| PART 1. FINANCIAL INFORMATION |
| |
| Item 1. |
|
Financial Statements |
|
|
|
|
| |
| eLEC Communications Corp. and Subsidiaries |
| Condensed Consolidated Balance Sheet |
| |
| |
|
|
|
May 31, 2007 |
|
Nov. 30, 2006 |
| |
|
|
|
(Unaudited) |
|
(See Note 1) |
| Assets |
|
|
|
|
| Current assets: |
|
|
|
|
| Cash and cash equivalents |
|
$ 49,183 |
|
$1,337,525 |
| Accounts receivable, net |
|
72,653 |
|
630,197 |
| Prepaid expenses and other current assets |
|
72,016 |
|
154,749 |
| Assets held for sale |
|
775,811 |
|
- |
| Deferred finance costs, net |
|
|
|
1,010,766 |
|
|
|
1,012,941 |
| Total current assets |
|
1,980,429 |
|
3,135,412 |
| |
| Property, plant and equipment, net |
|
835,414 |
|
903,281 |
| |
| |
| Other assets |
|
|
|
110,212 |
|
|
|
149,525 |
| Total assets |
|
|
|
$2,926,055 |
|
|
|
$4,188,218 |
| |
| Liabilities and stockholders’ equity deficiency |
|
|
|
|
| Current liabilities: |
|
|
|
|
| Current portion of long-term debt and capital lease obligations |
|
$2,538,059 |
|
$3,347,707 |
| Warrant liability |
|
2,073,892 |
|
1,251,182 |
| Accounts payable and accrued expenses |
|
2,438,623 |
|
2,897,495 |
| Taxes payable |
|
7,964 |
|
559,617 |
| Liabilities assumed in sale |
|
2,390,151 |
|
- |
| Deferred Revenue |
|
|
|
- |
|
|
|
166,100 |
| Total current liabilities |
|
9,448,689 |
|
8,222,101 |
| |
| Long-term debt and capital lease obligations, less current maturities |
|
|
|
189,448 |
|
|
|
214,907 |
| Total liabilities |
|
|
|
9,638,137 |
|
|
|
8,437,008 |
| |
| Stockholders’ equity deficiency: |
|
|
|
|
| Preferred stock $.10 par value, 1,000,000 shares authorized, |
|
|
|
|
| none issued and outstanding |
|
- |
|
- |
| Common stock $.10 par value, 50,000,000 shares authorized, |
|
|
|
|
| 22,459,282 and 22,434,282 shares issued and outstanding in 2007 and |
|
|
|
|
| 2006 |
|
2,245,928 |
|
2,243,428 |
| Capital in excess of par value |
|
27,337,537 |
|
27,071,584 |
| Deficit |
|
(36,284,625) |
|
(33,554,700) |
| Accumulated other comprehensive loss, unrealized loss on securities |
|
|
|
(10,922) |
|
|
|
(9,102) |
| Total stockholders’ equity deficiency |
|
|
|
(6,712,082) |
|
|
|
(4,248,790) |
| Total liabilities and stockholders’ equity deficiency |
|
|
|
$2,926,055 |
|
|
|
$4,188,218 |
| |
| See notes to the condensed consolidated financial statements. |
|
|
|
|
| eLEC COMMUNICATIONS CORP. |
| |
| Notes To Condensed Consolidated Financial Statements (Unaudited) |
| |
| |
| |
| Note 1-Basis of Presentation |
| |
| The accompanying unaudited condensed consolidated financial statements have been |
| prepared in accordance with generally accepted accounting principles for interim financial |
| information and in accordance with the rules and regulations of the Securities and Exchange |
| Commission for Form 10-Q. Accordingly, they do not include all of the information and |
| footnotes required by generally accepted accounting principles for complete financial statements. |
| In the opinion of management, all adjustments (consisting of normal recurring accruals) |
| considered necessary for a fair presentation have been included. Operating results for the three- |
| month or six-month periods ended May 31, 2007 are not necessarily indicative of the results that |
| may be expected for the year ended November 30, 2007. For further information, refer to the |
| consolidated financial statements and footnotes thereto included in our Annual Report on Form |
| 10-K for the year ended November 30, 2006. |
| |
| Note 2-Going Concern Matters and Realization of Assets |
| |
| The accompanying financial statements have been prepared on a going concern basis, |
| which contemplates the realization of assets and the satisfaction of liabilities in the |
| ordinary course of business. However, we have sustained substantial losses from |
| continuing operations in recent years and we have negative working capital and a |
| stockholders’ equity deficiency. In addition, similar to many start-up ventures, we are |
| experiencing difficulty in generating sufficient cash flow to meet our obligations and |
| sustain our operations. We are currently in default of our financing agreement with our |
| principal lender (Note 10). |
| |
| We expect our operating losses and cash deficits from operations to continue through |
| fiscal 2007. As a result, we will need to raise additional cash through some combination |
| of borrowings, sale of equity or debt securities or sale of assets to enable us to meet our |
| cash requirements. |
| |
| We may not be able to raise sufficient additional debt, equity or other cash on acceptable |
| terms, if at all. Failure to generate sufficient revenues, achieve certain other business |
| plan objectives or raise additional funds could have a material adverse effect on the |
| Company’s results of operations, cash flows and financial position, including our ability |
| to continue as a going concern, and may require us to significantly reduce, reorganize, |
| discontinue or shut down our operations. |
| |
| In view of the matters described above, recoverability of a major portion of the recorded |
| asset amounts shown in the accompanying balance sheet is dependent upon continued |
| operations of the company which, in turn, is dependent upon our ability to meet our |
| financing requirements on a continuing basis, and to succeed in our future operations. |
| The financial statements do not include any adjustments relating to the recoverability and |
| classification of recorded asset amounts or amounts and classification of liabilities that |
