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 February 28, 2005.
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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
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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: 16,759,782 shares of Common
Stock, par value $.10 per share, as of April 1, 2005.
PART 1. FINANCIAL INFORMATION
-----------------------------
Item 1. Financial Statements
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eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Balance Sheet
Feb. 28, 2005
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(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 1,552,349
Accounts receivable, net 1,660,152
Prepaid expenses and other current assets 12,849
------------
Total current assets 3,225,350
Property, plant and equipment, net 291,967
Other assets 55,204
Deferred finance costs 342,157
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Total assets $ 3,914,678
============
Liabilities and stockholders' equity deficiency
Current liabilities:
Short-term borrowings $ 280,320
Current maturities of long-term debt and capital lease obligations 638,161
Accounts payable and accrued expenses 2,399,209
Taxes payable 755,741
Due to related party 36,363
Deferred revenue 407,666
------------
Total current liabilities 4,517,460
------------
Long-term debt 669,017
Stockholders' equity deficiency:
Common stock $.10 par value, 50,000,000 shares authorized,
16,759,282 shares issued 1,675,928
Capital in excess of par value 26,400,644
Deficit (29,345,535)
Accumulated other comprehensive loss, unrealized loss on securities (2,836)
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Total stockholders' equity deficiency (1,271,799)
------------
Total liabilities and stockholders' equity deficiency $ 3,914,678
============
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 Three Months Ended
Feb. 28, 2005 Feb. 29, 2004
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Revenues $ 3,863,479 $ 1,873,992
------------ ------------
Costs and expenses:
Costs of services 2,055,539 880,075
Selling, general and administrative 2,221,007 936,646
Depreciation and amortization 1,355 3,858
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Total costs and expenses 4,277,901 1,820,579
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Income (loss) from operations (414,422) 53,413
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Other income (expense):
Interest expense (51,616) (2,762)
Change in warrant valuation 47,089 --
Interest and other income 17,264 29,081
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Total other income 12,737 26,319
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Income (loss) before bankruptcy reorganization items and
income tax benefit (401,685) 79,732
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Reorganization items:
Gain on settlement with creditors -- 51,474
Professional fees -- (120,066)
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-- (68,592)
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Income (loss) before income tax benefit (401,685) 11,140
Income tax benefit -- (45,000)
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Net income (loss) (401,685) 56,140
Other comprehensive loss - unrealized
loss on marketable securities (585) --
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Comprehensive income (loss) ($402,270) $ 56,140
============ ============
Basic and diluted earnings (loss) per share ($0.02) $ 0.00
============ ============
Weighted average number of common shares outstanding
Basic 16,681,726 16,257,667
============ ============
Diluted 16,681,726 16,568,565
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See notes to the condensed consolidated financial statements.
3
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Three Months Ended
Feb. 28, 2005 Feb. 29, 2004
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Net cash used in operating activities: ($771,279) ($58,581)
----------- ---------
Cash flows used in investing activities:
Purchase of property and equipment (100,910) --
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Net cash used in investing activities (100,910) --
----------- ---------
Cash flows from financing activities:
Repayment of long-term debt (1,731)
Proceeds form the exercise of options 34,500 --
Proceeds from notes, warrants and common stock issuances 2,018,186 --
----------- ---------
Net cash provided by (used in) financing activities 2,052,686 (1,731)
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Increase (decrease) in cash and cash equivalents 1,180,497 (60,312)
Cash and cash equivalents at beginning of period 371,852 669,022
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Cash and cash equivalents at the end of period $ 1,552,349 $ 608,710
=========== =========
See notes to the condensed consolidated financial statements.
4
eLEC COMMUNICATIONS CORP.
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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 three-month period ended February 28, 2005
are not necessarily indicative of the results that may be expected for the year
ended November 30, 2005. 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, 2004.
Note 2-Principal Financing Arrangements
---------------------------------------
On December 17, 2004, we sold a promissory note (the "Note") in the principal
amount of approximately $328,767 and 160,000 shares of our restricted common
stock to an unaffiliated party for $300,000 of which $32,000 has been allocated
to common stock issuances. The Note is payable on December 17, 2005 and is
unsecured. The Note requires us to spend the proceeds of the Note on sales and
marketing efforts. We recorded costs of $36,314 in connection with the issuance
of the Note which are being amortized over the term of the Note. Amortization of
these costs for the three-month period ended February 28, 2005 was $13,850, of
which $7,362 was included in our selling, general and administrative expenses
("SG&A") as financing costs and $6,488 allocated to the $32,000 debt discount
was included in interest expense using the effective interest method.
