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 August 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.
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(Exact Name of Small Business Issuer as Specified in Its Charter)
New York 13-2511270
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(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
75 South Broadway, Suite 302, White Plains, New York 10601
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(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number, Including Area Code: 914-682-0214
------------
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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: 16,254,282 shares of Common
Stock, par value $.10 per share, as of September 30, 2004.
PART 1. FINANCIAL INFORMATION
-----------------------------
Item 1. Financial Statements
------- --------------------
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Balance Sheet
August 31, 2004
---------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 183,325
Accounts receivable, net 1,230,025
Prepaid expenses and other current assets 65,061
------------
Total current assets 1,478,411
Property, plant and equipment, net 101,848
Other assets 49,980
------------
Total assets $ 1,630,239
============
Liabilities and stockholders' equity deficiency
Current liabilities:
Current maturities of capital lease obligations $ 32,100
Accounts payable and accrued expenses 2,176,214
Taxes payable 528,944
Due to related parties 41,084
Deferred revenue 272,884
------------
Total current liabilities 3,051,226
------------
Stockholders' equity deficiency:
Common stock $.10 par value, 50,000,000 shares authorized,
16,254,282 shares issued 1,625,428
Capital in excess of par value 25,624,234
Deficit (28,668,083)
Accumulated other comprehensive loss, unrealized loss on securities (2,566)
------------
Total stockholders' equity deficiency (1,420,987)
------------
Total liabilities and stockholders' equity deficiency $ 1,630,239
============
See notes to the condensed consolidated financial statements.
2
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
(Unaudited)
For the Nine Months Ended For the Three Months Ended
Aug. 31, 2004 Aug. 31, 2003 Aug. 31, 2004 Aug. 31, 2003
------------- ------------- ------------- -------------
Revenues $ 6,207,988 $ 3,776,334 $ 2,438,064 $ 1,275,889
------------ ------------ ------------ ------------
Costs and expenses:
Costs of services 2,955,924 1,986,726 1,159,223 649,597
Selling, general and administrative 3,610,693 3,792,201 1,670,626 1,053,647
Depreciation and amortization 12,112 80,850 4,301 17,207
------------ ------------ ------------ ------------
Total costs and expenses 6,578,729 5,859,777 2,834,150 1,720,451
------------ ------------ ------------ ------------
Loss from operations (370,741) (2,083,443) (396,086) (444,562)
------------ ------------ ------------ ------------
Other income (expense):
Interest expense (3,126) (105,509) -- (36,065)
Other income (loss) 28,153 88,063 (22,498) (34,300)
Gain on sale of assets -- 3,511,297 -- 1,254,442
Gain on sale of investment securities and other
investments 770 121,687 -- 37,926
------------ ------------ ------------ ------------
Total other income (expense) 25,797 3,615,538 (22,498) 1,222,003
------------ ------------ ------------ ------------
Income (loss) before bankruptcy reorganization
items and income tax benefit (expense) (344,944) 1,532,095 (418,584) 777,441
------------ ------------ ------------ ------------
Reorganization items:
Gain on settlement with creditors 904,027 -- -- --
Professional fees (161,000) (49,000) -- (49,000)
------------ ------------ ------------ ------------
743,027 (49,000) -- (49,000)
------------ ------------ ------------ ------------
Income (loss) before income tax benefit
(expense) 398,083 1,483,095 (418,584) 728,441
Income tax benefit (expense) 47,937 (34,000) -- (34,000)
------------ ------------ ------------ ------------
Net income (loss) 446,020 1,449,095 (418,584) 694,441
Other comprehensive (loss) -
unrealized (loss) on marketable securities (2,566) -- (270) --
------------ ------------ ------------ ------------
Comprehensive income (loss) $ 443,454 $ 1,449,095 ($ 418,854) $ 694,441
============ ============ ============ ============
Basic and diluted earnings (loss) per share $ 0.03 $ 0.09 ($ 0.03) $ 0.04
============ ============ ============ ============
Weighted average number of common shares
outstanding
Basic 16,254,282 15,633,829 16,254,282 15,684,369
============ ============ ============ ============
Diluted 16,652,398 15,664,231 16,254,282 15,733,552
============ ============ ============ ============
See notes to the condensed consolidated financial statements.