| might be necessary should we be unable to continue operating. |
| |
| Management’s plans include (1) seeking additional financing to continue operations as a |
| broadband voice carrier and increasing our sales channels and sales staff so our |
| broadband voice facilities are more fully utilized, (2) seeking additional financing to |
| purchase target businesses that are generating positive cash flow, and (3) evaluating |
| strategic partnerships with companies that may want to purchase a portion of our |
| business. |
| |
| There can be no assurance that we will be able to achieve our business plan objectives or |
| that we will achieve or maintain cash flow positive operating results. If we are unable to |
| generate adequate funds from operations or raise additional funds, we may not be able to |
| repay its existing debt, continue to operate our network, respond to competitive pressures |
| or fund our operations. As a result, we may be required to significantly reduce, |
| reorganize, discontinue or shut down our operations. Our financial statements do not |
| include any adjustments that might result from this uncertainty. |
| |
| Note 3-Major Customers |
| |
| During the six-month and three-month periods ended May 31, 2007, one customer |
| accounted for 42% and 50%, respectively, of revenue from continuing operations. During the |
| six-month and three-month periods ended May 31, 2006, one customer accounted for 48% and |
| 36%, respectively, of revenue from continuing operations, and a second customer accounted for |
| 19% and 20%, respectively, of revenue from continuing operations. |
| |
| |
| |
| Note 4-Loss Per Common Share |
| |
| Basic loss per common share is calculated by dividing net loss by the weighted average |
| number of common shares outstanding during the period. |
| |
| Approximately 13,093,000 and 10,950,000 shares of common stock issuable upon the |
| exercise of our outstanding stock options and warrants and in the six-month and three-month |
| periods ending May 31, 2006, the conversion of our outstanding convertible debt, were excluded |
| from the calculation of loss per share for the six-month and three-month periods ended May 31, |
| 2007 and 2006, respectively, because the effect would be anti-dilutive. |
| |
| |
| Note 5-Risks and Uncertainties |
| |
| We have created our own proprietary Internet Protocol (“IP”) telephony network and have |
| transitioned from a reseller of traditional wireline telephone services into a facilities-based |
| broadband service provider to take advantage of the network cost savings that are inherent in an |
| IP network. Although we continue to build our IP telephony business, we face strong |
| competition and we continue to grow our IP telephony business without adequate financial |
| resources. At this point in time, the survival of our business is dependent upon the success of our |
| IP operations. 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: |
| |
| · |
|
The availability of additional funds to successfully pursue our business plan; |
| · |
|
The acceptance of IP telephony by mainstream consumers; |
| · |
|
Our ability to market our services to current and new customers and to generate customer |
| |
|
demand for our products and services in the geographical areas in which we operate; |
| · |
|
Our ability to comply with provisions of our financing agreements; |
| · |
|
The impact of changes the Federal Communications Commission or State Public Service |
| |
|
Commissions may make to existing telecommunication laws and regulations, including |
| |
|
laws dealing with Internet telephony; |
| · |
|
The highly competitive nature of our industry; |
| · |
|
Our ability to retain key personnel; |
| · |
|
Our ability to maintain adequate customer care and manage our churn rate; |
| · |
|
The cooperation of industry service partners that have signed agreements with us; |
| · |
|
Our ability to maintain, attract and integrate internal management, technical information |
| |
|
and management information systems; |
| · |
|
The availability and maintenance of suitable vendor relationships in a timely manner and |
| |
|
at reasonable cost; |
| · |
|
Our ability to manage rapid growth while maintaining adequate controls and procedures; |
| · |
|
Failure or interruption in our network and information systems; |
| · |
|
Our inability to adapt to technological change; |
| · |
|
The perceived infringement of our technology on another entity’s patents; |
| · |
|
Our inability to manage customer attrition and bad debt expense; |
| · |
|
Failure or bankruptcy of other telecommunications companies upon which we rely for |
| |
|
services and revenues; |
| · |
|
Our lack of capital or borrowing capacity, and inability to generate cash flow; |
| · |
|
The decrease in telecommunications prices to consumers; and |
| · |
|
General economic conditions. |
| |
| |
| Note 6-Stock-Based Compensation Plans |
| |
| We issue stock options to our employees and outside directors pursuant to stockholder- |
| approved and non-approved stock option programs. In December 2004, the Financial |
| Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment”. SFAS |
| 123R is a revision of SFAS 123, and supersedes APB 25. Among other items, SFAS 123R |
| eliminates the use of APB 25 and the intrinsic value method of accounting, and requires |
| companies to recognize in their financial statements the cost of employee services received in |
| exchange for awards of equity instruments, based on the grant date fair value of those awards. |
