date of the acquisitions and
financing set forth above, the Company's management had been preoccupied with
the relocation and reestablishment of its businesses, assessing and processing
of insurance claims with the assistance of a risk manager with its insurers, and
seeking sources of financing. In 2002, the Company received insurance proceeds,
based on
See Notes to Consolidated Financial Statements.
8
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE A - THE COMPANY (CONTINUED)
replacement costs, in amounts that have exceeded the net carrying value of the
destroyed assets. The Company also had insurance coverage for other than assets
destroyed. In 2003, all outstanding insurance claims relating to the catastrophe
were settled.
In addition, the Company applied for government assistance grants related to the
catastrophe. In 2002 and 2003, the Company received grants aggregating $300,000
($291,827 at March 31, 2003). The grants have a restriction that could require
their repayment, specifically if the Company were to relocate a substantial
portion its operations outside of New York City before May 1, 2005. Until such
time as this restriction shall no longer apply, the grants will be classified as
a liability of the Company. Upon the satisfaction or lapse of the restrictions,
the Company will remove the liability and record grant income on its financial
statements or, alternatively, repay such grants if the above condition is not
satisfied.
NOTE B - SIGNIFICANT ACCOUNTING POLICIES
[1] Principles of consolidation:
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries, SRC and CareerEngine
Network, Inc. ("CareerEngine Network"). All significant intercompany
balances and transactions have been eliminated.
[2] Revenue recognition:
The Company's operations relating to manufacturing, marketing and
servicing its remote and cellular-based emergency response products
recognizes revenue from the sale of a product upon installation or
delivery to the customer, depending on the terms of the underlying sales
agreement.
E-recruiting fees are earned on job placement advertisements and
sponsorship advertisements on the Company's website and are recognized
over the period during which the advertisements are exhibited. Website
construction fees are recognized ratably over the construction period.
Monthly hosting and maintenance fees for such sites are recognized ratably
over the period of the underlying contract.
[3] Depreciation and amortization:
Furniture, fixtures and equipment are being depreciated using the
straight-line method over estimated lives of three to seven years.
Computer equipment is being depreciated on a straight-line basis over an
estimated life of three to five years.
Leasehold improvements were amortized on a straight-line basis over the
shorter of the term of the lease or their estimated useful lives.
[4] Cash and cash equivalents:
The Company considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents. At March
31, 2004, cash equivalents amounting to
See Notes to Consolidated Financial Statements.
9
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
$51,492 consisted of $9,934 in an interest bearing savings account and a
$41,558 certificate of deposit with a bank. At December 31, 2003 there
were no cash equivalents.
[5] Accounts and Trade Receivables:
The Company extends credit to its customers on an unsecured basis in the
ordinary course of business but mitigates the associated credit risk by
performing credit checks and actively pursuing past due accounts. An
allowance for doubtful accounts has been established since management is
of the opinion that all accounts receivable may not be fully collectible.
The allowance for doubtful accounts is based on an estimated percentage of
overall accounts receivable.
[6] Concentration of Credit Risk:
Financial instruments that subject the Company to risk of loss consist
principally of accounts receivable and deposits with financial
institutions. The Company grants credit terms to customers in the normal
course of doing business. Credit risk with respect to trade receivables is
considered minimal due to the Company's diverse customer base throughout
the United States and strict enforcement of its credit policies. The
Company generally does not require security deposits or other collateral
to support credit sales. The consolidated financial statements have been
adjusted for anticipated losses thereon. Deposits held with banks may
exceed the amount of insurance provided on such deposits.
The Company's sales are made primarily to customers throughout the United
States. Non-U.S. customers are required to pay in U.S. Dollars when the
order is placed. There were no sales to non-U.S. customers for the
three-month periods ended March 31, 2004 and 2003. During the three-month
periods ended March 31, 2004 and 2003, no single customer or group of
related customers accounted for ten percent (10%) or more of the Company's
sales, and credit losses were not significant.
[7] Inventory:
Inventory is stated at the lower of cost (determined by first-in,
first-out method) or market. The Company's inventory consists of the
following:
March 31, December 31,
2004 2003
-------- --------
Raw materials $277,182 $158,347
Work in progress 8,600 3,089
Finished goods 7,500 85,283
-------- --------
Total $293,282 $246,719
======== ========
See Notes to Consolidated Financial Statements.
10
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[8] Income (loss) per share:
Basic and diluted earnings (loss) per common share have been computed in
accordance with SFAS No. 128, "Earnings Per Share." Basic earnings per
share ("BEPS") is computed by dividing net income (loss) by the
weighted-average number of common shares outstanding during the
three-month period ended March 31, 2004 and 2003, respectively. Common
stock equivalents to purchase common stock of the Company that were
outstanding at March 31, 2004 and March 31, 2003 were not included in the
computation of diluted net loss per share as their effect would have been
anti-dilutive.
[9] Financial instruments:
The Financial Accounting Standards Board's Statement of Financial
Accounting Standards No. 107, Disclosures about Fair Value of Financial
Instruments ("SFAS 107"), defines fair value of a financial instrument as
the amount at which the instrument could be exchanged in a current
transaction between willing parties. The Company's carrying value of cash,
accounts receivable, inventory, accounts payable, short-term credit
arrangements, lines of credit, notes payable, and subordinated debt
approximates fair value because the instruments have a short-term maturity
or because the applicable interest rates are comparable to current
investing or borrowing rates of those instruments.
[10] Stock-based compensation:
As permitted under SFAS No. 123, Accounting for Stock-based Compensation
(SFAS No. 123), the Company has elected to continue to follow the guidance
of APB Opinion No. 25, Accounting for Stock Issued to Employees (APB No.
25), and Financial Accounting Standards Board Interpretation No. 44,
Accounting for Certain Transactions Involving Stock Compensation--an
Interpretation of APB Opinion No. 25 (FIN No. 44), in accounting for its
stock-based employee compensation arrangements. Accordingly, no
compensation cost is recognized for any of the Company's fixed stock
options granted to employees when the exercise price of each option equals
or exceeds the fair value of the underlying common stock as of the grant
date for each stock option. Changes in the terms of stock option grants,
such as extensions of the vesting period or changes in the exercise price,
result in variable accounting in accordance with APB Opinion No. 25.
Accordingly, compensation expense is measured in accordance with APB No.
25 and recognized over the vesting period. If the modified grant is fully
vested, any additional compensation costs is recognized immediately. The
Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123.