3
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Nine Months Ended
Aug. 31, 2004 Aug. 31, 2003
------------- -------------
Net cash used in operating activities: ($366,808) ($1,099,236)
--------- -----------
Cash flows from investing activities:
Purchase of property and equipment (88,569) (3,200)
Proceeds from sale of investment securities and other investments 770 198,273
Proceeds from the sale of property and equipment -- 16,025
Proceeds from note -- 209,102
--------- -----------
Net cash (used in) provided by investing activities (87,799) 420,200
--------- -----------
Cash flows from financing activities:
Proceeds from short-term note -- 200,000
Principal payments on pre-petition debt in bankruptcy proceedings (23,830) --
Repayment of long-term debt (7,260) (55,026)
--------- -----------
Net cash (used in) provided by financing activities (31,090) 144,974
--------- -----------
Decrease in cash and cash equivalents (485,697) (534,062)
Cash and cash equivalents at beginning of period 669,022 938,528
--------- -----------
Cash and cash equivalents at the end of period $ 183,325 $ 404,466
========= ===========
See notes to the condensed consolidated financial statements.
4
eLEC COMMUNICATIONS CORP.
-------------------------
Notes To Condensed Consolidated Financial Statements (Unaudited)
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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 nine-month or three-month periods ended
August 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-Major Customer
---------------------
During the nine and three months ended August 31, 2004 and 2003, no one customer
accounted for more than 10% of our revenue.
Note 3-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. As of November 30, 2003, our
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.
Note 4- Earnings (Loss) Per Common Share
----------------------------------------
Basic earnings (loss) per common share are calculated by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted earnings (loss) per share are 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 (loss) per common share for the
nine and three months ended August 31, 2004 and 2003 is as follows:
5
Nine Months Ended
Aug. 31, 2004 Aug. 31, 2003
------------- -------------
Weighted average common shares outstanding 16,254,282 15,633,829
Dilutive effect of securities 398,116 30,402
---------- ----------
16,652,398 15,664,231
========== ==========
Three Months Ended
Aug. 31, 2004 Aug. 31, 2003
------------- -------------
Weighted average common shares outstanding 16,254,282 15,684,369
Dilutive effect of securities -- 49,183
---------- ----------
16,254,282 15,733,552
========== ==========
The computation of diluted earnings (loss) per share for the nine and three
months ended August 31, 2004 and 2003 excluded the effect of the assumed
exercise of approximately 1,500,000 and 2,500,000 outstanding stock options and
warrants for the nine and three months ended August 31, 2004, respectively, and
approximately 1,750,000 outstanding stock options and warrants for the nine and
three months ended August 31, 2003 because the effect would be anti-dilutive.
For the three months ended August 31, 2004, all of the options and warrants were
anti-dilutive.
Note 5-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 our wholly-owned
subsidiary, Telecarrier Services, Inc. ("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, which funds
were distributed by July 22, 2004 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 on April 8, 2004.
For the nine months ended August 31, 2004, Telecarrier reported a gain of
$904,027 as a result of being judicially released from 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
==========
6
Telecarrier had an agreement, effective January 2, 2002, with Telco Services,
Inc. ("Telco"), a corporation owned by one of our former shareholders, 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. Such reduction was included in the gain on settlement
with creditors for the nine months ended August 31, 2004. As of August 31, 2004,
all of Telco's claims related to the Telecarrier bankruptcy had been paid in
full, including $65,000 in administrative claims and approximately $31,000 in
unsecured claims. The President of Telco is also the President of Glad Holdings
(See Note 7).
Note 6-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 our
relationship with the primary RBOC that we buy services from or a significant
unfavorable change in the regulatory agreements that establish the cost of our
services 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 our 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.
- 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. The FCC has
issued interim rules that, after March 2005 adversely affect the
pricing of network elements and bundles thereof. Such rules may
limit our ability to pursue our current "customer first" strategy of
acquiring a base of customers before acquiring and installing
network assets. Such
7
change may force us to accelerate the development of our Voice over
Internet Protocol ("VoIP") network before our operations are ready
to handle a potentially large transition of our customer base.
- Failure of our collection management system and credit controls
efforts for customers.
- Our inability to adapt to technological change or implement VoIP
service.
- Competition in the telecommunications industry.
- Our 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 or revenues.
- Our inability to secure financing.