| SFAS 123R permits companies to adopt its requirements using either a “modified prospective” |
| method, or a “modified retrospective” method. Under the “modified prospective” method, |
| compensation cost is recognized in the financial statements beginning with the effective date, |
| based on the requirements of SFAS 123R for all share-based payments granted after that date, |
| and based on the requirements of SFAS 123 for all unvested awards granted prior to the effective |
| date of SFAS 123R. Under the “modified retrospective” method, the requirements are the same |
| as under the “modified prospective” method, but this method also permits entities to restate |
| financial statements of previous periods based on proforma disclosures made in accordance with |
| SFAS 123. Beginning in fiscal 2006, we account for stock-based compensation in accordance |
| with the provisions of SFAS 123R and have elected the “modified prospective” method and have |
| not restated prior financial statements. For the six-month periods ended May 31, 2007 and 2006, |
| we recorded approximately $91,000 and $100,000, respectively, in employee stock-based |
| compensation expense, which is included in our selling, general and administrative expenses. For |
| the three-month periods ended May 31, 2007 and 2006, we recorded approximately $44,000 and |
| $47,000, respectively, in employee stock-based compensation expense. As of May 31, 2007, |
| there was approximately $142,000 of unrecognized stock-compensation expense for previously- |
| granted unvested options that will be recognized over a three-year period. |
| |
| Note 7-Impairment of Long-Lived Assets |
| |
| We review long-lived assets for impairment whenever events or changes in circumstances |
| indicate that the carrying value of an asset may not be recoverable. Recoverability of assets to be |
| held and used is measured by a comparison of the carrying amount of an asset to future |
| forecasted net undiscounted cash flows expected to be generated by the asset. If such assets are |
| considered to be impaired, the impairment to be recognized is measured by the amount by which |
| the carrying amount of the assets exceeds the fair values. We founded our IP telephony business |
| in 2004, and since its inception it has incurred significant operating and cash flow losses. It can |
| be considered a late-stage start-up business, and we have evaluated the assets of this business and |
| future operations to determine if we need to recognize an impairment expense. We recently |
| received a written offer for this business payable in stock of a public company, |
| assumption of debt and cash. Even if the portion payable in stock is discounted, the offer is |
| significantly higher than the book value of the assets of our IP telephony business. Accordingly, |
| we have determined that such assets are not impaired. In addition, subsequent to the balance |
| sheet date of May 31, 2007, we sold our wireline telephony business for a gain (see Note 12), |
| and consequently, we determined that such assets were not impaired. |
| |
| Note 8-Accrued Expenses |
| |
| At May 31, 2007, we were disputing payments on invoices from Verizon amounting to |
| approximately $537,000 because we believe Verizon overcharged us for certain calls made by |
| our former wireline telephone customers. Although we are not currently required to pay the disputed |
| amount, Verizon initially rejected our claims. We have escalated many of our claims and hired a |
| firm that specializes in telecom disputes to analyze past call records and to resubmit and pursue |
| the claims. Although we intend to vigorously pursue all claims and would consider a settlement |
| for a partial amount, the minimum amount of claims that our outside claim consultant believes |
| will be honored is $65,000. Consequently, we have recorded $477,000 of the disputed charges as |
| a liability and have not recorded the $65,000 amount. |
| |
| |
| Note 9-Defined Benefit Plan |
| |
| We sponsor a defined benefit plan covering one active employee 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 six-month and three-month periods ended May 31, 2007 and 2006, we recorded pension |
| expense of $48,000 and $24,000, respectively. In the six-month period ended May 31, 2007, we |
| contributed $10,000 to our defined benefit plan. There were no contributions in the three-months |
| ended May 31, 2007. In the six- and three-month periods ended May 31, 2006, we contributed |
| $52,500 and $0, respectively, to the pension plan. We expect to contribute |
| approximately $68,000 to our defined benefit plan in fiscal 2007. 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%. |
| |
| We also sponsor a 401(k) profit sharing plan for the benefit of all eligible employees, as |
| defined. The plan provides for the employees to make voluntary contributions not to exceed the |
| statutory limitation provided by the Internal Revenue Code. We may make discretionary |
| contributions. There were no discretionary contributions made for the six-month and three- |
| month periods ended May 31, 2007 or 2006. |
| |
| Note 10-Principal Financing Arrangements |
| |
| We have completed three financings with our principal lender, one in February 2005, one |
| in November 2005 and one in May 2006. Each financing requires a certain amount of monthly |
| principal payments. We did not make any principal payments on our loans during fiscal 2007, |
| and on April 16, 2007 we received a waiver and a modification to our lending agreement from |
