UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended May 31, 2004.
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from ________________ to ________________.
Commission file number 0-4465
eLEC Communications Corp.
(Exact Name of Small Business Issuer as Specified in Its Charter)
New York 13-2511270
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
75 South Broadway, Suite 302, White Plains, New York 10601
(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number, Including Area Code: 914-682-0214
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 |_|.
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: 16,259,782 shares of Common
Stock, par value $.10 per share, as of June 30, 2004.
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Balance Sheet
May 31, 2004
------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 206,695
Restricted cash 258,924
Accounts receivable, net 647,645
Tax refund receivable 145,000
Prepaid expenses and other current assets 171,476
------------
Total current assets 1,429,740
Property, plant and equipment, net 20,899
Other assets 68,000
------------
Total assets $ 1,518,639
============
Liabilities and stockholders' equity deficiency
Current liabilities:
Current maturities of capital lease obligations $ 34,938
Accounts payable and accrued expenses 2,071,694
Due to bankruptcy creditors 258,924
Due to related parties 7,556
Deferred revenue 147,660
------------
Total current liabilities 2,520,772
------------
Stockholders' equity deficiency:
Common stock $.10 par value, 50,000,000 shares authorized,
16,265,282 shares issued 1,626,528
Capital in excess of par value 25,636,884
Deficit (28,249,499)
Treasury stock at cost, 5,500 shares (13,750)
Accumulated other comprehensive loss, unrealized loss on securities (2,296)
------------
Total stockholders' equity deficiency (1,002,133)
------------
Total liabilities and stockholders' equity deficiency $ 1,518,639
============
See notes to the condensed consolidated financial statements.
2
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Statements of Operations and Comprehensive Income
(Unaudited)
For the Six Months Ended For the Three Months Ended
May 31, 2004 May 31, 2003 May 31, 2004 May 31, 2003
------------ ------------ ------------ ------------
Revenues $ 3,769,924 $ 2,500,445 $ 1,895,932 $ 1,153,416
------------ ------------ ------------ ------------
Costs and expenses:
Costs of services 1,796,701 1,337,129 916,626 579,434
Selling, general and administrative 2,101,067 2,780,871 1,044,355 1,247,456
Depreciation and amortization 7,811 63,643 3,953 32,827
------------ ------------ ------------ ------------
Total costs and expenses 3,905,579 4,181,643 1,964,934 1,859,717
------------ ------------ ------------ ------------
Loss from operations (135,655) (1,681,198) (69,002) (706,301)
------------ ------------ ------------ ------------
Other income (expense):
Interest expense (3,544) (69,444) (782) (34,357)
Other income 51,069 164,680 21,988 79,622
Gain on debt reduction in bankruptcy 904,027 -- 852,553 --
Gain on sale of assets -- 2,256,855 -- 659,966
Gain on sale of investment securities and other
investments 770 83,761 770 49,925
------------ ------------ ------------ ------------
952,322 2,435,852 874,529 755,156
------------ ------------ ------------ ------------
Net income before income tax benefit 816,667 754,654 805,527 48,855
Income tax benefit 47,937 -- 2,937 --
------------ ------------ ------------ ------------
Net income 864,604 754,654 808,464 48,855
Other comprehensive income (loss) -
unrealized gain (loss) on marketable securities (2,296) 4,226 (2,296) 13,796
------------ ------------ ------------ ------------
Comprehensive income $ 862,308 $ 758,880 $ 806,168 $ 62,651
============ ============ ============ ============
Basic and diluted earnings per share $ 0.05 $ 0.05 $ 0.05 $ 0.00
============ ============ ============ ============
Weighted average number of common shares
outstanding
Basic 16,258,730 15,608,282 16,259,782 15,608,282
============ ============ ============ ============
Diluted 16,580,715 15,629,293 16,592,854 15,632,209
============ ============ ============ ============
See notes to the condensed consolidated financial statements.
3
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Six Months Ended
May 31, 2004 May 31, 2003
------------ ------------
Net cash used in operating activities: ($450,810) ($745,399)
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment (3,319) --
Purchase of investment securities (4,546) --
Proceeds from sale of investment securities and other investments 770 153,227
Proceeds from the sale of property and equipment -- 15,650
Proceeds from note -- 29,102
--------- ---------
Net cash (used in) provided by investing activities (7,095) 197,979
--------- ---------
Cash flows from financing activities:
Repayment of long-term debt (4,422) (57,819)
--------- ---------
Net cash used in financing activities (4,422) (57,819)
--------- ---------
Decrease in cash and cash equivalents (462,327) (605,239)
Cash and cash equivalents at beginning of period 669,022 938,528
--------- ---------
Cash and cash equivalents at the end of period $ 206,695 $ 333,289
========= =========
See notes to the condensed consolidated financial statements.
4
eLEC COMMUNICATIONS CORP.
Notes To Condensed Consolidated Financial Statements (Unaudited)
Note 1-Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB of Regulation
S-B. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three-month or six-month periods ended May
31, 2004 are not necessarily indicative of the results that may be expected for
the year ended November 30, 2004. For further information, refer to the
consolidated financial statements and footnotes thereto included in our Annual
Report on Form 10-KSB for the year ended November 30, 2003.
Note 2-Principal Financing Arrangements
At May 31, 2004, we had no financing arrangements. See the discussion on
liquidity below.
Note 3-Investment Securities
Details as to our investment securities included in prepaid expenses and other
current assets at May 31, 2004 are as follows:
Fair Unrealized
Cost Value Holding Loss
---- ----- ------------
Equity securities $4,546 $2,250 $2,296
Note 4-Major Customer
During the six and three months ended May 31, 2004 and 2003, no one customer
accounted for more than 10% of our revenue.