At March 31, 2004 and December 31, 2003, the Company had a stock-based
employee compensation plan - the 2003 Plan. Two of Company's subsidiaries
each had separate stock-based employee compensation plans. These
subsidiaries' plans were contractually terminated by the Company upon the
acquisition of SRC and ECI on April 23, 2003. Furthermore, on March 14,
2003, all recipients of options granted pursuant to these plans rescinded
all of their interests.
See Notes to Consolidated Financial Statements.
11
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
As permitted under SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure, which amended SFAS No. 123, the
Company has elected to continue to follow the intrinsic value method in
accounting for its stock-based employee compensation arrangements as
defined by APB No. 25 and related interpretations including FIN No. 44.
The following table illustrates the effect on net loss and loss per share
if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee compensation for options granted under its
plan.
Three Month Period
Ended March 31,
---------------------------
2004 2003
----------- -----------
Net loss, as reported $ (473,834) $ (242,923)
Less, Total stock-based employee compensation expense
determined under fair value-based method for all awards,
net of related tax effects
(168,280) --
----------- -----------
Pro forma net loss $ (642,114) $ (242,923)
=========== ===========
Net loss per share - basic and diluted:
As reported $ (0.05) $ (0.04)
=========== ===========
Pro forma $ (0.06) $ (0.04)
=========== ===========
On April 30, 2003, incentive stock options to purchase 1,987,500 shares of
the Company's Common Stock were granted by the Incentive Compensation
Committee to five officers (1,800,000) and one employee (187,500) of the
Company at a weighted average exercise price of $1.32 per share. On
November 4, 2003, incentive stock options to purchase 950,000 shares of
the Company's Common Stock were granted by the Incentive Compensation
Committee to three officers of the Company at a weighted average exercise
price of $1.09 per share. On January 21 2004, incentive stock options to
purchase 601,000 shares of the Company's common stock were granted by the
Incentive Compensation Committee of the Board of Directors to one officer
and 18 employees of the Company at a weighted average exercise price of
$0.50 per share. On April 30, 2003 (435,000), November 4, 2003 (220,000),
November 21, 2003 (100,000) and January 21, 2004 (295,500), non-qualified
stock options to purchase an aggregate 1,050,500 shares of the Company's
Common Stock were granted by the Board of Directors to certain independent
contractors of the Company. The Company recorded a charge of $-0- in
general and administrative expense, relating to the 1,050,000
non-qualified stock options that were vested at March 31, 2004, on its
Statement of Operations for the three-month period then ended. No options
granted have been exercised.
[11] Use of estimates:
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.
See Notes to Consolidated Financial Statements.
12
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[12] Advertising costs:
Advertising costs, which amounted to $24,720 and $0 for the three-month
periods ended March 31, 2004 and 2003, respectively, are expensed as
incurred.
[13] Warranty Expense:
The Company generally warrants its products against defects for a period
of one to three years. A provision for estimated future costs relating to
warranties is recorded when products are shipped and revenue recognized.
At March 31, 2004 and December 31, 2003, estimated future costs relating
to warranties were $34,602 and $40,260, respectively.
[14] Impairment of long-lived assets:
Impairment losses are recognized for long-lived assets used in operations
when indicators of impairment are present and the undiscounted cash flows
estimated to be generated by those assets are not sufficient to recover
the assets' carrying amount. The impairment loss is measured by comparing
the fair value of the asset to its carrying amount. No write-down of
assets for impairment losses were required during the three-month period
ended March 31, 2004 and the year ended December 31, 2003.
[15] Intellectual Property Rights and Goodwill:
In July 2001, the FASB issued SFAS No. 141, Business Combinations ("SFAS
141"), and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS 141
requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001, and that certain intangible
assets acquired in a business combination be recognized as assets apart
from goodwill. SFAS 142 requires goodwill to be tested for impairment on
an annual basis and between annual tests in certain circumstances, and
written down when impaired, rather than being amortized as previous
standards required. Furthermore, SFAS 142 requires intangible assets,
other than goodwill, to be amortized over their useful lives unless these
lives are determined to be indefinite. Other intangible assets are carried
at cost less accumulated amortization. Intellectual Property Rights
acquired by the Company in the ECI business combination in April 2003 (see
Note A) are being amortized on a straight-line basis over the shorter of
the remaining lives of the patents when acquired or their estimated useful
remaining lives, generally eleven to fourteen years. No goodwill
impairment charge has been recorded in 2004 or 2003 in accordance with
SFAS No. 142.
[16] Startup Activities
Costs associated with the organization and start-up activities of the
Company are expensed as incurred.
See Notes to Consolidated Financial Statements.
13
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[17] Recent accounting pronouncements:
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." In general, a variable
interest entity is a corporation, partnership, trust, or any other legal
structure used for business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors that do not
provide sufficient financial resources for the entity to support its
activities. FIN 46 requires certain variable interest entities to be
consolidated by the primary beneficiary of the entity if the investors do
not have the characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. The
consolidation requirements of FIN 46 apply immediately to variable
interest entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or interim
period beginning after December 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31,
2003, regardless of when the variable interest entity was established. The
adoption of this statement has had no effect on the Company's financial
position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS
No. 149 amends and clarifies financial accounting and reporting for
derivative instruments, including certain derivative instruments embedded
in other contracts (collectively referred to as derivatives) and for
hedging activities under FASB Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities". This Statement requires
that contracts with comparable characteristics be accounted for
consistently as either derivatives or hybrid instruments. This Statement
is effective for contracts entered into or modified after June 30, 2003,
and for hedging relationships designated after June 30, 2003. The adoption
of this statement has had no effect on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity." SFAS No. 150 changes the accounting for certain financial
instruments that under previous guidance issuers could account for as
equity. It requires that those instruments be classified as liabilities in
balance sheets. The guidance in SFAS No. 150 is generally effective for
all financial instruments entered into or modified after May 31, 2003, and
otherwise is effective on July 1, 2003. The adoption of this statement has
had no effect on the Company's financial statements.
NOTE C - CONVERSION OF DEBENTURES PAYABLE
In August and September 2003, holders of 95.83333% of $2,400,000 principal
amount of the debentures payable issued by a subsidiary of the Company elected
to (i) convert the outstanding principal balance of their debentures amounting
to $2,300,000 into 1,150,000 shares of the Company's Common Stock, (ii) cancel
575,000 of the related 600,000 outstanding B Warrants of the subsidiary of the
Company (the related Class A Warrants of the subsidiary of the Company expired
on March 31, 2003), and (iii) waive all accrued and unpaid interest relating
thereto ($345,000), in consideration for the issuance of the Company's five-year
common stock Class F Warrants to purchase 1,150,000 shares of the Company's
See Notes to Consolidated Financial Statements.