| our principal lender that deferred principal payments on our February 2005 financing and our |
| November 2005 financing, so that monthly principal payments on such loans were not required |
| until June 1, 2007, and August 1, 2007, respectively. In consideration for the principal deferral, we |
| issued to our lender a seven-year warrant to purchase 1,200,000 shares of our common stock at a |
| price of $0.25 per share. We valued the warrant at $313,162 using the Black-Scholes method with an |
| interest rate of 5.25%, volatility of 103%, zero dividends and an expected term of seven years. The |
| underlying contracts provide for a potential cash settlement and accordingly, the warrants are |
| classified as debt. Deferred financing cost of $313,162 was also recorded as of April 16, 2007 and |
| is being amortized to interest expense over the life of the notes payable. |
| |
| In conjunction with the sale of two of our subsidiaries in June 2007 (see Note 11), the |
| remaining principal balance from our financing in February 2005, which had a book value of $1,006,799 |
| as of May 31, 2007, has been paid in full. We are in default with our lender for not making all of |
| our June and July 2007 principal and interest payments, and we are working with our lender to |
| adjust our payment schedule. Because of the default on such debt, the debt can be called |
| immediately, and we have classified such debt as a current liability on our balance sheet and |
| have shown the related debt finance costs as a current asset. |
| |
| |
| Note 11-Income Taxes |
| |
| At November 30, 2006, we had net operating loss carryforwards for Federal income tax |
| purposes of approximately $25,400,000 expiring in the years 2008 through 2026. As a result of |
| the sale of two wholly owned subsidiaries in June 2007 (see Note 11), the amount of our net |
| operating loss that we can carry forward to future years will be reduced by the amount of the net |
| operating losses that are attributable to the divested subsidiaries. We have not yet determined the |
| reduction in the amount of net operating loss carryforwards available to us. We will continue to |
| have an annual limitation of approximately $187,000 on the utilization of approximately |
| $2,400,000 of our remaining net operating loss carryforwards under the provisions of Internal |
| Revenue Code Section 382. We did not provide for a tax benefit, as it is more likely than not |
| that any such benefit will not be realized. |
| |
| |
| Note 12-Sale of Subsidiaries |
| |
| On December 14, 2006, we entered into two separate definitive purchase agreements |
| (“Agreements”) to sell to Cyber Digital, Inc. (“Purchaser”), a publicly-traded shell company, our |
| two wholly-owned subsidiaries that operate as competitive local exchange carriers (“CLECs”). |
| The CLECs were sold in June 2007. The operations of the CLECs are presented in our income |
| statement as discontinued operations for the six-month and three-month periods ended May 31, |
| 2007 and 2006. The gain on the sale of the CLECs will be recorded in the third fiscal quarter of |
| fiscal 2007. The May 31, 2007 balance sheet includes assets held for sale of approximately |
| $776,000 and liabilities assumed in sale of approximately $2,390,000 to reflect the May 31, 2007 |
| balances of the assets and liabilities that were transferred to the Purchaser in June 2007. Further, |
| in the third quarter of fiscal 2007, we will write off the remaining deferred financing costs of |
| approximately $319,000 from the February 2005 loan that was paid in full as part of the sale of |
| the CLECs. We anticipate recording a gain on the sale of discontinued operations |
| of approximately $1,200,000. |
| |
| CLEC revenues amounted to approximately $3,013,000 and $1,456,000 for the six-month |
| and three-month periods ended May 31, 2007 and approximately $4,591,000 and $2,112,000 for |
| the six-month and three-month periods ended May 31, 2006. Pretax income (loss) attributable to |
| the operations of the CLECs amounted to approximately ($182,000) and ($147,000) for the six- |
| month and three-month periods ended May 31, 2007 and approximately $135,000 and ($11,000) |
| for the six-month and three-month periods ended May 31, 2006. |
| 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 our financial condition, results of operations and business, 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 those factors set forth under Note 4 – Risks and |
| Uncertainties. |
| |
| These forward-looking statements are subject to numerous assumptions, risks and |
| uncertainties that may cause our actual results to be materially different from any future results |
| expressed or implied by us in those statements. These risk factors should be considered in |
| connection with any subsequent written or oral forward-looking statements that we or persons |
| acting on our behalf may issue. 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 these uncertainties, |
| we caution investors not to unduly rely on our forward-looking statements. We do not undertake |
| any obligation to review or confirm analysts’ expectations or estimates or to release publicly any |
| revisions to any forward-looking statements to reflect events or circumstances after the date of |
| this Report or to reflect the occurrence of unanticipated events. Further, the information about |
| our intentions contained in this Report is a statement of our intention as of the date of this |
| Report and is based upon, among other things, the existing regulatory environment, industry |