Note 7-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 has remained liable for substantially all the obligations assumed
in the sale until such time as they are 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 related to the assumption by Biz of the liabilities
of Essex until Essex was released from the assumed obligations. During the nine
and three-month periods ended August 31, 2003, EAC settled liabilities of
approximately $3,511,000 and $1,254,000, respectively, and accordingly, gain was
recorded during such periods for such amounts.
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 one of our former shareholders, 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, following such sale we concluded that it was unlikely
8
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 September 11, 2003, 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 nine- and three-month periods ended August
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 the
operations of the remaining company:
For the Nine Months Ended
-------------------------
Aug. 31, 2004 Aug. 31, 2003
------------- -------------
Revenues $ 6,207,988 $ 2,883,138
----------- -----------
Net income (loss) $ 446,020 ($1,757,858)
----------- -----------
Basic and dilutive income (loss) per share $ 0.03 ($ 0.11)
=========== ===========
For the Three Months Ended
--------------------------
Aug. 31, 2004 Aug. 31, 2003
------------- -------------
Revenues $ 2,438,064 $ 1,275,889
----------- -----------
Net loss ($ 418,584) ($ 535,638)
----------- -----------
Basic and dilutive loss per share ($ 0.03) ($ 0.03)
=========== ===========
Note 8- 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 (loss) for the nine and three months ended
August 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 five 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 ("SFAS") No. 123, "Accounting for Stock-Based
Compensation", as amended by SFAS No.148, "Accounting for Stock-Based
Compensation - Transition and Disclosure":
9
For the Nine Months Ended For the Three Months Ended
Aug. 31, 2004 Aug. 31, 2003 Aug. 31, 2004 Aug. 31, 2003
------------- ------------- ------------- -------------
Net income (loss) as reported $ 446,020 $ 1,449,095 ($ 418,584) $ 694,441
Deduct: Total stock-based employee
compensation expense determined
under fair value-based method
for all awards, net of related
tax effects (168,724) (227,386) (56,593) (77,573)
---------- ----------- ---------- ----------
Pro forma net income (loss) $ 277,296 $ 1,221,709 ($ 475,177) $ 616,868
---------- ----------- ---------- ----------
Earnings (loss) per share
Basic, as reported $ .03 $ .09 ($ .03) $ .04
Basic, pro forma $ .02 $ .08 ($ .03) $ .04
Diluted, as reported $ .03 $ .09 ($ .03) $ .04
Diluted, pro forma $ .02 $ .08 ($ .03) $ .03
Note 9 Related Party Transactions
---------------------------------
During the nine and three months ended August 31, 2004 and 2003, we billed
Cordia Corporation ("Cordia"), a related party, $306,804 and $8,773 and $127,087
and $38,153, respectively, for rent, telecommunications services, commissions
and other costs, and Cordia billed us $531,352 and $142,856 and $234,691 and
$133,178, respectively, for telecommunications services and other costs. As of
August 31, 2004, we owed Cordia $41,084. Cordia is controlled by entities owned
by one of our shareholders and former employees and members of his family.
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 telecommunications service holding company with
primary operations in two wholly-owned subsidiaries, that focus 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 MCI at discounts of 10% to
25%
11
off their published rates. We lease lines from Verizon in order to provide our
local telephone service. We also strive to provide friendly and helpful customer
service that exceeds the service provided by these large competitors.
We plan to increase our telecommunications offerings and decrease our reliance
on Verizon by providing VoIP network services. On July 23, 2004, we formed Vox
Communications Corp. ("Vox"), a wholly-owned subsidiary, to develop and provide
VoIP service. We believe the sales, provisioning, billing and collection
processes and procedures that we have in place for our CLEC operations give us
strong positioning to be a scalable and sizable VoIP provider. Our internal VoIP
system supports eight different hardware Internet access devices and Session
Initiation Protocol ("SIP") phones, in addition to most of the "software only"
types of devices that reside on a personal computer.
We are utilizing two basic strategies in rolling out our VoIP product.
Initially, we have begun providing VoIP services through a wholesaler. We plan
to pursue a variety of wholesale arrangements with several wholesalers so that
we can differentiate our service plans in our target markets. By starting with
this methodology, we are able to test, market, provision and bill a VoIP product
before our own VoIP technology is fully developed. The VoIP solution we have
chosen for our internal platform was developed over the past four months and is
now being tested. Our software platform has an open-source baseline
functionality that uses Linux as the operating system. We plan to use multiple
backbone providers and to continue to build our footprint as we see stable
providers entering the industry. We may also consider rolling out our own
network in those locations in which we have concentrations of customers in a
"smart-build" approach. As a CLEC and as a VoIP provider, we take a deferred
build approach to network assets. We believe it is a safer business practice to
first build and establish a customer base in a specific location and then to
build a network to serve the established customer base.