On February 8, 2005, we entered into a secured financing arrangement with Laurus
Master Fund, Ltd. ("Laurus"). The financing consists of a $2 million secured
convertible term note (the "Convertible Note") that bears interest at the rate
of prime (as published in the Wall Street Journal), plus three percent (8.5% as
of February 28, 2005) that was initially scheduled to mature on February 8, 2006
but was subsequently extended to February 8, 2008. The Convertible Note is
convertible into shares of our common stock at an initial fixed price of $0.63
per share. The fixed conversion price of the Convertible Note is subject to
anti-dilution protection, on a weighted-average basis, upon our issuance of
additional shares of our common stock at a price that is less than the fixed
conversion price.
In connection with the financing, Laurus was also issued warrants to purchase up
to 793,650 shares of our common stock. The warrants are exercisable as follows:
264,550 shares at $0.72 per share; 264,550 shares at $0.79 per share and the
balance at $0.95 per share. The underlying contracts contained certain
provisions where there is a provision for a cash settlement. EITF 00-19
precludes classifying the warrants as equity, since all of the conditions stated
in paragraphs 14-32 of EITF 00-19 were not satisfied, and accordingly, the
warrants have been classified as debt. The proceeds of the Convertible Note were
allocated first to the fair value of the warrants (liability) and the remainder
to the debt instrument. We computed the beneficial conversion feature embedded
in
5
the debt instrument using the effective conversion price in accordance with EITF
98-5, EITF 00-19 and EITF 00-27. We recorded (i) debt discounts of $504,128 for
the valuation of the 793,650 warrants issued with the Convertible Note (computed
using a Black-Scholes model with an interest rate of 2.31%, volatility of 158%,
zero dividends and expected term of seven years); (ii) $610,628 for the
beneficial conversion feature inherent in the Convertible Note and (iii)
$106,500 for debt issue costs paid to affiliates of the lender. In addition, we
issued to Source Capital Group Inc., an investment banking firm, warrants to
purchase up to 253,968 shares of our common stock as additional debt issue
costs. These warrants were valued at $149,783 using the Black-Scholes model as
above. Total debt issuance costs incurred to third parties for arranging the
financing aggregated $313,363, including the value of the warrants to Source
Capital Group Inc. Amortization of these costs for the three-month period ended
February 28, 2005 was $57,452, of which $18,157 was included in SG&A as
financing costs and $39,295 was included in interest expense. Discounts are
being amortized over one year, the initial term of the Convertible Note, using
the effective interest method. The warrant liability is adjusted at each
reporting date to fair market value using the Black-Scholes model with a
corresponding charge or credit to income.
To secure the payment of all obligations to Laurus, we entered into a Master
Security Agreement that assigns and grants to Laurus a continuing security
interest in all of the following property now owned or at any time acquired by
us or our subsidiaries, or in which any assignor now has or at any time in the
future may acquire any right, title or interest: all cash, cash equivalents,
accounts, deposit accounts, inventory, equipment, goods, documents, instruments
(including, without limitation, promissory notes), contract rights, general
tangibles, chattel paper, supporting obligations, investment property,
letter-of-credit rights, trademarks, trademark applications, patents, patent
applications, copyrights, copyright applications, and any other intellectual
property, in each case, in which any assignor now has or may acquire any right,
title or interest, all proceeds and products thereof (including, without
limitation, proceeds of insurance) and all additions, accessions and
substitutions. In the event any assignor wishes to finance an acquisition in the
ordinary course of business of any hereafter-acquired equipment and has obtained
a commitment from a financing source to finance such equipment from an unrelated
third party, Laurus has agreed to release its security interest on such
hereafter-acquired equipment so financed by such third party financing source.
The Convertible Note is to be repaid using cash or an equity conversion option;
the details of both methods for repayment are as follows: Beginning on May 1,
2005, which is the first scheduled payment date, we are obligated to make
monthly payments to Laurus on each repayment date until the maturity date, each
in the amount of $60,606, together with any accrued and unpaid interest to date.