| conditions, market conditions and prices, the economy in general and our assumptions as of such |
| date. We may change our intentions, at any time and without notice, based upon any changes in |
| such factors, in our assumptions or otherwise. |
| |
| Overview |
| |
| We are a provider of wholesale Internet Protocol (“IP”) telephone services. We route |
| telephone calls over broadband services using our own IP telephony product. IP telephony is the |
| real time transmission of voice communications in the form of digitized “packets” of information |
| over the Internet or a private network, which is analogous to the way in which e-mail and other |
| data is transmitted. We use proprietary softswitch technology that runs on Cisco and Dell |
| hardware to provide broadband telephone services to other service providers, such as cable |
| operators, Internet service providers, WiFi and fixed wireless broadband providers, data |
| integrators, value-added resellers and satellite broadband providers. Our technology enables |
| these carriers to quickly and inexpensively offer premier broadband telephone services, complete |
| with order flow management for efficient provisioning, billing and support services and user |
| interfaces that are easily customized to reflect the carrier’s unique brand. |
| |
| The worldwide rollout of broadband voice services has allowed consumers and |
| businesses to communicate at dramatically reduced costs in comparison to traditional telephony |
| networks. Traditionally, telephone service companies have built networks based on circuit |
| switching technology, which creates and maintains a dedicated path for individual telephone |
| calls until the call is terminated. While circuit-switched networks have provided reliable voice |
| communications services for more than 100 years, transmission capacity is not efficiently utilized |
| in a circuit-switched system. Under circuit-switching technology, when a person makes a |
| telephone call, a circuit is created and remains dedicated for the entire duration of that call, |
| rendering the circuit unavailable for the transmission of any other calls. |
| |
| Data networks, such as IP networks, utilize packet switching technology that divides |
| signals into packets and simultaneously routes them over different channels to a final destination |
| where they are reassembled into the original order in which they were transmitted. No dedicated |
| circuits are required and a fixed amount of bandwidth is not needed for the duration of each call. |
| The more efficient use of network capacity results in the ability to transmit significantly greater |
| amounts of traffic over a packet-switched network than a circuit-switched network. Packet- |
| switching technology enables service providers to converge traditional voice and data networks |
| in an efficient manner by carrying voice, fax, video and data traffic over the same network. IP |
| networks are therefore less expensive for carriers to operate, and these cost savings can be passed |
| on to the consumer in the form of lower costs for local, long distance and international long |
| distance telephone services. |
| |
| We have created our own Linux-based IP platform and have transitioned into a |
| facilities-based broadband service provider to take advantage of the network cost savings that are |
| inherent in an IP network. Our proprietary softswitch provides more than 20 of the Class 5 call |
| features, voice mail and enhanced call handling on our own Session Initiation Protocol (“SIP”) |
| server suite. We control all of the features we offer to broadband voice customers because we |
| write the software code for any new features that we desire to offer our customers rather than |
| relying on a third-party software vendor. We have no software licensing fees and our other |
| variable network costs are expected to drop as we increase our network traffic and as we attract |
| more pure-IP telephony users with traffic that does not incur the cost of originating or |
| terminating on a circuit-switched network. |
| |
| Our SIP servers are part of a cluster of servers, which we refer to as a server farm, in |
| which each server performs different network tasks, including back-up and redundant services. |
| We believe the server farm structure can be easily and cost-effectively scaled as our broadband |
| voice business grows. In addition, servers within our server farm can be assigned different tasks |
| as demand on the network dictates. If an individual server ceases to function, our server farm is |
| designed in a manner that subscribers should not have their calls interrupted. |
| |
| We began our telecom operations in 1998 as a reseller of local telephone service. Our |
| reseller subsidiaries were sold to a third-party purchaser in June 2007 and have been presented in |
| our financial statements as discontinued operations. |
| Plan of Operations |
| |
| Our objective is to build a profitable telephone company on a stable and scalable |
| platform with minimal network costs. We want to be known for our high quality of service, |
| robust features and ability to deliver any new product to a wholesale customer or a web store |
| without delay. We believe that to achieve our objective we need to have “cradle to grave” |
| automation of our back-office web and billing systems. We have written our software for |
| maximum automation, flexibility and changeability. |
| |
| We know from experience in provisioning complex telecom orders that back-office |