Our CLEC subsidiaries lease lines from Verizon, using 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
published 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. It is a useful platform for
servicing a customer base until such base has reached a quantity large enough to
justify moving the customers to an owned network. We believe UNE-P's future
viability is somewhat in jeopardy due to recent regulatory developments.
Initially, the anticipated impact of the regulatory developments appears to be
an increase in our costs that may decrease our gross margins by approximately
five to ten percent. Because we know we will be receiving a price increase from
Verizon within the next five months, we raised the selling price of our most
popular bundled service plan by five dollars a month for new customers only,
beginning October 1, 2004. This price increase has not yet had an adverse impact
on the ability of our outside telemarketing firms to obtain new customers. We
will continue to use UNE-P for as long as we can generate margins that are high
enough to provide cash flow to cover our general and administrative expenses.
Additionally, we believe it is important for us to establish a relationship with
telephone services users so that we can
12
eventually offer them our VoIP service, which should allow us to keep them as
customers without using the UNE-P service offering.
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. On September 13, 2004, the FCC
published interim requirements establishing the details of a 12-month transition
plan governing unbundled access by CLECs to the network elements of ILECs. These
requirements were issued to avoid disruption in the telecommunications industry
for an interim period of up to one year, while the FCC is writing new rules.
Among other things, they require the ILECs to continue providing unbundled
access to switching, enterprise market loops and dedicated transport under the
same rates, terms and conditions that applied under interconnection agreements
with CLECs that were in effect on June 15, 2004. The rates, terms and conditions
are to remain in place until the earlier of the issuance of final unbundling
rules by the FCC or six months after September 13, 2004, except to the extent
that they have been replaced by (1) a voluntarily negotiated commercial
agreement between the ILEC and CLEC; (2) an intervening commission order; or (3)
a state public utility commission order that raises the rates to the CLEC to
purchase network elements.
If the FCC has not issued new rules within six months, then for the next
six-month period an ILEC will only be required to lease the switching element to
a CLEC in combination with shared transport and loops (as a component of a UNE
platform) at a rate equal to the higher of (1) the rate existing at June 15,
2004 plus one dollar, or (2) the rate set by a state public utility commission,
if any, between June 16, 2004 and March 13, 2005, for this combination of
elements, plus one dollar. These rates that are available during the second
six-month period will only apply to the embedded customer base. They will not
apply to new customers.
We cannot predict the outcome of the new rules written by the FCC or the outcome
of various state commissions that are examining the pricing structures. As
previously noted, this regulatory environment has led us to increase our prices
to new customers in an effort to maintain our gross margins after we receive
price increases from Verizon, early in 2005. We continue to sell and provision
new lines on the UNE-P service offering, where we anticipate the gross margins
will remain at approximately 50% for the remainder of the year. We have always
viewed the UNE-P service offering as a stepping-stone to a packet-based network.
We believe our lack of network assets, our size and our ability to write the
appropriate software programs for a SIP server and customer support web sites
will enable us to survive the transition from UNE-P to VoIP, and to become a
stable VoIP provider.
To mitigate the impact of any regulatory developments on our larger customers,
we now have the ability to provide VoIP services to carry local and long
distance 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 are looking to sign
agreements with other VoIP wholesale
13
carriers, and believe we will also have VoIP customers on our own VoIP platform
before the end of our fourth quarter.
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 telemarketing generally leads to a higher level
of initial customer churn and bad debts than most other selling strategies, we
believe these excesses are acceptable due to the low acquisition cost of a
telemarketed line. It is not unusual for 20% or more of new lines acquired in
any month to leave our service within two months of the sale. Large winback
offers from Verizon contribute to the high rate of initial churn. However, we
plan to continue telemarketing UNE-P lines, as they currently generate an
acceptable gross profit percentage. While we believe we have enough cash flow
from operations 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 an equity placement to generate the financing
needed for more rapid growth.