14
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE C - CONVERSION OF DEBENTURES PAYABLE (CONTINUED)
Common Stock at $3.00 per share. One-half of these warrants (575,000) were
exercisable upon issuance with the balance exercisable commencing January 1,
2004. In addition, unamortized debt discount of $29,768 on the debentures was
recognized as interest expense in 2002. The Company also recognized as expense
the unamortized deferred financing costs associated with the debentures of
$320,350 in 2002. The subsidiary of the Company also granted the placement agent
a warrant exercisable through June 2005 to purchase five units at $60,000 per
unit. If the warrant for all five units is exercised, the purchaser shall
effectively receive 125,000 shares of the Company's common stock and the right
to purchase an additional 62,500 common shares at $6.00 per share - see Note G.
At March 31, 2004 and December 31, 2003 the outstanding principal balance of a
debenture payable of a subsidiary of the Company was $100,000.
NOTE D - SUBORDINATED NOTES PAYABLE
The Company has the following subordinated notes payable at March 31, 2004 and
December 31, 2003:
10% Subordinated Notes due April 30, 2005
On April 23, 2003, the Company issued $1,000,000 in principal amount of its 10%
Subordinated Notes originally due April 30, 2004 to investors for a 15%
non-dilutive interest in the Company in the form of 4,165,800 cashless warrants,
each to purchase one share of Common Stock at $0.50 per share. The Company has
the option to extend the maturity date of the notes to April 30, 2005 in
consideration for issuing the noteholders an additional 4% non-dilutive interest
in the Company (see below). The notes also require the Company to prepay them in
an amount equal to 100% of any net financing proceeds obtained by the Company
after the issuance of the notes. The noteholders waived this provision to the
extent of $2,000,000 through April 15, 2004, of which $1,200,000 has been
raised. The investors included two officers of the Company. Interest is payable,
in arrears, calendar quarterly. The Company valued the warrants, utilizing the
Black-Scholes Pricing Model, at $699,000, which is being accounted for as debt
discount and is being amortized ratably over the initial one-year term of the
Notes.
On March 12, 2004, the Company notified the Class B Warrant holders that, to
satisfy the 15% non-dilutive provisions of their Warrants, these Warrants were
now exercisable for an aggregate of 5,245,200 shares of the Company's common
stock at approximately $0.40 per share. On this date, the Company also exercised
its option to extend the maturity date of the notes to April 30, 2005 and
satisfied the requirement for the additional 4% non-dilutive interest in the
Company by issuing to the noteholders Class B Warrants to purchase an additional
1,708,900 shares of the Company's common stock at $0.50 per share. The
non-dilutive provisions of the Warrants terminate when all of the notes have
been paid in full. At March 31, 2004 and December 31, 2003 the 10% subordinated
notes had an outstanding principal balance of $891,821 and $767,000,
respectively.
8% Subordinated Notes due April 30, 2008
On April 23, 2003, the Company issued $2,000,000 of its 8% subordinated notes
due April 30, 2008 to three officers and an employee of the Company. Interest is
payable quarterly on a calendar year basis. The notes are secured by the all of
the issued and outstanding common stock of SRC and ECI, which represents
substantially all of the assets of the Company, pursuant to a certain Pledge
Agreement, which shall terminate upon repayment or other satisfaction of a
certain subsidiary's indebtedness (see Note I)
See Notes to Consolidated Financial Statements.
15
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE D - SUBORDINATED NOTES PAYABLE (CONTINUED)
that initially amounted to $2,400,000. At March 31, 2004 and December 31, 2003,
$2,300,000 of this indebtedness had been converted into Common Stock of the
Company as discussed in Note C.
On August 31, 2003, two holders who are officers of the Company, converted
$1,000,000 of the Company's 8% Subordinated Notes into 1,000,000 shares of the
Company's Series AA Preferred Stock, par value $.00001 per share. The Series AA
Preferred Stock has a liquidating preference to all other equity securities of
the Company. It also has an 8% cumulative dividend, payable in common stock or
cash. At March 31, 2004 and December 31, 2003 the 8% subordinated notes had an
outstanding principal balance of $1,000,000.
NOTE E - PREFERRED STOCK
Preferred Stock consisted of the following at March 31, 2004 and December 31,
2003:
Par value per share $ 0.00001
==========
Authorized number of shares 25,000,000
==========
Issued and outstanding number of shares:
Series AA 1,000,000
Series A 1,697,966
Series B 4,400
Series C 9,735,875
----------
Total 12,438,241
==========
The Series AA Preferred Stock has an 8% cumulative dividend, payable in common
stock or cash, and a liquidating preference over all other CNE equity of
$1,000,000. The Series A Preferred Stock has a liquidating preference over all
other CNE equity except the Series AA of $1,697,961. The Series B Preferred
Stock has a liquidating preference over all other CNE equity except the Series
AA and A Preferred Stock of $440,000. The Series C Preferred Stock has no
liquidating preference.
NOTE F - COMMON STOCK
Common Stock consists of the following:
March 31, December 31,
2004 2003
----------- ------------
Par value per share $ 0.00001 $ 0.00001
=========== ===========
Authorized number of shares 40,000,000 40,000,000
=========== ===========
Issued number of shares 11,879,571 10,129,571
Less, Treasury shares (1,238,656) (1,238,656)
----------- -----------
Issued and outstanding number of shares 10,640,915 8,890,915
=========== ===========
See Notes to Consolidated Financial Statements.