| automation is a key factor in keeping overhead costs low. Technology continues to work for 24 |
| hours a day and we believe that the fewer people a company has in the back office, the more |
| efficiently it can run, which should drive down the cost per order. |
| |
| Furthermore, our strategy is to grow rapidly by leveraging the capital, customer base and |
| marketing strength of our wholesale customers. Many of our targeted wholesale customers and |
| some of our existing wholesale customers have ample capital to market a private-labeled |
| broadband voice product to their existing customer bases or to new customers. We believe our |
| strength is our technology-based platform. By providing our technology to cable companies, |
| CLECs, ISPs, WiFi and fixed-wireless broadband providers, data integrators, value-added |
| resellers, and satellite broadband providers and any other entity that desires to offer a broadband |
| telephony product, we believe we will require significantly less cash resources than other |
| providers will require to attract a similar number of subscribers. |
| |
| By taking a wholesale approach, our goal is to obtain and manage 500 customers that |
| have an average customer base of 1,000 end-users. We believe we will be more successful and |
| more profitable taking this approach to reaching 500,000 end-users than we would be if we tried |
| to attract and manage 500,000 individual end-users by ourselves. |
| |
| |
| Six Months Ended May 31, 2007 vs. Six Months Ended May 31, 2006 |
| |
| Our revenue from continuing operations for the six-month period ended May 31, 2007 |
| increased by approximately $325,000, or approximately 392%, to approximately $409,000 as |
| compared to approximately $83,000 reported for the six-month period ended May 31, 2006. The |
| increase in revenues was directly related to the increase in the number of wholesale customers |
| that began reselling our Internet telephone service. At May 31, 2007, we were billing 45 |
| wholesale customers, as compared to 15 customers at May 31, 2006. As of May 31, 2007, we |
| had signed 87 wholesale customer contracts, consisting of seven CLECs, seven cable operators, |
| five Internet service providers, eight data integrators, 35 resellers and 25 agents. When we sign |
| up a new customer, typically it will be several months before the customer begins to resell our |
| service to individual retail consumers. Some of our wholesale customers will abandon their |
| efforts to sell Internet telephony services and we will never be able to bill them. In addition to |
| the 87 signed wholesale customers, we have 39 potential customers in trial and we anticipate |
| continued rapid growth in our monthly billings, as many of the wholesale customers that we |
| signed early in the year are beginning to turn up services. We anticipate that our billings in July |
| 2007 will increase more than 25% over our June 2007 billings. |
| |
| We attained a negative gross profit for the six-month period ended May 31, 2007 of |
| approximately ($127,000), which was an improvement of approximately $31,000 over the |
| negative gross profit of approximately ($158,000) reported in the six-month period ended May |
| 31, 2006. Our IP telephony facilities have significant unused capacity and we have therefore |
| been unable to generate a positive gross profit on a quarterly basis, although we did achieve a |
| positive gross profit for the month of May. We need to attain higher sales volumes to cover fixed |
| costs and to negotiate lower variable costs with vendors. We are currently moving traffic to a |
| vendor that can lower our variable costs, and we are speaking with another low-cost vendor that |
| could lower our variable costs, but that charges monthly minimums. We currently have a |
| sufficient number of minutes to meet proposed contractual minimums. |
| |
| Selling, general and administrative expenses increased by approximately $182,000, or |
| approximately 16%, to approximately $1,341,000 for the six-month period ended May 31, 2007 |
| from approximately $1,159,000 reported in the same prior-year fiscal period. Additional salary |
| and marketing expense accounted for the majority of the increase. |
| |
| Depreciation and amortization expense increased by approximately $122,000 for the six |
| months ended May 31, 2007 to approximately $235,000 as compared to approximately $113,000 |
| for the same period in fiscal 2006. Approximately $83,000 of the increase was for deferred |
| financing costs related to our financing agreements and approximately $39,000 related to our |
| Internet telephony platform. |
| |
| Interest expense increased by approximately $89,000 to approximately $356,000 for the |
| six months ended May 31, 2007 as compared to approximately $267,000 for the six months |
| period ended May 31, 2006. The increase was due to higher interest expense paid to our |
| principal lender of approximately $94,000 due to higher borrowing levels in the fiscal 2007 |
| period. |
| |
| Warrant expense for the six months ended May 31, 2007 amounted to approximately |
| $510,000, primarily due to the significant increase in the market value of our common stock from |
| November 30, 2006 to May 31, 2007, as compared to the warrant income of approximately |
| $225,000 for the same period in fiscal 2006. The warrant income resulted from a decrease in the |
| price of our common stock at May 31, 2006 as compared to the value at November 30, 2005. |
| |