In the third quarter of fiscal 2004, we made approximately $80,000 of capital
expenditures related to the development of our VoIP platform. 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 the purchase of
certain 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 believe our VoIP solution will give us the opportunity to lower our per
minute costs for calls that our customers complete using our VoIP service. In
addition to having our own VoIP technology, we plan to provide VoIP services
through several wholesale carriers, so that we are not dependent on one network
and can perform least-cost routing.
Unlike the CLEC landline services we provide, where it is customary to charge
for features, or to bundle features in a plan package so we can increase the
selling price of a bundled plan, most features in the VoIP platform come without
an additional charges to the customer, and we incur no additional per minute
usage cost for these features. The free features include voice mail, caller ID,
call waiting, call forwarding, call block and call return. Our customers will
also be able to view calls and bills online, and play back their voicemail
messages by simply clicking a link in their Internet browser. Our goal will be
to move as much control as is reasonable to the end user, thereby providing a
valuable tool to our customer, while reducing our costs associated with customer
service.
Nine Months Ended August 31, 2004 vs. Nine Months Ended August 31, 2003
-----------------------------------------------------------------------
Our revenues for the nine-month period ended August 31, 2004 increased by
approximately $2,432,000, or approximately 64%, to approximately $6,208,000 as
compared to approximately $3,776,000 reported for the nine-month period ended
August 31, 2003. Included in our revenue
14
for the nine-month period ended August 31, 2003 were approximately $2,883,000 in
aggregate sales reported by New Rochelle Telephone Corp. ("NRTC") and
Telecarrier and approximately $893,000 in sales reported by our former
wholly-owned subsidiary, Essex (See Note 7). Aggregate revenue reported by NRTC
and Telecarrier for the nine-month period ended August 31, 2004 increased by
approximately $3,325,000, or approximately 115%, over the year-ago period. We
anticipate revenues for NRTC and Telecarrier will continue to increase in the
fourth quarter of fiscal 2004, as we work to add new customers. While the number
of telephone lines we serve and our customer base has continued to grow in the
fourth quarter of 2004, we believe 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 nine-month period ended August 31, 2004 increased by
approximately $1,462,000 to approximately $3,252,000 from approximately
$1,790,000 reported in the nine-month period ended August 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 nine
months of fiscal 2004, compared to the states in which we were operating during
the first nine months 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 sell in 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 is petitioning regulatory bodies to raise the UNE-P
rates it charges us beginning in 2005, and the FCC has agreed to rate increases
with the interim requirements it published on September 13, 2004. We also plan
to sell VoIP services nationwide in fiscal 2005. The margins for such services
will be dependent on the cost structures we negotiate with carriers for
wholesale services or to terminate calls from our customers' SIP phone to a
traditional landline phone. Any calls from one SIP phone to another SIP phone
would not generate any usage cost to us.
Selling, general and administrative expenses ("SG&A") decreased by approximately
$181,000, or approximately 5%, to approximately $3,611,000 for the nine-month
period ended August 31, 2004 from approximately $3,792,000 reported in prior
year fiscal period. Approximately $650,000 of this decrease in expense was
directly related to the sale of our Essex operations and approximately $124,000
was related to a decrease in insurance expense resulting partially from a
settlement with our insurance carrier on the amount of audit premiums that were
recorded in the prior fiscal year and partially from a reduction in property
insurance premiums as a result of the sale of our headquarters building in the
fourth quarter of fiscal 2003. These expense reductions were partially offset by
an increase of approximately $328,000 in new line acquisition costs as our line
count increased by approximately 120% over the year-ago period and approximately
$140,000 in bad debt expense. Additionally, we curtailed our in-house billing
and telemarketing efforts in the third quarter of fiscal 2003 and outsourced
these functions to third-party vendors. By outsourcing these functions, we only
pay for telephone lines billed and telemarketed lines accepted, thereby
eliminating staffing and other associated overhead cost. For the nine-month
period ended August 31, 2004, our SG&A costs averaged approximately $400,000 per
month, of which approximately $130,000 represented new line acquisition costs.
15
Depreciation expense decreased by approximately $69,000, to approximately
$12,000 for the nine-month period ended August 31, 2004 as compared to
approximately $81,000 for the nine-month period ended August 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.