By the fifth business day prior to each amortization date, Laurus may deliver to
us a written notice directing that the monthly amount payable on the next
repayment date shall be paid in either shares of common stock or a combination
of cash and common stock. If a repayment notice is not delivered by Laurus on or
before the applicable notice date for any repayment date, then we are obligated
to pay the monthly amount due in cash. Any portion of the monthly amount paid in
cash shall be paid to Laurus in an amount equal to 102% of the principal portion
of the monthly amount due. If Laurus elects to receive all or a portion of the
monthly amount in shares of our common stock, the number of such shares to be
issued by us will be determined by dividing the portion of the monthly amount to
be paid in shares of common stock, by the applicable fixed conversion price,
which is presently $0.63 per share.
A registration rights agreement was executed requiring us to register the shares
of our common stock underlying the Convertible Note and warrants so as to permit
the public resale thereof.
6
Liquidated damages in the amount of 2% of the Convertible Note balance per month
accrue if the registration statement has not been declared effective by the
Securities and Exchange Commission by June 8, 2005. The registration statement
was filed with the Securities and Exchange Commission on March 31, 2005 but has
not yet been declared effective.
Note 3-Major Customer
---------------------
During the three-month periods ended February 28, 2005 and February 29, 2004, no
one customer accounted for more than 10% of revenue.
Note 4-Income Taxes
-------------------
At November 30, 2004, we had net operating loss carryforwards for Federal income
tax purposes of approximately $20,850,000 expiring in the years 2008 through
2024. There is an annual limitation of approximately $187,000 on the utilization
of approximately $2,450,000 of such net operating loss carryforwards under the
provisions of Internal Revenue Code Section 382.
Note 5- 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 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 unless such inclusion reduced the loss per
share. A reconciliation of the shares used in the computation of our basic and
diluted earnings per common share is as follows:
Three Months Ended
2/28/05 2/29/04
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Weighted average common shares outstanding 16,681,726 16,257,667
Dilutive effect of securities -- 310,898
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16,681,726 16,568,565
========== ==========
Approximately 8,125,000 and 1,500,000 of our stock options, warrants and shares
issuable upon the potential conversion of the Convertible Note were excluded
from the calculation of diluted earnings (loss) per share for the three months
ended February 28, 2005 and February 29, 2004 because the effect would be anti
dilutive.
Note 6-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 "Bankruptcy Plan") for
Telecarrier Services, Inc. ("TSI"). On July 29, 2002, TSI, a wholly-owned
subsidiary, 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 Bankruptcy Plan authorized us to disburse $325,000 to
creditors in full satisfaction of claims amounting to approximately $1,229,000.
For the year ended
7
November 30, 2004, TSI reported a gain of $904,027 as a result of being
judicially released from these claims.
For the three-month period ended February 29, 2004, TSI reported a gain of
approximately $51,000 as a result of a court-stipulated reduction in
post-petition liabilities (See Note 10) and approximately $120,000 in
professional fees. These items are included under the heading "Reorganization
items" in our Condensed Consolidated Statement of Operations and Comprehensive
Income (Loss). No such transactions occurred in the three-month period ended
February 28, 2005.
8
Note 7-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 changes that govern the rates we are to
be charged and the obligations of the RBOCs to interconnect with, or provide
unbundled network elements to their competitors. The FCC and state public
utility commissions have adopted extensive rules to implement the
Telecommunications Act of 1996, which sets standards for relationships between
communications providers, and they revisit such regulations on an ongoing basis
in response to the evolving marketplace and court decisions. In light of the
foregoing, it is possible that the loss of our relationship with the primary
RBOC that supplies us with wholesale telephone services or a significant
unfavorable change in the regulatory environment would have a severe near-term
impact on our ability to conduct our telecommunications business. In order to
reduce regulatory risks going forward, our main operating subsidiary has signed
a commercially negotiated wholesale services agreement with two of the RBOCs.
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 or functionality of incumbent local
telephone companies' networks, as they relate to the unbundled
network element platform or the resale of such services.
- Increased price competition in local and long distance service.
- Failure or interruption in our network and information systems.
- Changes in government policy, regulation and enforcement.
- 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 and bad debt expense.
- Adverse change in our relationship with third party carriers.