Note 5-Income Taxes
At November 30, 2003, we had net operating loss carryforwards for Federal income
tax purposes of approximately $19,000,000 expiring in the years 2004 through
2022. There is an annual limitation of approximately $187,000 on the utilization
of approximately $1,300,000 of such net operating loss carryforwards under the
provisions of Internal Revenue Code Section 382. Income taxes have not been
provided in 2004 and 2003 due to the usage of net operating loss carryovers in
2003 and the tax-free gain on the bankruptcy settlement in 2004. As of May 31,
2004 and November 30, 2003 the company's deferred tax asset in the amount of
$6,700,000 was reduced to zero by a valuation allowance. The income tax benefit
recorded for fiscal 2004 represents adjustments to previously recorded accruals.
5
Note 6- Earnings Per Common Share
Basic earnings per common share are calculated by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
earnings per share is calculated by dividing net income by the sum of the
weighted average number of common shares outstanding plus all additional common
shares that would have been outstanding if potentially dilutive securities had
been issued. A reconciliation of the shares used in the computation of our basic
and diluted earnings per common share for the six and three months ended May 31,
2004 and 2003 is as follows:
Six Months Ended
May 31, 2004 May 31, 2003
------------ ------------
Weighted average common shares outstanding 16,258,730 15,608,282
Dilutive effect of securities 321,985 21,011
---------- ----------
16,580,715 15,629,293
========== ==========
Three Months Ended
May 31, 2004 May 31, 2003
------------ ------------
Weighted average common shares outstanding 16,259,782 15,608,282
Dilutive effect of securities 333,072 23,927
---------- ----------
16,592,854 15,632,209
========== ==========
For the six and three months ended May 31, 2004 and 2003, the computation of
diluted earnings per share excluded the effect of the assumed exercise of
approximately 1,700,000 and 1,750,000 outstanding stock options and warrants
that were outstanding because the effect would be anti-dilutive.
Note 7-Subsidiary's Plan of Reorganization
On April 8, 2004, the United States Bankruptcy Court for the Southern District
of New York confirmed a Plan of Reorganization (the "Plan") of Telecarrier. On
July 29, 2002, Telecarrier had filed a voluntary petition for relief under
Chapter 11 of the Federal Bankruptcy Code in the United States Bankruptcy Court
for the Southern District of New York. The Plan authorized us to purchase the
reorganized capital stock of Telecarrier for a purchase price of $325,000.
Subsequent to April 8, 2004, we deposited $325,000 into a segregated
distribution account, the funds of which will be distributed in accordance with
the Plan in full satisfaction of pre-petition claims, including an unsecured
line of credit, certain post-petition claims, administrative claims and legal
fees, amounting to an aggregate of approximately $1,229,000 at such date. On
June 22, 2004, the Bankruptcy Court approved the payment of legal fees to be
paid out of the segregated bank account. We are now able to calculate and make
the appropriate remittance to the unsecured creditors for the remainder of the
$325,000 purchase price of the reorganized Telecarrier. Approximately $66,000 in
administrative claims had been paid by May 31, 2004. As a result of being
judicially released from the liabilities on April 8, 2004, the Company has
recorded the gain on extinguishment of debt as of May 31, 2004.
6
For the six months ended May 31, 2004, Telecarrier reported a gain of $904,027
resulting from the disposition of liabilities and claims as follows:
Pre-petition claims:
Unsecured line of credit $ 150,000
Trade payables and due to related party 618,481
Other accrued expenses 103,250
----------
Total pre-petition claims 871,731
Post-petition payables and accrued expenses 68,124
Administrative claims and legal costs 289,172
----------
Total claims 1,229,027
Plan proceeds 325,000
----------
Gain on debt reduction $ 904,027
==========
Telecarrier had an agreement, effective January 2, 2002, with Telco Services,
Inc. ("Telco"), a corporation owned by a former shareholder, under which Telco
provided Telecarrier with collection, sales and other services. As a result of a
court-stipulated agreement between Telecarrier and Telco, entered into on
February 6, 2004, the amount owed Telco for such services was reduced by
approximately $51,000 and such reduction was reported as a gain for the
three-month period ended February 29, 2004. As of May 31, 2004, we paid $65,000
in administrative claims to Telco and at such date owed Telco approximately an
additional $29,000 as an unsecured creditor of Telecarrier. The President of
Telco is also the President of Glad Holdings (See Note 9).
Note 8-Risks and Uncertainties
We buy substantially all of our telecommunication services from Regional Bell
Operating Companies ("RBOCs"), and are, therefore, highly dependent upon them.
We believe our relationship with the RBOCs from which we purchase services is
satisfactory. We also believe there are other suppliers of telecommunication
services in the geographical locations in which we conduct business. In
addition, we are at risk to regulatory agreements that govern the rates we are
to be charged. In light of the foregoing, it is possible that the loss of one or
more of our relationships with the RBOCs or a significant unfavorable change in
the regulatory agreements structure would have a severe near-term impact on our
ability to conduct our telecommunications business.
Future results of operations involve a number of risks and uncertainties.
Factors that could affect future operating results and cash flows and cause
actual results to vary materially from historical results include, but are not
limited to:
- Our business strategy with respect to bundled local and long
distance services may not succeed.
- Failure to manage, or difficulties in managing, our growth,
operations or restructurings, including attracting and retaining
qualified personnel and opening up new territories for its service
with favorable gross margins.
- Dependence on the availability, pricing or functionality of
incumbent local telephone companies' networks, as they relate to the
unbundled network element platform or the resale of such services.
7
- Our operations are currently using cash, and our cash position is
deteriorating. We may run out of cash and be unable to conduct
business.
- Increased price competition in local or long distance service.
- Failure or interruption in our network or information systems.
- Changes in government policy, regulation or enforcement. (See
management's analysis and discussion of financial condition and
results of operation and regulatory developments.