| Discontinued operations reflect the net loss for the six-month periods ended May 31, |
| 2007 and 2006 attributable to our former CLEC operations, which were sold in June 2007. |
| |
| |
| Three Months Ended May 31, 2007 vs. Three Months Ended May 31, 2006 |
| |
| Our revenue from continuing operations for the three-month period ended May 31, 2007 |
| increased by approximately $155,000, or approximately 266%, to approximately $213,000 as |
| compared to approximately $58,000 reported for the three-month period ended May 31, 2006. |
| The increase in revenues was directly related to the increase in the number of wholesale |
| customers that began reselling our Internet telephone service. As discussed above, at May 31, |
| 2007, we were billing 45 wholesale customers as compared to 15 customers at May 31, 2006. |
| |
| We attained a negative gross profit for the three-month period ended May 31, 2007 of |
| approximately ($18,000) which was an improvement of approximately $58,000 over the negative |
| gross profit of approximately ($76,000) reported in the three-month period ended May 31, 2006. |
| Our IP telephony facilities have significant unused capacity and we have therefore been unable to |
| generate a positive gross profit on a quarterly basis, although we did show a positive gross profit |
| amount for the month of May 2007. We anticipate that we will be able to continue generating a |
| positive gross margin on a monthly basis given the current revenue volume we have reached, and |
| given the anticipated continued growth of our services. The increase volume of minutes on our |
| network allows us to cover all of our fixed network costs and to negotiate lower variable costs |
| with other carriers. |
| |
| Selling, general and administrative expenses increased by approximately $68,000, or |
| approximately 11%, to approximately $675,000 for the three-month period ended May 31, 2007 |
| from approximately $607,000 reported in the same prior year fiscal period. Most of the increase |
| related to increased personnel costs and marketing expenses. |
| |
| Depreciation and amortization expense increased by approximately $80,000 for the three |
| months ended May 31, 2007 to approximately $138,000 as compared to approximately $58,000 |
| for the same period in fiscal 2006. Approximately $33,000 of the increase was for deferred |
| financing costs related to our financing agreements and approximately $17,000 related to our |
| Internet telephony platform. |
| |
| Interest expense increased by approximately $69,000 to approximately $212,000 for the |
| three months ended May 31, 2007 as compared to approximately $143,000 for the three months |
| period ended May 31, 2006. The increase was due to higher non-cash interest charges of |
| approximately $29,000 in the 2007 fiscal period and higher cash interest expense of |
| approximately $40,000 due to higher borrowing levels in the fiscal 2007 period. The non-cash |
| interest expense consisted of the accretion of a debt discount using the effective interest method |
| over the term of the related debt. |
| |
| Warrant income for the three months ended May 31, 2007 amounted to approximately |
| $450,000 due to the decrease in the market price of our common stock at May 31, 2007 as |
| compared to February 28, 2007. Similarly, a decrease in the market price of our common stock |
| at May 31, 2006 as compared to the market price at February 28, 2006, generated warrant income |
| of approximately $247,000 in the three month period ended May 31, 2006. |
| |
| Discontinued operations reflect the net loss for the three-month periods ending May 31, |
| 2007 and 2006 attributable to our former CLEC operations, which were sold in June 2007. |
| |
| |
| Liquidity and Capital Resources |
| |
| At May 31, 2007, we had cash and cash equivalents of approximately $49,000 and |
| negative working capital of approximately $7,468,000. |
| |
| Net cash used in operating activities aggregated approximately $1,457,000 and $882,000 |
| in the six-month periods ended May 31, 2007 and 2006, respectively. The principal use of cash |
| in fiscal 2007 was the loss for the period of approximately $2,730,000, which was partially offset |
| by a non-cash mark-to-market warrant adjustment of $510,000. The principal use of cash in |
| fiscal 2006 was the loss for the period of $1,311,000. |
| Net cash used in investing activities in the six-month periods ended May 31, 2007 and |
| 2006 aggregated approximately $84,000 and $178,000, respectively, resulting primarily from |
| expenditures related to enhancements to our IP telephony software. |
| |
| Net cash provided by financing activities aggregated approximately $253,000 and |
| $1,311,000 in the six-month periods ended May 31, 2007 and 2006, respectively. In fiscal 2007, |
| net cash provided in financing activities resulted from the proceeds of notes of approximately |
| $275,000, which was offset in part by the repayment of long-term debt of approximately |
| $22,000. In fiscal 2006, net cash provided by financing activities resulted from the proceeds of |
| long-term notes of approximately $1,754,000, which was partially offset by the repayment of |
| short-term debt of approximately $328,000 and repayment of long-term debt of approximately |
| $115,000. |
| |
| For the six months ended May 31, 2007, we had approximately $84,000 in capital |
| expenditures primarily related to our IP telephony business. We expect to make equipment |
| purchases of approximately $50,000 to $100,000 in the third fiscal quarter of 2007, depending on |