- Failure or bankruptcy of other telecommunications companies upon
whom we rely for services and revenues.
- Lack of capital or borrowing capacity, and inability to generate
cash flow.
9
Note 8- Stock-Based Compensation Plans
--------------------------------------
We issue stock options to our employees and outside directors pursuant to
stockholder-approved and non-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 three months ended
February 28, 2005 and February 29, 2004, 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 option 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 ("SFAS") No. 123, "Accounting for
Stock-Based Compensation", as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure":
For the Three Months Ended
2/28/05 2/29/04
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Net income (loss), as reported ($401,685) $ 56,140
Deduct: Total stock-based employee
compensation expense determined
under fair value-based method
for all awards, net of related
tax effects (99,426) (58,986)
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Pro forma net income (loss) ($501,111) ($2,846)
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Earnings (loss) per share
Basic, as reported ($.02) $ .00
Basic, pro forma ($.03) $ .00
Diluted, as reported ($.02) $ .00
Diluted, pro forma ($.03) $ .00
Note 9 Related Party Transactions
---------------------------------
TSI had an agreement, effective January 2, 2002, with Telco Services, Inc.
("Telco"), a corporation owned by a former shareholder, under which Telco
provided TSI with collection, sales and other services. As a result of a
court-stipulated agreement between TSI and Telco, entered into on February 6,
2004, the amount owed Telco for such services was reduced by approximately
$51,000. Such reduction was reported as a gain for the three-month period ended
February 29, 2004 (See Note 6).
During the three-month periods ended February 28, 2005 and February 29, 2004, we
billed Cordia Corporation ("Cordia"), a related party, $23,403 and $135,322,
respectively, for telecommunications services, commissions and other costs, and
Cordia billed us $137,807 and $51,099, respectively, for telecommunications
services and other costs. As of February 28, 2005, we owed Cordia $36,363.
10
Note 10-Reclassification
------------------------
Certain 2004 amounts related to the bankruptcy of TSI have been reclassified to
conform to the 2005 presentation.
Note 11-Defined Benefit Plan
----------------------------
We sponsor a defined benefit plan covering two active employees and a number of
former employees. Our funding policy with respect to the defined benefit plan is
to contribute annually not less than the minimum required by applicable law and
regulation to cover the normal cost and to fund supplemental costs, if any, from
the date each supplemental cost was incurred. Contributions are intended to
provide not only for benefits attributable to service to date, but also for
those expected in the future.
For the three-month periods ended February 28, 2005 and February 29, 2004, we
recorded pension expense of $24,000 for each fiscal period. We did not make any
pension contributions in the first fiscal period of 2005 but we expect to
contribute $100,000 to our defined benefit plan in fiscal 2005. In the first
fiscal period of 2004, we contributed $26,000 to our defined benefit plan. The
current investment strategy for the defined benefit plan is to invest in
conservative debt and equity securities. The expected long-term rate of return
on plan assets is 8%. -
11
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
operations in three wholly-owned subsidiaries that focus on delivering
integrated telephone service by leasing landlines as a competitive local
exchange carrier ("CLEC") and by utilizing high-speed Internet connections to
provide Voice over Internet Protocol ("VoIP") services. 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, VoIP, and a full suite of features and
calling plans.
Almost all of the local telephone calls made by our customers are routed over a
circuit-switched network that we lease from Verizon Services Corp. ("Verizon").
Although we plan to increase the
12
number of local access lines that we route over the Verizon network during
fiscal 2005, we also plan to use other networks by offering local exchange
services on the Qwest Corporation ("Qwest") network in some of the 14 states in
which Qwest is the incumbent local exchange carrier ("ILEC") and by offering
VoIP services on an Internet network over which our customers will make
telephone calls through a high-speed Internet connection. When we route a
telephone call by our customers over an Internet network, a carrier other than
Verizon or Qwest will terminate the call for us into the public switched
telephone network ("PSTN"). We also are able to terminate some calls ourselves
that are made by our customers, in which cases we do not incur any marginal
costs for such calls.
Until December 31, 2004, both of our CLEC subsidiaries leased lines from
Verizon, using the unbundled network elements platform ("UNE-P") service
offering. UNE-P allowed us to lease the network elements we needed, such as the
local line and local circuit switching, so that we could provide local dial tone
service to our customers.