16
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE G - WARRANTS
At March 31, 2004 outstanding warrants to acquire common stock consisted of:
March 31, December 31,
2004 2003
Type of Exercise --------- ------------
Warrant Exercise Date Expiration Date Price Shares of Common Stock
------- ------------- --------------- -------- -----------------------------
Class A October 22, 2008 April 22, 2013 $1.00 1,697,966 1,697,966
Class B April 23, 2003 April 30, 2013 $0.50 -- 4,904,800
Class B April 23, 2003 April 30, 2013 $0.40 5,245,200 --
Class B March 12, 2004 April 30, 2013 $0.50 1,708,900 --
Class BB May 10, 2003 May 10, 2006 $0.50 20,000 20,000
Class BB June 10, 2003 June 10, 2006 $0.50 20,000 20,000
Class BB July 10, 2003 July 10, 2006 $0.50 20,000 20,000
Class BB August 10, 2003 August 10, 2006 $0.50 20,000 20,000
Class BB September 10, 2003 September 10, 2006 $0.50 20,000 20,000
Class BB October 10, 2003 October 10, 2006 $0.50 20,000 20,000
Class BB June 10, 2003 June 10, 2006 $2.50 10,000 10,000
Class BB July 10, 2003 July 10, 2006 $3.00 10,000 10,000
Class BB August 10, 2003 August 10, 2006 $4.00 10,000 10,000
Class BB September 10, 2003 September 10, 2006 $4.50 10,000 10,000
Class BB October 10, 2003 October 10, 2006 $5.00 10,000 10,000
Class BB January 21, 2004 February 4, 2009 $0.50 150,000 --
Class BB February 10, 2004 February 10, 2014 $1.00 350,000 --
Class C October 22, 2008 April 22, 2013 $1.00 9,735,875 9,735,875
Class F January 1, 2004 December 31, 2009 $3.00 1,150,000 1,150,000
Class B(1) Immediate March 31, 2005 $6.00 25,000 25,000
Class B(1) Immediate June 28, 2005 $6.00 62,500 62,500
---------- ----------
20,295,441 17,746,141
========== ==========
(1) Class B warrants and Units of a subsidiary of the Company are exercisable
for the Company's common shares (see Note C: Conversion of Debentures
Payable).
(2) A subsidiary of the Company has issued debentures, which if converted, and
units, which if exercised, would entitle the holders thereof to 175, 000
shares of the Common Stock of the Company.
NOTE H - CAPITAL CONTRIBUTIONS
On January 21, 2004, (retroactive to December 31, 2003) certain officers,
directors and stockholder of the Company waived certain amounts due to them as
follows:
Compensation and certain reimbursable expenses $ 66,246
Interest on promissory notes 13,334
Accounts receivable due stockholders 130,000
--------
Total $209,580
========
These aforementioned amounts were reflected in the financial statements as
contributions to the capital of the Company during the year ended December 31,
2003.
See Notes to Consolidated Financial Statements.
17
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE H - CAPITAL CONTRIBUTIONS (CONTINUED)
In addition, on January 21, 2004 an officer and an employee of the Company
waived the interest on the Company's 8% Subordinated Note Payable for the period
January 1, 2004 thought December 31, 2004 amounting to $20,000 per calendar
quarter. The aforementioned amount has been reflected in the financial
statements as a contribution to the capital of the Company during the
three-month period ended March 31, 2004.
NOTE I - SETTLEMENT OF TAX ASSESSMENT PAYABLE OF A SUBSIDIARY OF THE COMPANY
On July 16, 2003, the IRS accepted an "Offer in Compromise," submitted in April
2003, by a subsidiary of the Company to settle its Tax Assessment Payable
amounting to approximately $946,000, including interest, at June 30, 2003. The
accepted Offer in Compromise provided for payment of $50,000 cash on or before
October 14, 2003. The $50,000 cash was paid in July and September 2003. The
Company recognized a gain on settlement in the amount of $895,622 relating to
this transaction during the year ended December 31, 2003.
NOTE J - ACQUISITIONS AND RELATED UNAUDITED PRO FORMA FINANCIAL INFORMATION
The purchase price of the acquisition of SRC and ECI was allocated to the assets
and liabilities acquired, both tangible and intangible (as determined by an
independent appraiser), with the excess of the purchase price over the fair
value of the net assets acquired of $7,285,894 being recorded as Goodwill. The
value of the intellectual property rights, amounting to $1,550,609, acquired in
the related financing was also determined by an independent appraiser. Due to
these acquisitions and related financing, SRC has acquired intellectual property
rights to certain key elements of these products - specifically, certain
communication, data entry and telemetry devices.
The Company's consolidated financial statements include the results of
operations of SRC from its respective acquisition dates. The following unaudited
pro forma information presents a summary of our consolidated results of
operations as if the SRC and ECI acquisitions and the related financing had
taken place on January 1, 2003 for the three-month period ended March 31, 2003.
The SRC and ECI acquisitions have been recorded in accordance with SFAS No. 141;
therefore, no amortization of goodwill or intangible assets without determinable
lives related to SRC and ECI is reflected in the prior year amounts. These pro
forma results have been prepared for comparative purposes only and do not
purport to be indicative of the results of operations which actually would have
resulted had the acquisitions occurred on January 1, 2003.
Three Months Ended
March 31, 2003
--------------
Unaudited
Revenues $ 794,399
Expenses 1,565,223
-----------
Net loss $ (770,824)
===========
Loss from continuing operations per share:
Basic and diluted $ (0.14)
===========
See Notes to Consolidated Financial Statements.
18
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE K - STOCK OPTION PLANS
At March 31, 2004, the Company had a stock-based employee compensation plan -
the 2003 Stock Incentive Plan. Two of Company's subsidiaries each had separate
stock-based employee compensation plans. These subsidiaries' plans were
contractually terminated by the Company upon the acquisition of SRC and ECI on
April 23, 2003. Furthermore, on March 14, 2003, all recipients of options
granted pursuant to these terminated plans rescinded all of their interests.
2003 Stock Incentive Plan
On April 30, 2003, the Board of Directors of the Company approved the 2003 Stock
Incentive Plan, which provided, among other matters, for incentive and
non-qualified stock options to purchase 3,500,000 shares of the Company's common
stock. On November 4, 2003, the 2003 Stock Incentive Plan was amended by the
Board of Directors of the Company to increase the number of shares of Common
Stock for which the incentive and non-qualified stock options may be granted
from 3,500,00 to 5,000,000. The purpose of the 2003 Stock Incentive Plan, as
amended, ("2003 Stock Incentive Plan") is to provide incentives to officers, key
employees, directors, independent contractors and agents whose performance will
contribute to the long-term success and growth of the Company, to strengthen the
ability of the Company to attract and retain officers, key employees, directors,
independent contractors and agents of high competence, to increase the identity
of interests of such people with those of the Company's stockholders and to help
build loyalty to the Company through recognition and the opportunity for stock
ownership. The 2003 Stock Incentive Plan, as amended, was ratified by a majority
of the stockholders of the Company on December 18, 2003. On April 16,2004, the
2003 Stock Incentive Plan was amended by the Board of Directors of the Company
to increase the number of shares of Common Stock for which the incentive and
non-qualified stock options may be granted from 5,000,00 to 10,000,000. The
Company is seeking to obtain stockholder ratification for this amendment at its
annual stockholders meeting scheduled to be held on June 18, 2004. The Plan is
administered by the Incentive Compensation Committee of the Board.