- Failure of our collection management system and credit controls
efforts for customers.
- Inability to adapt to technological change.
- Competition in the telecommunications industry.
- Inability to manage customer attrition or bad debt expense.
- Adverse change in our relationship with third party carriers.
- Failure or bankruptcy of other telecommunications companies upon
which we rely for services and revenues.
Note 9-Asset Sale
On September 3, 2002, we entered into an agreement with Essex Acquisition Corp.
("EAC"), a wholly-owned subsidiary of BiznessOnline.com, Inc. ("Biz"), to sell
substantially all the assets (amounting to $1,102,103 at November 30, 2002) of
our former wholly-owned subsidiary, Essex Communications Inc. ("Essex"), for
five dollars plus the assumption of certain liabilities of Essex (amounting to
$10,081,382 at November 30, 2002), including all obligations due and payable to
Essex's largest vendor, Verizon Services Corp. ("Verizon"). EAC entered into an
agreement with Verizon that provided a payment schedule for the liabilities
assumed from Essex and Verizon granted EAC a discount on the assumed liabilities
provided EAC adheres to the payout schedule. EAC also paid us $270,000 to
reimburse us for amounts paid by us to Essex's former lender, Textron Financial,
formerly known as RFC Capital Corporation. The sale to EAC closed on December
31, 2002. As the creditors of Essex did not consent to the assignment of their
claims, Essex had remained liable for substantially all the obligations assumed
in the sale until such time as they were paid. The June 30, 2002 unaudited
financial statements of Biz indicated that Biz had a stockholders' equity
deficiency of approximately $20,500,000 and had negative working capital of
approximately $3,500,000. The most recent independent auditor's report of Biz
expressed significant doubt about Biz's ability to continue as a going concern.
These factors indicated there was significant uncertainty as to the ability of
Biz and its subsidiaries' to repay the obligations described above. Accordingly,
we did not record any gain until Essex was released from the assumed
obligations. During the six and three-month periods ended May 31, 2003, EAC
settled liabilities of approximately $2,257,000 and $660,000, respectively, and
accordingly, gain was recorded during such periods for such amounts.
8
On September 11, 2003, we sold all the outstanding capital stock of Essex to
Glad Holdings, LLC, ("Glad Holdings") a New Jersey limited liability company
owned by a former shareholder of the company, for an aggregate purchase price of
$100 and a general release from Glad Holdings with respect to any and all
matters arising prior to September 11, 2003. Based on all available information
and consultation with counsel, we concluded that it was unlikely that any
creditor of Essex would be able to hold us responsible for any debts or
liabilities of Essex. As a result, on a consolidated basis, we believe we have
been released of all the liabilities related to Essex, which amounted to
approximately $7,314,000 on such date, and accordingly, recorded such amount as
gain in the fourth quarter of fiscal 2003.
The following unaudited pro forma summary presents consolidated financial
information of our operations for the six- and three-month periods ended May 31,
2004 and 2003, as if the sale of Essex's assets had occurred at the beginning of
each period presented. The pro forma amounts include certain adjustments that
eliminate all the operations of Essex for the periods presented. The pro forma
information does not necessarily reflect the actual results that would have
occurred had the sale taken place for the periods presented, nor is it
necessarily indicative of the future results of operations of the remaining
company:
For the Six Months Ended
------------------------
May 31, 2004 May 31, 2003
------------ ------------
Revenues $3,769,924 $ 1,607,249
---------- -----------
Net income (loss) $ 864,604 ($1,222,220)
---------- -----------
Basic and dilutive income (loss) per share $ 0.05 ($0.08)
---------- -----------
For the Three Months Ended
--------------------------
May 31, 2004 May 31, 2003
------------ ------------
Revenues $1,895,932 $ 1,153,416
---------- -----------
Net income (loss) $ 808,464 ($624,928)
---------- -----------
Basic and dilutive income (loss) per share $ 0.05 ($0.04)
---------- -----------
Note 10- Stock-Based Compensation Plans
We issue stock options to our employees and outside directors pursuant to
stockholder-approved stock option programs. We account for our stock-based
compensation plans under the intrinsic value method of accounting, as defined by
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. No stock-based employee compensation
cost was reflected in net income for the six and three months ended May 31, 2004
and 2003, as all options granted under these plans had an exercise price equal
to the fair market value of the underlying common stock on the date of the
grant. For pro forma disclosures, the estimated fair value of the options was
amortized over the vesting periods, which range from immediate vesting to three
years. The following table illustrates the affect on net income (loss) per share
if we had accounted for our stock option and stock purchase plans under the fair
value method of accounting under Statement of Financial Accounting Standards
9
("SFAS") No. 123, "Accounting for Stock-Based Compensation", as amended by SFAS
No.148, "Accounting for Stock-Based Compensation - Transition and Disclosure":
For the Six Months Ended For the Three Months Ended
May 31, 2004 May 31, 2003 May 31, 2004 May 31, 2003
------------ ------------ ------------ ------------
Net income as reported $ 864,604 $ 754,654 $ 808,464 $ 48,855
Deduct: Total stock-based employee
compensation expense determined
under fair value-based method
for all awards, net of related
tax effects (112,131) (149,813) (55,785) (74,906)
---------- ---------- ---------- ----------
Pro forma net income (loss) $ 752,473 $ 604,841 $ 752,679 ($26,051)
---------- ---------- ---------- ----------
Earnings (loss) per share
Basic, as reported $ .05 $ .05 $ .05 $.00
Basic, pro forma $ .05 $ .04 $ .05 ($.00)
Diluted, as reported $ .05 $ .05 $ .05 $.00
Diluted, pro forma $ .05 $ .04 $ .05 ($.00)
Note 11 Related Party Transactions
During the six and three months ended May 31, 2004 and 2003, we billed Cordia
Corporation ("Cordia"), a related party, $298,030 and $88,934 and $109,529 and
$37,458, respectively, for rent, telemarketing services, telecommunications
services, commissions and other costs, and Cordia billed us $379,996 and
$101,513 and $229,900 and $84,203, respectively, for telecommunications services
and other costs. As of May 31, 2004, we owed Cordia $7,556.