UNE-P, however, has been the subject of various court battles between the CLECs
and ILECs that have resulted in an Order on Remand in WC Docket No. 04-313 and
CC Docket No. 01-338, released on February 4, 2005 (the "TRO Remand Order") by
the Federal Communications Commission ("FCC"). The TRO Remand Order effectively
made local circuit switching under UNE-P unavailable to CLECs for new orders as
of March 11, 2005. For existing customers, the FCC announced a one-year
transition period during which a CLEC will be obligated to pay an immediate
monthly price increase of $1 per line for existing customer's switching. During
this transition period, the CLEC's embedded customer base can remain on UNE-P,
as the CLEC attempts to find an appropriate network to transition to, such as
its own network, a resale network from the RBOC, or a competitive network from
another carrier. We plan to use this transition period for one of our CLEC
subsidiaries, TSI, as TSI had been operating on the UNE-P service offering and
currently has no other arrangements to utilize another network.
Although we cannot add any new lines to TSI, we plan to rapidly grow our other
CLEC, New Rochelle Telephone Corp. ("NRTC"), which will not be impacted by the
regulatory rulings relating to UNE-P. In February 2005, NRTC signed a wholesale
advantage services agreement with Verizon, effective on January 1, 2005, that
provides NRTC with all the features and functionalities of Verizon's UNE-P
service offering, plus certain additional services. While our costs under the
wholesale advantage services agreement are somewhat higher than our costs were
under UNE-P, the agreement locks in this cost structure for five years and gives
us a significant benefit by eliminating the current regulatory uncertainty about
the future of our CLEC business. The agreement allows us to plan for steady
high-margin growth in a business that has been our core business since 1999.
We also provide local and long distance telephone service on a VoIP platform
through our wholly-owned subsidiary, VoX Communications Corp. ("VoX"). Unlike
many other CLECs, during the past few years we avoided buying any
circuit-switched equipment and instead leased circuit-switched lines from ILECs.
We believe packet telephony services represent a significant step in the
advancement of telecommunications. Consequently, we have focused our network
building efforts on building packet telephony technology and, unlike many of the
new VoIP providers, we have written and own the code to our own software.
Ultimately, our goal is to have a wholly-owned telecommunications network that
generates revenues and high margins and does not require us to lease facilities
from an ILEC. If we are no longer dependent upon an ILEC, we will be able to
offer features and services we develop that can be turned on and off almost
instantly without requiring an ILEC employee to intervene. We will also lower
our cost of services when we route a
13
telephone call over our packet-based network, as we will not be required to pay
an ILEC for line rentals or for call origination, transport and termination.
In the foreseeable future, we will continue to lease lines from the ILECs, as we
have wholesale agreements with Verizon and Qwest that allow us to lease lines
and provide Plain Old Telephone Service ("POTS"). We anticipate that these
agreements will allow us to continue to obtain an acceptable gross margin on the
POTS services we provide. We plan to attract VoIP-only customers on our
packet-switched network and eventually to offer VoIP services to our POTS
customers in NRTC and TSI. Although we believe many of our future customers will
want VoIP-only services, we are finding that many accounts want VoIP for the
bulk of their telephony needs but still desire to maintain one or two POTS
lines. We plan to be able to satisfy our customer needs for both services by
maintaining our CLEC status and by continuously advancing our VoIP product
offerings.
We anticipate that the embedded customers using TSI will be transitioned to our
NRTC network for POTS lines or to our VoX subsidiary in the event the customer
is interested in utilizing VoIP services. Although several CLECs have lobbied
for regulatory changes, and plan to continue to do so in an effort to salvage
some of the UNE-P service offering, we are assuming that efforts put forth by
the CLECs will not significantly change the results of the TRO Remand Order. The
announced merger of AT&T Corp with SBC Communications Inc. and Verizon's and
Qwest's announced bids for MCI Inc., if completed, will effectively eliminate
the two largest CLECs, each of which has been a strong voice in federal and
state lobbying efforts related to telecommunications issues.