On April 30, 2003, incentive stock options to purchase 1,987,500 shares of the
Company's Common Stock were granted by the Incentive Compensation Committee to
five officers (1,800,000) and one employee (187,500) of the Company at a
weighted average exercise price of $1.32 per share. On November 4, 2003,
incentive stock options to purchase 950,000 shares of the Company's Common Stock
were granted by the Incentive Compensation Committee to three officers of the
Company at a weighted average exercise price of $1.09 per share. On January 21
2004, incentive stock options to purchase 601,000 shares of the Company's common
stock were granted by the Incentive Compensation Committee of the Board of
Directors to one officer and 18 employees of the Company at a weighted average
exercise price of $0.50 per share. On April 30, 2003 (435,000), November 4, 2003
(220,000), November 21, 2003 (100,000) and January 21, 2004 (295,500),
non-qualified stock options to purchase an aggregate 1,050,500 shares of the
Company's Common Stock were granted by the Board of Directors to certain
independent contractors of the Company. No options granted have been exercised.
See Notes to Consolidated Financial Statements.
19
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE K - STOCK OPTION PLANS (CONTINUED)
Stock option activity, for the three-month period ended March 31, 2004, under
the 2003 Stock Incentive Plan is summarized as follows:
Three-Month Period Ended March 31, 2004
---------------------------------------------
Incentive Non-Qualified Weighted Average
Shares Shares Exercise Price
--------- ------------- ----------------
Options outstanding at
December 31, 2003 2,937,500 755,000 $ 1.14
Options granted 601,000 295,500 $ 0.50
Options cancelled -- --
--------- ---------
Options outstanding
at March 31, 2004 3,538,500 1,050,500 $ 1.02
========= =========
Options available
at March 31, 2004 411,000 $ 1.04
=========
The following table presents information relating to stock options outstanding
at March 31, 2004 relating to the 2003 Incentive Stock Plan:
Options Outstanding Options Available
--------------------------------------- ---------------------------------------
Weighted
Range Weighted Average Weighted
of Average Remaining Average
Exercise Exercise Life in Exercise
Price Shares Price Years Shares Price
-------- ------ -------- --------- ------ --------
$0.15 - $3.00 4,589,000 $ 1.02 8.68 411,000 $ 1.04
NOTE L - BREACH OF SELLERS' ACQUISITION REPRESENTATIONS
As set forth in Note A above, in April 2003, the Company acquired all the
outstanding stock of ECI. Pursuant to the related acquisition agreements the
sellers represented to the Company that certain real estate and related
encumbrances were removed from ECI prior to the closing of the transaction. On
or about May 6, 2004, the Company was informed that the real estate and related
encumbrances remained in the name of ECI, contrary to such representations. The
sellers who, respectively, are currently an officer and an employee of the
Company, are responsible for any adverse consequences the Company may suffer as
a result their breach of such representation, including any related expenses
associated with its correction.
The Company is currently rectifying this matter expeditiously and expects to
complete the removal of the real estate and related encumbrances by the end of
June 2004. Based on a review of an independent appraisal of the real estate
performed in May 2004, the Company believes that the valuation of the real
estate exceeds the outstanding principal balance of the related mortgages. In
addition, the rent from related leases exceeds the property's related expenses
and debt service payments on the related mortgages.
As appropriate, the financial statements of the Company do not reflect the
ownership of the real estate and the related encumbrances. In addition, the
financial statements do not reflect the activities related to such real estate
including income from rents or property and mortgage related expenses.
See Notes to Consolidated Financial Statements.
20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General
CNE Group, Inc. (the "Company," "CNE" or "we") is a holding company whose
primary operating subsidiary is SRC. SRC, also a holding company, is the
parent of Connectivity, ECI, and US Commlink. These companies, which we
acquired on April 23, 2003, market, manufacture, repair and maintain
remote radio and cellular-based emergency response products to a variety
of federal, state and local government agencies as well as other vertical
markets located throughout the United States. In addition, we engage in
the business of e-recruiting through our subsidiary, CareerEngine, Inc.
The e-recruiting business does not generate a significant part of our
revenue, and is not significant to the operations of the Company.
Acquisition of all of the outstanding stock of SRC and ECI
On April 23, 2003 we issued (i) 899,971 shares of our common stock, (ii)
1,697,966 shares of our non-voting Series A Preferred Stock and an equal
number of ten year Class A Warrants, (iii) 4,400 shares of our Series B
Preferred Stock, and (iv) 9,735,875 shares of our non-voting Series C
Preferred Stock and a like number of ten year Class C Warrants, for 100%
ownership of SRC and ECI. In addition, ECI's sellers retained certain of
ECI's trade receivables aggregating approximately $100,000. We also
acquired a patent related to the operation of ECI's business in exchange
for notes aggregating $2,000,000 bearing 8% interest. The consolidated
financial statements include the operating results of SRC and ECI from the
date of acquisition. The details of such transactions are set forth below.
SRC
On April 23, 2003, we issued to Michael J. and Carol L. Gutowski, the
former principal common stockholders of SRC and each currently a director
and an executive officer of the Company, an aggregate of 4,867,937 shares
of its non-voting Series C Preferred Stock and a like number of ten year
Class C Warrants, each to purchase one share of its Common Stock at $1.00
per share. The Class C Warrants are not exercisable or detachable from the
Series C Preferred Stock prior to 66 months after their issuance.
We issued to the other former common stockholders of SRC, including Larry
M. Reid, currently one of the Company's directors and executive officers,
an aggregate of 899,971 shares of its Common Stock, 1,697,966 shares of
its non-voting Series A Preferred Stock and a like number of ten year
non-detachable Class A Warrants, each to purchase one share of its Common
Stock at $1.00 per share. The Class A Warrants are not exercisable or
detachable from the Series A Preferred Stock prior to 66 months after
their issuance.
21
We issued an aggregate of 4,400 shares of our Series B Preferred Stock to
the former holders of the SRC Series B Preferred Stock.