Interest expense decreased by approximately $103,000, to approximately $3,000
for the nine-month period ended August 31, 2004 as compared to approximately
$106,000 for the nine-month period ended August 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 (loss) for the nine-month period ended August 31, 2004 was income
of approximately $28,000 as compared to income of approximately $88,000 for the
nine-month period ended August 31, 2003. The income for the nine-month period
ended August 31, 2004, resulted primarily from commission income of
approximately $70,000, partially offset by charges for environmental costs of
approximately $45,000 directly related to the sale of our headquarters building
in the fourth quarter of fiscal 2003. The income for the nine-month period ended
August 31, 2003, resulted primarily from rental and commission income of
approximately $219,000, partially offset by the write-down of certain assets of
approximately $131,000, including the write-down of certain fixed assets
associated with the curtailment of our telemarketing and billing efforts in the
third quarter of fiscal 2003.
For the nine-month period ended August 31, 2004, Telecarrier reported income of
approximately $904,000 from debt reduction in bankruptcy. No such income was
reported for the nine-month period ended August 31, 2003. Bankruptcy
reorganization costs for the nine-month periods ended August 31, 2004 and 2003
of approximately $161,000 and $49,000, respectively, represented legal cost
associated with the TSI bankruptcy (See Note 5).
Gain on the sale of assets for the nine-month period ended August 31, 2003 was
approximately $3,511,000 (See Note 7). We had no such sale for the nine-month
period ended August 31, 2004.
For the nine-month period ended August 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 $122,000 for the
nine-month period ended August 31, 2003, which resulted from the sale of shares
of Cordia and Talk America Holdings Inc. ("Talk").
For the nine-month period ended August 31, 2004, we recorded a net tax benefit
of approximately $48,000, which resulted from the reduction of an estimated
accrual of corporate tax expense for fiscal 2003. For the nine-month period
ended August 31, 2003, we recorded estimated corporate tax expense of
approximately $34,000.
Three Months Ended August 31, 2004 vs. Three Months Ended August 31, 2003
-------------------------------------------------------------------------
Our revenue for the three-month period ended August 31, 2004 increased by
approximately $1,162,000, or approximately 91%, to approximately $2,438,000 as
compared to approximately $1,276,000 reported for the three-month period ended
August 31, 2003. No sales were reported
16
by our former wholly-owned subsidiary, Essex, for the three-month period ended
August 31, 2003 (See Note 7). We anticipate revenues of NRTC and Telecarrier to
continue to increase in the fourth quarter of fiscal 2004, as we work to add new
customers. While the number of telephone lines we serve and our customer base
has continued to grow in the fourth 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.
Our gross profit for the three-month period ended August 31, 2004 increased by
approximately $653,000 to approximately $1,279,000 from approximately $626,000
reported in the three-month period ended August 31, 2003, and our gross profit
percentage increased to approximately 52% from approximately 49% reported in the
prior fiscal period. The increase in our gross profit was a direct result of
increased sales due to continued growth in the number of telephone lines we
serve. 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%. The increase in gross profit percentage is primarily due to a higher
percentage of our customer base using our long distance telephone service.
SG&A increased by approximately $617,000, or approximately 59%, to approximately
$1,671,000 for the three-month period ended August 31, 2004 from approximately
$1,054,000 reported in the prior year fiscal period. Of this increase in
expense, approximately $300,000 was in new line acquisition costs and
approximately $155,000 in bad debt expense. Additionally, we curtailed our
in-house billing and telemarketing efforts in the third quarter of fiscal 2003
and outsourced these functions to third-party vendors. By outsourcing these
functions, 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 August 31, 2004, our SG&A costs averaged
approximately $546,000 per month, of which, approximately $207,000 represented
new line acquisition costs.
Depreciation expense decreased by approximately $13,000, to approximately $4,000
for the three-month period ended August 31, 2004 as compared to approximately
$17,000 for the three-month period ended August 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 $36,000 for the three-month period
ended August 31, 2004. 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 (loss) for the three-month period ended August 31, 2004 was a loss
of approximately $22,000 as compared to a loss of approximately $34,000 for the
three-month period ended August 31, 2003. The loss for the three-month period
ended August 31,2004, resulted primarily from commission income of approximately
$22,000, partially offset by charges for environmental costs directly related to
the sale of our headquarters building in the fourth quarter of fiscal 2003 of
approximately $45,000. The loss for the three-month period ended August 31,
2003, resulted primarily from the write-down of certain assets of approximately
$89,000, including the write-down of certain fixed assets associated with the
curtailment of our telemarketing and billing efforts in the third quarter of
fiscal 2003, partially offset by rental and commission income of approximately
$55,000.