Plan of Operation
Our financial condition was significantly improved in February 2005, when we
issued to Laurus a fixed secured convertible term note that is convertible at a
price of $0.63 per share in the principal amount of $2,000,000. Laurus required
the note be repaid within one year if we did not sign a wholesale services
agreement with an appropriate carrier. Our signing of a Verizon wholesale
services agreement on February 24, 2005 changed the loan to a three-year term,
payable in thirty-three equal monthly principal installments of $60,606, plus
monthly interest at prime plus 3%, beginning on May 1, 2005 (See Note 1). As a
result of these two transactions, we now have cash balances that we can use for
new customer acquisitions, and a five-year agreement that will allow us to
continue our core business regardless of whether the FCC or state public service
commissions rule in favor of or against UNE-P.
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 growth, our cash balances may not be sufficient to generate the growth
we desire for our VoIP subsidiary. We plan to reassess our cash requirements for
VoIP on a regular basis as we begin adding customers to our platform.
We expect to have controlled capital expenditures for our VoIP product during
the next 12 months. The amount expended will depend on the demand for our
product. We believe we will be able to make such expenditures as we grow our
business so that the utilization percentages of our network
14
equipment will remain high. Until that time, we do not see a need to purchase
network assets that may remain idle or underutilized.
Three Months Ended February 28, 2005 vs. Three Months Ended February 29, 2004
-----------------------------------------------------------------------------
Our revenue for the three-month period ended February 28, 2005 increased by
approximately $1,989,000, or approximately 106%, to approximately $3,863,000 as
compared to approximately $1,874,000 reported for the three-month period ended
February 29, 2004. The growth in revenues was directly related to the growth in
our customer base or number of local access lines that we served. We anticipate
revenues for NRTC to continue to increase in the second quarter of fiscal 2005
as we work to add new customers. On the other hand, we anticipate a decrease in
revenue for TSI as we do not plan to add new customers in TSI as discussed
earlier. However, our revenue growth in NRTC many not be as rapid as in the past
as we are re-evaluating our telemarketing strategy and may determine to call
only businesses and residential prospects who are home owners.
Our gross profit for the three-month period ended February 28, 2005 increased by
approximately $814,000 to approximately $1,808,000 from approximately $994,000
reported in the three-month period ended February 29, 2004. During the same
fiscal periods, our gross profit percentage decreased to 46.8% from 53%. The
increase in our dollars of gross profit resulted from the increase in our
customer base in first quarter of fiscal 2005 over the first quarter fiscal
2004. The decrease in our gross profit percentage during the 2005 period
resulted from the higher cost of services that we are now incurring under our
wholesale services agreement with Verizon, as compared to the costs we
previously incurred under the UNE-P service offering. Our selling strategy in
fiscal 2005 is to continue to penetrate states that offer the opportunity to
achieve higher margins.
SG&A increased by approximately $1,284,000, or approximately 137%, to
approximately $2,221,000 for the three-month period ended February 28, 2005 from
approximately $937,000 reported in prior year fiscal period. Of this increase,
approximately $730,000 was for bad debt expense, approximately $150,000 was for
telemarketing costs, approximately $73,000 was for billing costs, and
approximately $212,000 was for increased personnel costs, of which approximately
$80,000 was related to VoX. Although our marketing has been directed to
consumers with acceptable credit scores, we recently adjusted our marketing
strategy for the future in order to reduce our bad debt expense. We are now
telemarketing more actively to small businesses and have changed our
requirements for residential customers so that we are marketing only to
consumers who are homeowners and have proven records of good credit history.
Although this strategy will most likely increase our acquisition costs per line,
we anticipate the extra cost associated with purchasing homeowner-only leads of
credit-worthy customers will decrease our bad debt expense, which in the most
recent quarter was unacceptable to us.
Depreciation expense decreased to approximately $1,000 for the three-month
period ended February 28, 2005 as compared to approximately $4,000 for the
three-month period ended February 29, 2004. Although we have limited VoIP
revenues and are confident that our VoIP platform is functional, we have not
started to amortize the capitalized costs of our VoIP platform as we are still
in the final testing stages. We anticipate that our final live platform, which
will be co-located in a major data center, will be launched during the second
quarter of fiscal 2005.
15
Interest expense increased by approximately $49,000 to approximately $52,000 for
the three-month period ended February 28, 2005 as compared to approximately
$3,000 for the three-month period ended February 29, 2004, as a result of our
recent financing agreements (See Note 1). Interest and other income decreased by
approximately $12,000, to approximately $17,000 for the three-month period ended
February 28, 2005 as compared to approximately $29,000 for the three-month
period ended February 29, 2004. The decrease resulted primarily from a reduction
in commission income.