10
Item 2. Management's Analysis and Discussion of Financial Condition and Results
of Operations
The statements contained in this Report that are not historical facts are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 with respect to the financial condition, results
of operations and business of the Company, which can be identified by the use of
forward-looking terminology, such as "estimates," "projects," "plans,"
"believes," "expects," "anticipates," "intends," or the negative thereof or
other variations thereon, or by discussions of strategy that involve risks and
uncertainties. Management wishes to caution the reader of the forward-looking
statements, that such statements, which are contained in this Report, reflect
our current beliefs with respect to future events and involve known and unknown
risks, uncertainties and other factors, including, but not limited to, economic,
competitive, regulatory, technological, key employee, and general business
factors affecting our operations, markets, growth, services, products, licenses
and other factors discussed in our other filings with the Securities and
Exchange Commission, and that these statements are only estimates or
predictions. No assurances can be given regarding the achievement of future
results, as actual results may differ materially as a result of risks facing us,
and actual events may differ from the assumptions underlying the statements that
have been made regarding anticipated events. Factors that may cause our actual
results, performance or achievements, or industry results, to differ materially
from those contemplated by such forward-looking statements include, without
limitation: (1) the availability of additional funds to successfully pursue our
business plan; (2) the impact of changes the Federal Communications Commission
or State Public Service Commissions may make to existing telecommunication laws
and regulations; (3) the cooperation of incumbent carriers in implementing the
unbundled network elements platform required by the Federal Communications
Commission; (4) our ability to maintain, attract and integrate internal
management, technical information and management information systems; (5) our
ability to market our services to current and new customers and generate
customer demand for our product and services in the geographical areas in which
we operate; (6) our success in gaining regulatory approval to access new
markets; (7) our ability to negotiate and maintain suitable interconnection
agreements with the incumbent carriers; (8) the availability and maintenance of
suitable vendor relationships, in a timely manner, at reasonable cost; (9) the
intensity of competition; and (10) general economic conditions. All written and
oral forward looking statements made in connection with this Report that are
attributable to us or persons acting on our behalf are expressly qualified in
their entirety by these cautionary statements. Given the uncertainties that
surround such statements, prospective investors are cautioned not to place undue
reliance on such forward-looking statements.
Overview
eLEC Communications Corp. is a full-service telecommunications company that
focuses on developing integrated telephone service in the competitive local
exchange carrier ("CLEC") industry. We offer small businesses and residential
consumers an integrated set of telecommunications products and services,
including local exchange, local access, domestic and international long distance
telephone, and a full suite of local features and calling plans. In the states
in which we operate, we compete with the incumbent local carrier and a variety
of other competitive carriers, including companies that were originally long
distance service providers or data service providers. We find that approximately
90% of the local telephone lines in the states in which we are operating are
served by Verizon, AT&T Corp. ("AT&T") or MCI Inc. ("MCI"). Our strategy is to
offer the same telephone products and services offered by Verizon, AT&T and
11
MCI at discounts of 10% to 25% off their rates. We also strive to provide
friendly and helpful customer service that exceeds the service provided by these
large competitors.
We believe that the Telecommunications Act of 1996 (the "Telecommunications
Act"), which opened the local exchange market to competition, has created an
attractive opportunity for CLECs. Like most CLECs, our entry in this industry
was dependent upon the provisions of the Telecommunications Act that allow CLECs
to lease various elements of the networks of the incumbent local exchange
carrier ("ILEC") that are necessary to provide local telephone service in a
cost-effective manner. This aspect of the Telecommunications Act is referred to
as "unbundling" the ILEC networks, and allows us to lease unbundled network
elements on an as-needed basis and provide such elements to our customers at a
lower cost than that which the ILEC is charging. See Regulatory Developments
discussed below.
Although we believe the opportunity for CLECs is attractive, it is also
challenging. We must contend with federal and state government regulators,
rapidly changing technologies, incumbent carriers that are better staffed and
capitalized than us and real-time business partners that also carry our
customer's telephone call, whether it is local, long distance or international.
At the same time that we are managing these challenges, we also must provide
connectivity, superior customer service and a culture of continuous improvement.
Because of the complexity of the business, we have focused our energies on
simplifying our working environment and improving performance through
automation.
Other CLECs have invested a substantial amount of capital to buy
circuit-switched equipment and rollout fiber, only to find that their equipment
is severely underutilized and that there is a significant shortfall in their
revenue stream when compared to their capital investment. We refer to this
strategy as a "facilities-first" strategy, because the CLEC has invested in its
equipment and placed the equipment in service before the CLEC has developed a
customer base. Our strategy is a "customer-first," or a "deferred-build"
strategy. We invested our capital in creating web based "back-office" support
systems so that we can mine data, easily analyze our customer base, and provide
comprehensive customer service to handle repairs, moves, adds and changes to
lines. After we have obtained a substantial geographical concentration of
customers, we will make decisions regarding the purchase and installation of our
own network equipment. This strategy allows us to be very flexible with our
customer base as we grow our business. We can move our customer base to
alternative access, if appropriate, and we do not become a captive of our own
underutilized equipment, as can happen with a "facilities-first" CLEC. The
technological advances in equipment and the lowering of equipment prices have
substantiated our deferred-build strategy and have enabled us to better utilize
our limited capital.