ECI
On April 23, 2003, the Company issued to Thomas Sullivan and Gary
Eichsteadt, the former stockholders of ECI and currently, respectively, an
executive officer and employee of the Company, an aggregate of 4,867,938
shares of its Series C Preferred Stock and a like number of Class C
Warrants. In addition, Messrs. Eichsteadt and Sullivan retained certain of
ECI's trade receivables aggregating approximately $100,000. We also
acquired a patent ("ECI Patent) related to the operation of ECI's business
from Mr. Eichsteadt for notes in the aggregate principal amount of
$2,000,000, bearing interest at the annual rate of 8%, payable quarterly,
and due on October 31, 2008. The notes are currently secured by a certain
Pledge Agreement - see Note D. Mr. Sullivan remained an executive officer
ECI. On July 31, 2003, we transferred all the stock of ECI to SRC and ECI
became a wholly-owned subsidiary of SRC. In addition, we transferred our
title to the ECI Patent to SRC.
On May 19, 2003, Mr. Eichsteadt assigned $1,500,000 of the aforementioned
8% notes equally to Mr. Sullivan, Mr. Gutowski and Mrs. Gutowski. On
August 31, 2003, Mr. and Mrs. Gutowski converted their notes aggregating
$1,000,000 into 1,000,000 shares of the Company's Series AA Preferred
Stock.
The Series AA Preferred Stock has an 8% cumulative dividend, payable in
common stock or cash, and a liquidating preference over all other CNE
equity of $1,000,000. The Series A Preferred Stock has a liquidating
preference over all other CNE equity except the Series AA of $1,697,961.
The Series B Preferred Stock has a liquidating preference over all other
CNE equity except the Series AA and A Preferred Stock of $440,000. The
Series C Preferred Stock has no liquidating preference.
The total consideration, including acquisition costs, was allocated based
on the estimated fair values of the net assets acquired on the acquisition
date.
ECI SRC Total
----------- ----------- -----------
Tangible assets $ 588,492 $ 292,979 $ 857,593
Patents 1,379,789 170,820 1,550,609
Goodwill 2,766,233 4,519,661 7,285,894
Liabilities (2,144,771) (857,033) (3,001,804)
----------- ----------- -----------
Net asset value $ 2,589,743 $ 4,126,427 $ 6,716,170
=========== =========== ===========
There were no relationships between us or any of our affiliates and any of
the sellers of the assets we acquired prior to the acquisition
transactions.
22
Catastrophe of September 11, 2001
Our headquarters were located at Suite 2112 of Two World Trade Center in
New York City. The catastrophe of September 11, 2001 involved no injury to
any of our employees. However, with the complete destruction of the
building, all of our leasehold improvements, furniture and fixtures, and
office and computer equipment located at this site were also destroyed.
Since the attack through the date of the acquisitions and financing set
forth above, our management had been preoccupied with the relocation and
reestablishment of our businesses, assessing and processing of insurance
claims with the assistance of a risk manager with our insurers, and
seeking sources of financing. The Company received insurance proceeds in
amounts that have exceeded the net carrying value of the destroyed assets.
We also had insurance coverage for other than assets destroyed. In 2003,
we received all outstanding insurance claims relating to the catastrophe.
In addition, we applied for governmental assistance grants related to the
catastrophe. In 2002 and 2003 we received grants aggregating $300,000. The
grants have a restriction that could require their repayment, specifically
if we were to relocate a substantial portion our operations outside of New
York City before May 1, 2005. Until such time as this restriction no
longer applies, we will classify the grants will as a liability of the
Company. We will remove the liability and record grant income on our
financial statements when these restrictions lapse or are satisfied or,
alternatively, repay such grants if the above condition is not satisfied.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with U.S. generally
accepted accounting principles requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of net
revenue and expenses during the reporting period. On an ongoing basis, we
evaluate our estimates, including those related to our allowance for
doubtful accounts, inventory reserves, goodwill and purchased intangible
asset valuations, and asset impairments. We base our estimates on
historical experience and on various other assumptions that we believe to
be reasonable under the circumstances, the results of which form the basis
for making judgments about the carrying values of assets and liabilities.
Actual results may differ from these estimates under different assumptions
or conditions.
We believe the following critical accounting policies, among others,
affect the significant judgments and estimates we use in the preparation
of our consolidated financial statements:
23
Revenue Recognition
We recognize product revenue when persuasive evidence of an arrangement
exists, the sales price is fixed, the service is performed or products are
shipped to customers, which is when title and risk of loss transfers to
the customers, and collectibility is reasonably assured.
Allowance for Doubtful Accounts
We evaluate the collectibility of our accounts receivable based on a
combination of factors. In circumstances where we are aware of a specific
customer's inability to meet its financial obligations to us, we record a
specific allowance to reduce the net receivable to the amount we
reasonably believe will be collected. For all other customers, we record
allowances for doubtful accounts based on the length of time the
receivables are past due, the prevailing business environment and our
historical experience. If the financial condition of our customers were to
deteriorate or if economic conditions were to worsen, additional
allowances may be required in the future.
At March 31, 2004, our allowance for doubtful accounts was $58,500 or
8.49% of gross receivables, compared to $51,500 or 19.8% of gross
receivables as of December 31, 2003. The decrease in the reserve as a
percentage of gross receivable from prior period is the result of a
significant increase in accounts receivable and a significant decrease in
the need for an allowance for doubtful accounts.
Inventory Valuation
At each balance sheet date, we evaluate our ending inventories for excess
quantities and obsolescence. This evaluation includes analyses of sales
levels by product and projections of future demand. If inventories on hand
are in excess of forecasted demand, we provide appropriate reserves for
such excess inventory. If we have previously recorded the value of such
inventory determined to be in excess of projected demand, or if we
determine that inventory is obsolete, we write off these inventories in
the period the determination is made. Remaining inventory balances are
adjusted to approximate the lower of our cost or market value. If future
demand or market conditions are less favorable than our projects,
additional inventory write-downs may be required, and would be reflected
in cost of revenues in the period the revision is made.
Valuation of Goodwill, Purchased Intangible Assets
and Long-Lived Assets
We perform goodwill impairment tests on an annual basis and on an interim
basis if an event or circumstance indicates that it is more likely than
not that impairment has occurred. We assess the impairment of other
amortizable intangible assets and long-lived assets whenever events or
changes in
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circumstances indicate that the carrying value may not be recoverable.