For the three-month period ended February 28, 2005, we recorded income of
approximately $47,000, which resulted from the change in the market value of the
warrants issued to Laurus as part of the Laurus financing (See Note 1). No such
income was recorded in the three-month period ended February 29, 2004.
For the three-month period ended February 29, 2004, reorganization items
included a gain of approximately $51,000 as a result of a court-stipulated
reduction in post-petition liabilities (See Note 10) and approximately $120,000
in professional fees reported by TSI (See Note 6). No such transactions occurred
in the three-month period ended February 28, 2005.
For the three-month period ended February 29, 2004, we recorded a tax benefit of
$45,000, 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 February 28, 2005.
Liquidity and Capital Resources
-------------------------------
At February 28, 2005, we had cash and cash equivalents of approximately
$1,552,000 and negative working capital of approximately $1,292,000.
Net cash used in operating activities aggregated approximately $771,000 and
$59,000 in the three-month periods ended February 28, 2005 and February 29,
2004, respectively. The principal use of cash in fiscal 2005 was the increase in
accounts receivable of approximately $1,157,000, offset by an increase in the
provision for doubtful accounts of approximately $745,000 and the loss for the
period of approximately $402,000. The principal use of cash in fiscal 2004 was
the net change in operating assets and liabilities, which was partially offset
by the income for the period of approximately $56,000.
Net cash used in investing activities in the three-month period ended February
28, 2005 aggregated approximately $101,000, resulting primarily from
expenditures related to our VoIP initiative. There were no investing activities
in the three-month period ended February 29, 2004.
Net cash provided by (used in) financing activities aggregated approximately
$2,052,686 and ($2,000) in the three-month periods ended February 28, 2005 and
February 29, 2004, respectively. In fiscal 2005, net cash provided by financing
activities resulted from the proceeds of short-term and long-term notes,
warrants and stock issuances and the exercise of stock options in the amounts of
approximately $2,018,000 and $34,500, respectively. In fiscal 2004, net cash
used in financing activities resulted from the repayment of debt.
For the three-month period ended February 28, 2005, we had approximately
$101,000 in capital expenditures primarily related to our VoIP initiative. We
expect to make equipment purchases of approximately $50,000 to $75,000 in the
second fiscal quarter of 2005. We expect that other
16
capital expenditures over the next 12 months will relate primarily to a
continued roll-out of VoIP services and will only be required to support a
growing customer base of VoIP subscribers.
We have stock purchase warrants that entitle us to purchase approximately 95,000
shares of Talk America Holdings Inc. ("Talk"). The warrant exercise price is
$6.30 per share and, at April 1, 2005, our warrants were in-the-money, as Talk
common stock was trading at approximately $6.41 per share at such date.
We have reported profits in the last two fiscal years, but we have also
sustained net losses from operations during those periods, as we have worked to
build our customer base. Our operating losses have been funded through the sale
of non-operating assets, the issuance of equity securities and borrowings. We
believe that current cash and cash equivalents will be sufficient to finance our
operations through at least the next twelve months. However, we continually
evaluate our cash needs and growth opportunities and we anticipate seeking
additional equity or debt financing in order to achieve our overall business
objectives. There can be no assurance that such financing will be available, or,
if available, at a price that would be acceptable to us. Failure to generate
sufficient revenues, raise additional capital or reduce certain discretionary
spending could have an adverse impact on our ability to achieve our longer-term
business objectives.
Item 3. Controls and Procedures
------- -----------------------
Disclosure Controls and Procedures. We maintain disclosure controls
and procedures designed to ensure that information required to be disclosed in
our reports under the Securities Exchange Act of 1934, as amended ( the
"Exchange Act") is recorded, processed, summarized and reported within the time
periods specified in the Exchange Act, and that such information is accumulated
and communicated to our management, including our chief executive officer/chief
financial officer, as appropriate to allow timely decisions regarding required
disclosure. In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible controls and
procedures.