When we lease lines from an ILEC, we use the unbundled network elements platform
("UNE-P") service offering. UNE-P allows us to lease the network elements we
need, such as the local line and the port on a local switch, so that we can
provide local dial tone service to our customers. We can provide virtually all
of the same additional voice services provided by any ILEC, such as three-way
calling, call waiting, call forwarding and caller ID. We sell our services at a
fee that is at least 10% and as much as 25% less than the rate charged by the
ILEC. We also offer a bundled package of local and regional calling minutes with
popular voice service features.
We believe UNE-P is the preferable platform under which any CLEC should operate
while it is growing and building a customer base. In March 2002, UNE-P became
more valuable to us when the costs charged to us for providing local voice
services on the UNE-P service offering in New York State were lowered. We
believe current rates are also very attractive in New Jersey,
12
Michigan and Pennsylvania. Our two CLECs, New Rochelle Telephone Corp. ("NRTC")
and Telecarrier, are selling services in New York State, New Jersey and
Pennsylvania, and are currently achieving gross margins of approximately 50%.
Regulatory Developments
Our ability to continue achieving our current level of gross margins is
dependent upon the pricing structure of the network elements that we obtain from
the ILECs. The requirement that the ILECs provide us with unbundled network
elements at the current rates is the subject of regulatory and judicial actions
that may affect their availability and pricing. Because of a legal challenge
from the ILECs, on March 2, 2004 the U.S. Court of Appeals for the District of
Columbia released a decision that reversed, vacated and remanded the FCC's
Triennial Review Order that is the basis for current pricing and unbundled
network elements availability, and is critical to our business.
On March 31, 2004, the FCC sent a letter to telecom companies urging negotiation
rather than litigation of the issues raised by the FCC's Triennial Review Order.
The letter stated that the FCC is seeking a 45-day extension of the stay that
the U.S. Court of Appeals imposed on its decision that overturned parts of the
Triennial Review Order. The FCC letter asked telecom companies to indicate by
April 6, 2004 whether they will participate in negotiations. We responded to the
FCC in writing by indicating that we will attempt to negotiate commercial
agreements with the ILECs. Several of the ILECs have expressed a willingness to
negotiate.
Although many CLECs encouraged the FCC and various elected governmental
representatives to appeal the March 2, 2004 decision, the United States
Solicitor General and the FCC failed to appeal the U. S. Court of Appeals
decision and on June 14, 2004, the United States Supreme Court rejected an
emergency request by AT&T and other CLECs to stay the ruling. Three of the five
commissioners of the FCC responded to the CLEC appeal request by writing that
they did not believe an appeal was needed because the four Bell Operating
Companies (including Verizon) verified to the FCC that they would not increase
prices to the CLECs for wholesale UNE-P until the end of the year.
FCC Chairman Powell wrote that the FCC "will promptly turn to writing a set of
sound rules that ensure access to incumbent networks where competition is truly
impaired." He also noted that he is "committed to developing competition rules
that comply with the court's mandate and are faithful to the statutory
objectives of the Telecommunications Act. Moreover, the Commission is prepared
to consider interim, transitional protections to bridge the gap that exists in
the period preceding adoption of our final rules." Commissioner Powell further
noted in a press release "The regional Bell companies have announced that they
will not unilaterally increase rates and have guaranteed the status quo until
the end of the year. Our top priority is to ensure that consumers do not
experience any disruption in service and to provide sorely needed stability in
the marketplace."
On June 8, 2004, Verizon sent us written notice that after September 9, 2004,
Verizon will no longer provide us UNE-P service for our customers who have four
or more lines. According to the notice, Verizon will continue to make local dial
tone services available on a resale basis to end users with four or more lines
after September 9, 2004. We project that buying service from Verizon on a resale
basis would make our accounts with four or more lines unprofitable to us. In
lieu of resale, CLECs may continue to try commercial negotiations with Verizon
for rates for
13
accounts with four or more lines. Our existing customer base currently has
approximately 1.5 lines per account, as we market to small businesses, home
offices and residential consumers. As a result, the four-line carve out rule is
not expected to have a major affect on our business operations. To mitigate the
impact of the rule on our larger customers, we now have the ability to provide
Voice-over-Internet Protocol ("VoIP") services to carry local voice traffic for
our larger accounts that have high speed Internet access. These services do not
rely on Verizon to originate, transport or terminate a telephone call. Instead
of routing a call through a Verizon switch, these calls travel in data packets
over a high speed Internet connection. We have a signed contract with a
wholesale carrier to terminate any voice Internet traffic for the customers to
whom we sell VoIP services. We have also signed a contract with a current
customer to provision an existing 100-line trunk to VoIP service. We have
targeted our larger accounts for this VoIP product and plan to use this product
on as many four-line accounts as we can before the September 9, 2004 change in
UNE-P availability.
Plan of Operation
Our primary methods of obtaining new customer accounts will continue to be
through telemarketing and outside sales agents. We believe these are effective
low-cost methods of building new accounts, and our past history with these
customer acquisition methods is helpful in planning and budgeting our operations
on a going forward basis. While we believe our cash balances are adequate for
continued limited growth, our cash balances are not sufficient to generate the
growth we desire or the growth that our internal operating systems are capable
of handling. We are therefore pursuing an asset-based lending agreement or a
factoring arrangement to generate the financing needed for more rapid growth.
We do not expect to purchase any significant assets or make any significant
capital expenditures in the next 12 months, although our VoIP initiative will
require some equipment that we plan to purchase with our cash on hand. We
believe our back-office systems are adequately developed and functioning well,
and we anticipate only minor expenditures to further automate such systems
during the next 12 months. We are continuing to pursue the utilization of VoIP
to carry our local voice traffic, and we entered into an agreement with a VoIP
wholesaler that allows us to sell VoIP services to end users in New York and the
New England states. We want to continue the development of our VoIP product so
that we will eventually be in a position in which we do not have to rely on any
ILEC to provide service to our customers.