17
Gain on the sale of assets for the three-month period ended August 31, 2003 was
approximately $1,254,000 (See Note 7). We had no such sale for the three-month
period ended August 31, 2004.
For the three-month period ended August 31, 2003, gain on the sale of investment
securities and other investments of approximately $38,000, resulted from the
sale of Talk shares. We had no such sale for the three-month period ended August
31, 2004.
Bankruptcy reorganization costs for the three-month period ended August 31, 2003
of approximately $49,000 represented legal cost associated with the TSI
bankruptcy (See Note 5). No such amount was recorded in the three-month period
ended August 31, 2004.
Liquidity and Capital Resources
-------------------------------
At August 31, 2004, we had cash and cash equivalents of approximately $183,000
and negative working capital of approximately $1,573,000.
Net cash used in operating activities aggregated approximately $367,000 and
$1,099,000 in the nine-month periods ended August 31, 2004 and 2003,
respectively. The principal use of cash in fiscal 2004 was the net change in
operating assets and liabilities and the pay-off of bankruptcy liabilities. This
use of cash was partially offset by the net income for the period of
approximately $446,000. The principal use of cash in fiscal 2003 was the net
income for the period of approximately $1,449,000, which was offset by a
non-cash item, the net effect of the gain of approximately $3,511,000 on the
transfer of assets of our former Essex subsidiary (See Note 7).
Net cash used in investing activities aggregated approximately $88,000 in the
nine-month period ended August 31, 2004 as compared to net cash provided by
investing activities that aggregated approximately $420,000 for the nine-month
period ended August 31, 2003. The principal use of cash in fiscal 2004 was the
purchase of equipment and software. The principal sources of cash in fiscal 2003
were the proceeds from the sale of investment securities and other investments
of approximately $198,000, the proceeds from the sale of equipment of
approximately $16,000 and the proceeds of a note of approximately $209,000.
Net cash used in financing activities aggregated approximately $31,000 in the
nine-month period ended August 31, 2004 as compared to net cash provided by
financing activities that aggregated approximately $145,000 in the nine-month
period ended August 31, 2003. In fiscal 2004, the principal use of cash resulted
from the repayment of debt of approximately $31,000. In fiscal 2003, net cash
provided by financing activities resulted from the proceeds of short-term notes
of approximately $200,000, offset by the repayment of long-term debt of
approximately $55,000.
For the nine-month period ended August 31, 2004, we spent approximately $89,000
on capital expenditures, primarily for software related to our VoIP initiative.
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 VoIP
network 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 as new
equipment is available, we may consider certain purchases.
18
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 September
30, 2004, our warrants were not in-the-money, as Talk common stock was trading
at approximately $5.23 per share at such date.
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.
During the third fiscal quarter, we were able to spend an average of
approximately $207,000 a month on customer acquisition costs. During the months
of August and September 2004, we billed our customers approximately $1 million
each month. With gross margins of approximately 50%, and a monthly average of
SG&A costs exclusive of customer acquisition costs of approximately $339,000, we
will not be able to maintain customer acquisition spending at its current level.
Our customer acquisition spending in the third fiscal quarter exceeded our cash
flow generated from operations. However, in our business model, the value of our
company is significantly enhanced by adding and retaining new customers as soon
as possible, and we would like to continue to add as many new customers as our
financial resources permit. We are currently evaluating term sheets for debt
financing, equity financing and a combination of both in order to have more
funds to accelerate our growth. We anticipate that with such financing, we will
be able to continue to accelerate our growth and also better manage and finance
our transition into a VoIP provider. Our inability to secure such financing or
our inability to carry out this plan may result in a rapid curtailment of our
new customer acquisitions and a shut down of certain third-party telemarketing
centers that are currently providing us service (See Note 6).
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
third 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
------- ---------------------------------------------------
None
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)
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 July 1, 2004, we filed a Current Report on Form 8-K related
to the Company's press release of such date which reported the results of
the Company's second quarter and six month fiscal 2004 financial results.
20
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.
October 15, 2004 By: /s/ Paul H. Riss
--------------------- ----------------
Date Paul H. Riss
Chief Executive Officer
(Principal Financial and
Accounting Officer)
21