In connection with the completion of its audit of, and the issuance of an
unqualified report on, our consolidated financial statements for the fiscal year
ended November 30, 2004, our independent auditors, Nussbaum Yates and Wolpow,
P.C. ("NYW"), communicated to our Audit Committee that the following matters
involving our internal controls and operations were considered to be "reportable
conditions", as defined under standards established by the American Institute of
Certified Public Accountants or AICPA:
o Lack of quantity of staff, which led to issues related to lack of
segregation of duties, inadequate supervision, timeliness of
financial reporting and year end closing process; and
o Lack of quantity of staff, which led to issues related to the timely
preparation and filing of municipal telecommunications tax returns.
o Lack of quantity of staff, which led to tax payments being
classified as cost of services and an overstatement of
telecommunications taxes payable
Reportable conditions are matters coming to the attention of our independent
auditor that, in its judgment, relate to significant deficiencies in the design
or operation of internal controls and could adversely affect our ability to
record, process, summarize and report financial data consistent with
17
the assertions of management in the financial statements. In addition, NYW has
advised us that it considers the first matter noted above, which relates to the
lack of a segregation of duties, to be a "material weaknesses" that may increase
the possibility that a material misstatement in our financial statements might
not be prevented or detected by our employees in the normal course of performing
their assigned functions.
As required by SEC Rule 13a-15(b), we carried out an evaluation under the
supervision and with the participation of our management, including our chief
executive officer/chief financial officer, of the effectiveness of the design
and operations of our disclosure controls and procedures. Based on the
foregoing, our chief executive officer/chief financial officer determined that
the deficiencies identified by NYW could cause our disclosure controls and
procedures to be less effective at a reasonable assurance level than was
desirable. However, we are actively seeking to remedy the deficiencies
identified herein, including hiring additional staff to assure segregation of
duties, additional review procedures and, timeliness of financial reporting, as
well as preparing and filing telecommunications tax returns on a monthly basis,
instead of quarterly or semi-annually. The our chief executive officer/chief
financial officer did not note any other material weakness or significant
deficiencies in our disclosure controls and procedures during this evaluation.
We continue to improve and refine our internal controls. This process is
ongoing.
Internal Control Over Financial Reporting. Other than for the
matters discussed above, our chief executive officer/chief financial officer has
determined that our internal controls and procedures were effective as of the
end of the period covered by this report. Other than as described below, in the
first quarter of fiscal 2005, there were no significant changes in our internal
control over financial reporting or in other factors that materially affected,
or are reasonably likely to materially affect, our internal controls over
financial reporting.
During fiscal year 2004, we reported that we had been overstating
our telecommunications taxes payable for certain taxes we had paid directly to
our carrier. We have changed the way we analyze our carrier bills and our tax
liability accounts so that both our cost of services and taxes payable accounts
are not overstated, and we have enhanced the training of personnel involved in
the various processes. We believe these actions have remediated the reported
deficiency.
18
eLEC COMMUNICATIONS CORP.
-------------------------
PART II-OTHER INFORMATION
-------------------------
Item 1. Legal Proceedings
------- -----------------
None
Item 2. Changes in Securities and Purchases of Equity Securities
------- --------------------------------------------------------
In December 2005, we issued an aggregate of 505,000 shares of our
common stock. 345,000 shares of our common stock were issued in
conjunction with the exercise of options granted under our Employee
Stock Option Plan, as amended. 160,000 shares of our common stock
were issued to a lender in conjunction with a financing agreement as
interest expense. Such shares were issued in reliance upon the
exemption from registration provided by Section 4(2) of the
Securities Act of 1933, as amended, on the basis that such issuance
did not involve a public offering, no underwriter fees or
commissions were paid in connection with such issuance and such
person was an `accredited investor' as defined in Regulation D under
the Securities Act of 1933, as amended.
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 January 24, 2005, we filed a Current Report on Form 8-K
related to the appointment of Gayle Greer to our Board of
Directors.
19
On February 8, 2005, we filed a Current Report on Form 8-K
related to our financing agreement with Laurus Master Fund,
Ltd.
On February 24, 2005, we filed a Current Report on Form 8-K
related to our wholesale services agreement with Verizon
Services Corp.
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.
April 19, 2005 By: /s/ Paul H. Riss
------------------- -------------------------------
Date Paul H. Riss
Chief Executive Officer
(Principal Financial and
Accounting Officer)
21