We believe the most important trend in the industry will be the replacement of
traditional circuit-switched voice technology with packet-based networks. Packet
switching has tremendous advantages over circuit switching. Packets can be
transmitted over copper wire or over wireless facilities, packet-switched
equipment is substantially less expensive than circuit-switched equipment and
the price of packet-switched equipment is continually dropping, even as it
becomes technologically more sophisticated. We plan to move toward this
technology over the next six to 12 months, as this technology also allows us to
bypass the ILECs when we provide local telephone service to our customers.
Additionally, VoIP allows for added and integrated new service offerings, such
as integrated messaging, bandwidth on demand and voice emails. While we will
continue to seek and evaluate new technologies, our focus will continue to be on
building our customer base, and not in developing new technology. We plan to
continue our efforts to improve customer service and to maintain efficient
systems that will allow us to sell, provision, bill and collect, as our first
priority is to develop and maintain a stable core of customers that generates
positive cash flow from operations.
14
Six Months Ended May 31, 2004 vs. Six Months Ended May 31, 2003
Our revenues for the six-month period ended May 31, 2004 increased by
approximately $1,270,000, or approximately 51%, to approximately $3,770,000 as
compared to approximately $2,500,000 reported for the six-month period ended May
31, 2003. Included in our revenue for the six-month period ended May 31, 2003
were approximately $1,574,000 in sales reported by NRTC and Telecarrier and
approximately $893,000 in sales reported by our former wholly-owned subsidiary,
Essex (See Note 9). Revenue reported by NRTC and Telecarrier for the six-month
period ended May 31, 2004 increased by approximately $2,196,000, or
approximately 140%, over the year-ago period. We anticipate revenues for NRTC
and Telecarrier will continue to increase in the third quarter of fiscal 2004,
as we work to add new customers. While our line count and customer base has
continued to grow in the third quarter of 2004, additional growth will be
directly related to the amount of cash we have available for new line
acquisition costs. See the discussion on liquidity below.
Our gross profit for the six-month period ended May 31, 2004 increased by
approximately $810,000 to approximately $1,973,000 from approximately $1,163,000
reported in the six-month period ended May 31, 2003, and our gross profit
percentage increased to approximately 52% from approximately 47% reported in the
prior fiscal period. The increase in our gross profit and gross profit
percentage reflects our sales strategy to sell in only those states in which we
believe we will be able to achieve a margin of over 40%. The increase in gross
profit and gross profit percentage was attributable to lower buying prices from
ILECs in the states in which we operated during the first half of fiscal 2004,
compared to the states in which we were operating during the first half of 2003.
NRTC and Telecarrier are operating in states in which we can purchase unbundled
network elements at prices that are significantly lower than the prices charged
in some of the states in which our former wholly-owned subsidiary, Essex, was
operating. Our selling strategy in fiscal 2004 is to continue to penetrate
states that offer the opportunity to achieve higher margins. However, due to a
recent court ruling, as discussed above, we may not be able to continue to
achieve these margin levels in subsequent years, as Verizon plans to raise the
UNE-P rates it charges us beginning in 2005.
Selling, general and administrative expenses ("SG&A") decreased by approximately
$680,000, or approximately 24%, to approximately $2,101,000 for the six-month
period ended May 31, 2004 from approximately $2,781,000 reported in prior year
fiscal period. Approximately $645,000 of this decrease in expense was directly
related to the sale of our Essex operations, approximately $47,000 was related
to lower occupancy costs as a result of the sale of our headquarters building in
the fourth quarter of fiscal 2003, approximately $83,000 was related to a
decrease in insurance expense resulting from a settlement with our insurance
carrier on the amount of audit premiums that were recorded in the prior fiscal
year and approximately $70,000 was related to a decrease in billing costs
discussed below. These expense reductions were partially offset by an increase
of approximately $46,000 in new line acquisition costs and approximately
$124,000 in legal fees related to the bankruptcy proceedings of Telecarrier.
With the settlement of the Telecarrier bankruptcy, we expect to see a
significant reduction in our legal expenses for the remainder of fiscal 2004.
Additionally, we have seen savings in both our billing and telemarketing costs
as we curtailed our in-house efforts in both these areas in the third quarter of
fiscal 2003. By outsourcing these functions to third-party vendors, we only pay
for telephone lines billed and telemarketed lines accepted, thereby eliminating
staffing and other associated overhead cost. For the six-month period ended May
31, 2004, our SG&A costs
15
averaged approximately $350,000 per month, of which, approximately $85,000
represented new line acquisition costs.
Depreciation expense decreased by approximately $56,000, to approximately $8,000
for the six-month period ended May 31, 2004 as compared to approximately $64,000
for the six-month period ended May 31, 2003. The decline in depreciation expense
was primarily attributable to the sale of our headquarters building in the
fourth quarter of fiscal 2003 and to the sale of certain assets to EAC in the
first quarter of fiscal 2003 on December 31, 2002.
Interest expense decreased by approximately $66,000, to approximately $3,000 for
the six-month period ended May 31, 2004 as compared to approximately $69,000 for
the six-month period ended May 31, 2003. The decrease in interest expense was
partially attributable to the repayment of a mortgage note in conjunction with
the sale of our headquarters building in the fourth quarter of fiscal 2003.
Other income decreased by approximately $114,000 to approximately $51,000 for
the six-month period ended May 31, 2004 as compared to approximately $165,000
for the six-month period ended May 31, 2003. The decrease resulted primarily
from a reduction in commission and rental income.
For the six-month period ended May 31, 2004, Telecarrier reported a gain of
approximately $904,000 from debt reduction in bankruptcy (See Note 7). No such
gain was reported for the six-month period ended May 31, 2003.