Factors we consider important that could trigger an impairment review
include significant underperformance to historical or projected operating
results, substantial changes in our business strategy and significant
negative industry or economic trends. If such indicators are present, we
evaluate the fair value of the goodwill. For other intangible assets and
long-lived assets we determine whether the sum of the estimated
undiscounted cash flows attributable to the assets in question is less
than their caring value. If less, we recognize an impairment loss based on
the excess of the carrying amount of the assets over their respective fair
values. Fair value of goodwill is determined by using a valuation model
based on market capitalization. Fair value of other intangible assets and
long-lived assets is determined by future cash flows, appraisals or other
methods. If the long-lived asset determined to be impaired is to be held
and used, we recognize an impairment charge to the extent the anticipated
net cash flows attributable to the asset are less than the asset's
carrying value. The fair value of the long-lived asset then becomes the
asset's new carrying value, which we depreciate over the remaining
estimated useful life of the asset.
Recent Accounting Pronouncements
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities." In general, a variable
interest entity is a corporation, partnership, trust, or any other legal
structure used for business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors that do not
provide sufficient financial resources for the entity to support its
activities. FIN 46 requires certain variable interest entities to be
consolidated by the primary beneficiary of the entity if the investors do
not have the characteristics of a controlling financial interest or do not
have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. The
consolidation requirements of FIN 46 apply immediately to variable
interest entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or interim
period beginning after December 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31,
2003, regardless of when the variable interest entity was established. The
adoption of this statement has had no effect on the Company's financial
position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS
No. 149 amends and clarifies financial accounting and reporting for
derivative instruments, including certain derivative instruments embedded
in other contracts (collectively referred to as derivatives) and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This Statement requires that contracts
with comparable characteristics be accounted for consistently as either
derivatives or hybrid instruments. This Statement is effective for
contracts entered into or modified after June 30, 2003,
25
and for hedging relationships designated after June 30, 2003. The adoption
of this statement has had no effect on our financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity." SFAS No. 150 changes the accounting for certain financial
instruments that under previous guidance issuers could account for as
equity. It requires that those instruments be classified as liabilities in
balance sheets. The guidance in SFAS No. 150 is generally effective for
all financial instruments entered into or modified after May 31, 2003, and
otherwise is effective on July 1, 2003. The adoption of this statement has
had no effect on our financial statements.
A. Results of Operations: Three-Month Period Ended March 31, 2004 Compared to
the Three-Month Period Ended March 31, 2003
Revenues
Total revenues increased to $982,962 for the three-month period ended
March 31, 2004 from $45,039 for the three-month period ended March 31,
2003 due to the acquisition of SRC and its subsidiaries in April 2003.
Product sales income increased to $631,438 for the three-month period
ended March 31, 2004 from nil for the three-month period ended March 31,
2003 due to the acquired operations of SRC and its subsidiaries in April
2003.
Service fee income increased to $320,135 for the three-month period ended
March 31, 2004 from nil for the three-month period ended March 31, 2003
due to the acquired operations of SRC and its subsidiaries in April 2003.
Internet related income decreased to $31,369 for the three-month period
ended March 31, 2004 from $45,039 for the three-month period ended March
31, 2003 as the operations of our subsidiary, CareerEngine, Inc. have
continued to decline due to our relatively small size in the e-recruiting
industry.
Cost of Goods Sold
Costs of goods sold, which relates to product sales and related service
fee income increased to $503,699 for the three-month period ended March
31, 2004 from nil for the three-month period ended March 31, 2003 due to
the acquired operations of SRC and its subsidiaries in April 2003.
Other Expenses
Total other expenses increased to $747,238 for the three-month period
ended March 31, 2004 from $200,302 for the three-month period ended March
31, 2003 due to the acquired operations, in April 2003, of SRC and its
subsidiaries.
26
Selling expenses increased to $24,720 for the three-month period ended
March 31, 2004 from nil for the three-month period ended March 31, 2003
due to the acquired operations, in April 2003, of SRC and its
subsidiaries.
Compensation and related costs increased to $368,562 for the three-month
period ended March 31, 2004 from $90,231 for the three-month period ended
March 31, 2003 due to the acquired operations and related increase in
personnel, in April 2003, of SRC and its subsidiaries.
General and administrative expenses increased to $300,216 for the
three-month period ended March 31, 2004 from $98,988 for the three-month
period ended March 31, 2003 due to the costs associated with the
acquisition and related operations of SRC and its subsidiaries, and the
professional fees associated the significantly increased operations of the
Company.
Depreciation and amortization expenses increased to $47,499 for the
three-month period ended March 31, 2004 from $11,083 for the three-month
period ended March 31, 2003, due to the net effect of the depreciation and
amortization expense relating to the relatively long-life fixed assets and
intellectual property rights associated with the acquisition of SRC and
its subsidiaries in the three-month period ended March 31, 2004, and the
depreciation of certain short-life assets of the Company that remained in
the three-month period ended March 31, 2003.
Other Items
Amortization of debt discount increased to $124,821 for the three-month
period ended March 31, 2004 from nil for the three-month period ended
March 31, 2003 due to the commencement, in May 2003, of amortization of
the debt discount ($699,000) related to the newly issued 10% subordinated
notes.
Interest expense decreased to $81,182 for the three-month period ended
March 31, 2004 from $87,942 for the three-month period ended March 31,
2003 due primarily to the net effect of the issuance of the Company's 10%
and 8% subordinated notes in April 2003 and the cessation of interest
expense on a subsidiary's 12% Debentures Payable and Tax Assessment
Payable in July and August 2003.
Operating Loss
On a pre-tax basis, we had a net loss before income taxes of $473,834 for
the three-month period ended March 31, 2004 compared with a net loss
before income taxes of $242,923 for the three-month period ended March 31,
2003.
Our net loss for the three-month period ended March 31, 2004 was $473,834
compared with a net loss of $242,923 for the three-month period ended
March 31, 2003. For the three-month period ended March 31, 2004, net loss
per common share, basic and diluted, was $0.05 per share. For the
three-month period ended
27
March 31, 2003, net loss per common share, basic and diluted, was $0.04
per share.