Gain on the sale of assets for the six-month period ended May 31, 2003 was
approximately $2,257,000 (See Note 9). We had no such sale for the six-month
period ended May 31, 2004.
For the six-month period ended May 31, 2004, gain on the sale of investment
securities and other investments of approximately $1,000, resulted from the sale
of Cordia shares as compared to the gain of approximately $84,000 for the
six-month period ended May 31, 2003, which resulted from the sale of shares of
Cordia and Talk America Holdings Inc. ("Talk").
For the six-month period ended May 31, 2004, we recorded a tax benefit of
approximately $48,000, which resulted from the reduction of an estimated accrual
of corporate tax expense for fiscal 2003. No such benefit was recorded for the
six-month period ended May 31, 2003.
Three Months Ended May 31, 2004 vs. Three Months Ended May 31, 2003
Our revenue for the three-month period ended May 31, 2004 increased by
approximately $743,000, or approximately 64%, to approximately $1,896,000 as
compared to approximately $1,153,000 reported for the three-month period ended
May 31, 2003. No sales were reported by our former wholly-owned subsidiary,
Essex, for the three-month period ended May 31, 2003 (See Note 9). We anticipate
revenues of NRTC and Telecarrier to continue to increase in the third quarter of
fiscal 2004, as we work to add new customers. While our line count and customer
base has continued to grow in the third quarter of 2004 additional growth will
be directly related to the cash we have available for new line acquisition
costs. See the discussion on liquidity below.
16
Our gross profit for the three-month period ended May 31, 2004 increased by
approximately $405,000 to approximately $979,000 from approximately $574,000
reported in the three-month period ended May 31, 2003, and our gross profit
percentage increased to approximately 52% from approximately 50% reported in the
prior fiscal period. The increase in our gross profit was a direct result of
increased sales due to continued growth in our line count and customer base. The
gross profit percentage reflects our sales strategy to sell in only those states
in which we believe we will be able to achieve a margin of over 40%. NRTC and
Telecarrier are operating in states in which we can purchase unbundled network
elements at prices that are significantly lower than the prices charged in some
of the states in which our formerly wholly-owned subsidiary, Essex, was
operating.
SG&A decreased by approximately $203,000, or approximately 16%, to approximately
$1,044,000 for the three-month period ended May 31, 2004 from approximately
$1,247,000 reported in the prior year fiscal period. Approximately $26,000 of
this decrease in expense was related to lower occupancy costs as a result of the
sale of our headquarters building in the fourth quarter of fiscal 2003,
approximately $83,000 was related to a decrease in insurance expense resulting
from a settlement with our insurance carrier on the amount of audit premiums
that were recorded in the prior fiscal year and approximately $54,000 was
related to a decrease in billing costs. These expense reductions were partially
offset by an increase of approximately $15,000 in new line acquisition costs and
approximately $40,000 in legal fees related to the bankruptcy proceedings of
Telecarrier. With the settlement of the Telecarrier bankruptcy, we expect to see
a significant reduction in our legal expenses for the remainder of fiscal 2004.
Additionally, we have seen savings in both our billing and telemarketing costs
as we curtailed our in-house efforts in both these areas in the third quarter of
fiscal 2003. By outsourcing these functions to third-party vendors we only pay
for telephone lines billed and telemarketed lines accepted, thereby eliminating
staffing and other associated overhead cost. For the three-month period ended
May 31, 2004, our SG&A costs averaged approximately $350,000 per month, of
which, approximately $80,000 represented new line acquisition costs.
Depreciation expense decreased by approximately $29,000, to approximately $4,000
for the three-month period ended May 31, 2004 as compared to approximately
$33,000 for the three-month period ended May 31, 2003. The decline in
depreciation expense was primarily attributable the sale of our headquarters
building in the fourth quarter of fiscal 2003.
Interest expense decreased by approximately $33,000, to approximately $1,000 for
the three-month period ended May 31, 2004 as compared to approximately $34,000
for the three-month period ended May 31, 2003. The decrease in interest expense
was primarily attributable to the repayment of a mortgage note in conjunction
with the sale of our headquarters building in the fourth quarter of fiscal 2003.
Other income decreased by approximately $58,000 to approximately $22,000 for the
three-month period ended May 31, 2004 as compared to approximately $80,000 for
the three-month period ended May 31, 2003. The decrease resulted primarily from
a reduction in commission and rental income.
For the three-month period ending May 31, 2004 Telecarrier reported a gain of
approximately $853,000 from debt reduction in bankruptcy (See Note 7).
17
Gain on the sale of assets for the three-month period ended May 31, 2003 was
approximately $660,000 (See Note 9). We had no such sale for the three-month
period ended May 31, 2004.
For the three-month period ended May 31 2004, gain on the sale of investment
securities and other investments of approximately $1,000, resulted from the sale
of Cordia shares as compared to the gain of approximately $50,000 for the
three-month period ended May 31, 2003, which resulted from the sale of Talk
shares.
For the three-month period ended May 31, 2004, we recorded a tax benefit of
approximately $3,000, which resulted from the reduction of an estimated accrual
of corporate tax expense for fiscal 2003. No such benefit was recorded for the
three-month period ended May 31, 2003.
Liquidity and Capital Resources
At May 31, 2004, we had cash and cash equivalents of approximately $207,000 and
negative working capital of approximately $1,091,000. Additionally, we had cash
balances at May 31, 2004 of approximately $259,000 segregated to pay, in
accordance with the Plan, pre-petition and administrative claims of Telecarrier.
Net cash used in operating activities aggregated approximately $451,000 and
$745,000 in the six-month periods ended May 31, 2004 and 2003, respectively. The
principal use of cash in fiscal 2004 was the net change in operating assets and
liabilities, which was partially offset by the net income for the period of
approximately $865,000. The principal use of cash in fiscal 2003 was the net
income for the period of approximately $755,000, which was offset by a non-cash
item, the net effect of the gain of approximately $2,257,000 on the transfer of
assets of our former Essex subsidiary (See Note 9).
Net cash used in investing activities aggregated approximately $7,000 in the
six-month period ended May 31, 2004 as compared to net cash provided by
investing activities that aggregated approximately $198,000 for the six-month
period ended May 31, 2003. The principal use of cash in fiscal 2004 was the
purchase of equipment. The principal sources of cash in fiscal 2003 were the
proceeds from the sale of investment securities and other investments of
approximately $153,000, the proceeds from the sale of equipment of approximately
$15,000 and the proceeds of a note of approximately $29,000.
Net cash used in financing activities aggregated approximately $4,000 and
$58,000 in the six-month periods ended May 31, 2004 and 2003, respectively. In
fiscal 2004 and 2003, net cash used in financing activities resulted from the
repayment of debt.
For the six-month period ended May 31, 2004, we spent approximately $3,000 on
capital expenditures. We believe our back-office systems are adequately
developed and functioning well, and we anticipate only minor expenditures to
further automate such systems during the next 12 months. We are continuing to
pursue the utilization of a packet-based network, such VoIP, to carry our local
voice traffic. This technology is used to transmit voice conversations over a
data network using the Internet Protocol. Such data network may be the Internet
or may be a managed network. We do not plan to have substantial equipment
purchases to carry out this initiative, although we may consider sharing a
switch with another service provider.
We have stock purchase warrants that entitle us to purchase approximately 95,000
shares of Talk. The warrant exercise price is $6.30 per share and, at June 30,
2004, our warrants were in-the-
18
money, as Talk common stock was trading at approximately $7.67 per share at such
date. We have been in discussions with Talk management regarding our intention
to exercise the warrants during fiscal 2004, as we plan to use the proceeds of
the warrants to generate additional cash for line acquisition costs.
The report of the independent auditors on our 2003 financial statements
indicates there is substantial doubt about our ability to continue as a going
concern. The auditors noted a deficit in working capital and continuing losses
from operations. We are continuously working to improve our financial condition
and we are now operating our business with fixed costs that are substantially
lower than our fixed overhead during the previous three years. As discussed in
Note 7, on April 8, 2004, the bankruptcy court approved our purchase of the
reorganized Telecarrier for a total purchase price of $325,000. This purchase
and reorganization eliminated approximately $1,229,000 in liabilities and
administrative claims that were carried on our consolidated balance sheet. With
the purchase of a reorganized Telecarrier, we anticipate we will be able to
achieve profitable operations and will be able to further pursue implementation
of VoIP technology to establish an additional network on which to carry the
voice traffic of our customers. We are currently negotiating with a lender for a
factoring facility that would, if executed, provide us with financing of up
to 75% of our current accounts receivables and 75% of future invoices. We
anticipate that with such financing, we will be able to achieve our plan of
making an operating profit before the end of this fiscal year. However, our
inability to secure such financing or our inability to carry out this plan may
result in unprofitable operations, and the eventual shut down of vendor credit
facilities, which would adversely affect our ability to continue operating as a
going concern.
Item 3. Controls and Procedures
Disclosure Controls and Procedures. Our management, with the
participation of our chief executive officer/chief financial officer, has
evaluated the effectiveness of our disclosure controls and procedures (as such
term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange
Act of 1934, as amended (the "Exchange Act")) as of the end of the period
covered by this report. Based on such evaluation, our chief executive
officer/chief financial officer has concluded that, as of the end of such
period, our disclosure controls and procedures are effective in recording,
processing, summarizing and reporting, on a timely basis, information required
to be disclosed by the Company in the reports that it files or submits under the
Exchange Act.
Internal Control Over Financial Reporting. There have not been any
changes in the Company's internal control over financial reporting (as such term
is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the
second quarter of 2004 that have materially affected, or are reasonably likely
to materially affect, the Company's internal control over financial reporting.
19
eLEC COMMUNICATIONS CORP.
PART II-OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Purchases of Equity Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
The 2004 Annual Meeting of Shareholders (the "2004 Annual Meeting")
was duly held on June 23, 2004. All director nominees to the Board
of Directors were duly elected at the 2004 Annual Meeting. Set forth
below is a brief description of each other matter voted upon at the
2004 Annual Meeting and the results of vote with respect to each
matter.
(i) The approval and adoption of our 2004 Equity Incentive
Plan.
Votes For........................ 4,617,201
Votes Against.................... 966,626
Votes Abstaining................. 17,219
Non-Vote......................... 8,874,685
(ii) Ratification of the appointment of Nussbaum Yates &
Wolpow, P.C. as our auditors.
Votes For........................ 14,323,782
Votes Against.................... 118,199
Votes Abstaining................. 33,750
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
31.1 Certification of our Chief Executive Officer and Chief
Financial Officer, Paul H. Riss, Pursuant to 18 U.S.C.
1350 (Section 302 of the Sarbanes-Oxley Act of 2002)
20
32.1 Certification of our Chief Executive Officer and Chief
Financial Officer, Paul H. Riss, Pursuant to 18 U.S.C.
1350 (Section 906 of the Sarbanes-Oxley Act of 2002)
(b) Reports on Form 8-K
On April 16, 2004, we filed a Current Report on Form 8-K
reporting that the United States Bankruptcy Court for the Southern District of
New York confirmed a Plan of Reorganization (the "Plan") of Telecarrier. The
Plan authorizes us to purchase the reorganized capital stock of Telecarrier for
a purchase price of $325,000.
21
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
eLEC Communications Corp.
July 7, 2004 By: /s/ Paul H. Riss
---------------------- -----------------------------
Date Paul H. Riss
Chief Executive Officer
(Principal Financial and
Accounting Officer)
22