B. Liquidity and Capital Resources
The Company has incurred substantial losses, sustained substantial cash
outflows from operating activities and had a working capital deficit at
March 31, 2004 and December 31, 2003. The above factors raise substantial
doubt about the Company's ability to continue as a going concern. The
Company's continued existence depends on its ability to obtain additional
equity and/or debt financing to fund its operations, financial obligations
as they become due, and ultimately to achieve profitable operations. The
Company is continuously in the process of raising additional financing and
has initiated a cost reduction strategy. At March 31, 2004 and December
31, 2003, management believed that the working capital deficit, losses and
negative cash flow will ultimately be improved by (i) the acquisitions of
SRC and ECI, (ii) cost reduction strategies initiated in January 2004, and
(iii) additional equity and debt financing activities in addition to those
set forth in the financial statements. On January 2, 2004, the Company
received a notice dated December 31, 2003 from the American Stock Exchange
indicating that the Company had demonstrated compliance with the
requirement for continued listing on the Exchange. As is the case for all
listed issuers, the Company's continued listing eligibility will be
assessed on an ongoing basis; however, during the year ending December 31,
2004, the Company will be subject to additional scrutiny (as set forth in
Section 1009(h) of the AMEX Company Guide) as is the case for any listed
company that has regained compliance. There is no assurance that the
Company can obtain additional financing or achieve profitable operations
or generate positive cash flow.
Off-Balance Sheet Arrangements
At March 31, 2004 and December 31, 2003, the Company had no off-balance
sheet arrangements.
Operating Activities
We utilized $722,589 of cash in operating activities during the
three-month period ended March 31, 2004. We had a net loss of $473,834
during this period, which included an aggregate of $179,320 of non-cash
items, including depreciation and amortization, amortization of debt
discount and allowance for doubtful accounts. In addition to the impact of
non-cash items, our operating activities for the three-month period ended
March 31, 2004 also reflected an increase in accounts receivable,
inventory, prepaid expenses and other assets, and accrued expenses and
other liabilities. Our significant increase in accounts receivable is
principally due to the completion of our contract with the Nevada
Department of Transportation.
We utilized $86,453 of cash in operating activities during the three-month
period ended March 31, 2003. We had a net loss of $242,923 during this
period which
28
included depreciation, a non-cash item, amounting to $11,083. In addition
to the impact of non-cash items, our operating activities for the
three-month period ended March 31, 2003 also reflected an decrease in
accounts receivable, and an increase accrued expenses and other
liabilities.
On January 21, 2004, we took several initiatives to address our operating
cash deficiency, which included, but were not limited to, the reduction
and/or elimination of certain executive salaries, waiving of certain
interest payments due officers and/or directors, waiving of certain
accounts receivable due an officer and employee, and the reduction of
certain administrative costs. In addition, we raised gross proceeds of
$700,000 (net cash proceeds of $571,000) in February 2004 from the sale of
our common stock (see "Financing Activities" below), and restructured
certain short-term credit arrangements into a $300,000 Note payable due in
February 2005 (see Note A to our Consolidated Financial Statements).
Financing Activities
On April 23, 2003, we issued $1,000,000 in principal amount of our 10%
Subordinated Notes due April 30, 2004 to investors for a 15% non-dilutive
interest in the Company in the form of 4,165,800 cashless Class B
Warrants, each to purchase one share of Common Stock at $0.50 per share.
We had the option to extend the maturity date of the notes to April 30,
2005 in consideration for issuing the noteholders an additional 4%
non-dilutive interest in the Company. The notes also require prepayment in
an amount equal to 100% of any net financing proceeds obtained by us after
the issuance of the notes. The noteholders waived this provision to the
extent of $2,000,000 through April 15, 2004, of which $1,200,000 was
raised. The investors included two of our officers. Interest is payable,
in arrears, calendar quarterly. We valued the Warrants, utilizing the
Black-Scholes Pricing Model, at $699,000, which is being accounted for as
debt discount and is being amortized ratably over the initial one-year
term of the Notes.
On March 12, 2004, we notified the Class B Warrant holders that, to
satisfy the 15% non-dilutive provisions of their Warrants, these Warrants
were now exercisable for an aggregate of 5,245,200 shares of our common
stock at approximately $0.40 per share. On this date, we also exercised
our option to extend the maturity date of the notes to April 30, 2005 and
satisfied the requirement for the additional 4% non-dilutive interest in
the Company by issuing to the noteholders Class B Warrants to purchase an
additional 1,708,900 shares of our common stock at $0.50 per share. The
non-dilutive provisions of the Warrants terminate when all of the notes
have been paid in full.
In addition, on September 17, 2003, we sold 1,250,000 shares of our common
stock at $0.40 per share to an existing noteholder and stockholder of the
Company.
29
On February 10, 2004, the Company sold 1,750,000 shares of our common
stock at $0.40 per share in consideration of $700,000 cash (net cash
proceeds of $571,000).
We are using the funds obtained from these financings to pay certain ECI
notes payable and for working capital. The financings were effected
pursuant to the exemption from the registration provisions of the
Securities Act of 1993 provided by Section 4(2) thereof.
We did not have any material commitments for capital expenditures as of
March 31, 2004.
C. Inflation
Due to the nature of our business, inflation does not significantly impact
the Company's operations.
Item 3. Controls and Procedures
The Chief Executive Officer and Chief Financial Officer of the Company
have conducted an evaluation of the effectiveness of disclosure controls
and procedures pursuant to Exchange Act Rule 13a-14. Based on that
evaluation, they have concluded that the Company's disclosure controls and
procedures are effective in ensuring that all material information
required to be filed in this Quarterly Report on Form 10-QSB has been made
known to them in a timely fashion. There have been no significant changes
in internal controls, or in other factors that could significantly affect
internal controls, subsequent to the date they completed their evaluation.
30
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is a party to various vendor related litigations. Based on the
opinion of management and legal counsel, the Company has accrued a
liability of approximately $100,000.
Item 5. Other Information.
On April 28, 2004, the Company's Board of Directors approved the Company's
Code of Business Conduct and Ethics for the Directors, Officers and
Employees of CNE Group, Inc. (the "Code"). The Company has posted the Code
on its corporate website: www.cnegroupinc.com.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 from the Company's Chief Executive Officer
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 from the Company's Chief Financial Officer
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
A statement regarding the computation of per share earnings is
omitted because the computation is described in Note B of the
Notes to Consolidated Financial Statements (Unaudited) in this
Form 10-QSB.
(b) Reports on Form 8-K:
The Company filed a report on Form 8-K on February 10, 2004.
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CNE GROUP, INC.
/s/ George W. Benoit
-----------------------------------------
Date: May 24, 2004 George W. Benoit, Chairman of the Board
of Directors, and Chief Executive
Officer
/s/ Anthony S. Conigliaro
-----------------------------------------
Date: May 24, 2004 Anthony S. Conigliaro, Vice President and
Chief Financial Officer
32