| our growth and the availability of cash or equipment financing. We expect that other capital |
| expenditures over the next 12 months will relate primarily to a continued roll-out of our IP |
| telephony network that will be required to support a growing customer base of IP telephony |
| subscribers. |
| |
| As previously noted, we are in default with our lender for not making all our principal |
| payments and some of out interest payments due on June 1 and July 1, 2007. Because of the |
| default on such debt, the debt can be called immediately, and we have classified such debt as a |
| current liability on our balance sheet and have shown the related debt finance costs as a current |
| asset. If our lender accelerates such debt, we will not be able to satisfy such indebtedness in full, |
| which inability would adversely affect our ability to continue operating as a going concern. |
| |
| The report of our independent registered public accounting firm on our 2006 financial |
| statements indicates there is substantial doubt about our ability to continue as a going concern. |
| Our operating losses have been funded through the sale of non-operating assets, the issuance of |
| equity securities and borrowings. We believe our current cash resources will not be sufficient to |
| finance our operations. Accordingly, beginning in July 2007, a selling agent began efforts to |
| raise up to $1.5 million in equity to support our operating losses and fund the growth of our IP |
| telephony business. The agent has indicated to us that such equity raise will be forthcoming |
| shortly and that the business and technology we have built is attractive to investors. However, |
| there can be no assurance that we will receive any proceeds from such proposed financing or that |
| such financing, if completed in whole or in part, will be sufficient to get us to a break-even level. |
| Our failure to generate sufficient revenues and raise additional capital will have an adverse |
| impact on our ability to achieve our longer-term business objectives, and would adversely affect |
| our ability to continue operating as a going concern. |
| |
| Item 3. Quantitative and Qualitative Disclosure About Market Risk |
| |
| Our outstanding debt is primarily under three borrowing arrangements with one lender |
| and such borrowings are at the rate of 2% over the prime rate. We currently do not use interest |
| rate derivative instruments to manage our exposure to interest rate changes. As a result of |
| conversion features, warrant issuances and lender discounts, the effective rate of interest has |
| been calculated at rates of approximately 38% on our February 2005 financing, 47% on our |
| November 2005 financing and 185% on the $650,000 portion of our May 2006 financing. |
| Item 4. Controls and Procedures |
| |
| (a) 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, for the reasons set forth below, our |
| disclosure controls and procedures were not effective. We are presently taking the necessary |
| steps to improve the effectiveness of such disclosure controls and procedures. |
| |
| (b) Internal Control Over Financial Reporting. There have not been any changes in our |
| internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d- |
| 15(f) under the Exchange Act) during the second quarter of fiscal 2007 that have materially |
| affected, or are reasonably likely to materially affect, our internal control over financial |
| reporting. In connection with our year-end November 30, 2006 audit, our management became |
| aware of an inadequately designed accounting system as it pertains to our VoX subsidiary. As |
| reported in fiscal 2006 and 2005, we also have a lack of staffing within our accounting |
| department, both in terms of the small number of employees performing our financial and |
| accounting functions and their lack of experience to account for complex financial transactions. |
| Management believes the lack of qualified personnel, in the aggregate, and the inadequately |
| designed accounting system, are both a material weakness in our internal control over financial |
| reporting. We have updated and enhanced our internal reporting at VoX and we will continue to |
| evaluate the number of accounting employees we utilize, the need to engage outside consultants |
| with technical and accounting-related expertise to assist us in accounting for complex financial |
| transactions and the hiring of additional accounting staff with complex financing experience. |
| |
| We also are evaluating our internal controls systems so that when we are required to do |
| so, our management will be able to report on, and our independent auditors to attest to, our |
| internal controls, as required by Section 404 of the Sarbanes-Oxley Act of 2002. We will be |
| performing the system and process evaluation and testing (and any necessary remediation) |
| required in an effort to comply with the management certification and auditor attestation |
| requirements of Section 404 of the Sarbanes-Oxley Act. In connection with our year-end |
| November 30, 2006 and 2005 audits, we identified the control deficiencies and issues with our |
| internal controls over financial reporting that we believe amount in the aggregate to a significant |
| deficiency in our internal controls over financial reporting. Such deficiencies no longer exist as |
| of the date of this Report due to the sale of our CLEC businesses. |
| EXHIBIT 31.1 |
| |
| CERTIFICATION |
| |
| Pursuant to 18 U.S.C. 1350 |
| (Section 302 of the Sarbanes-Oxley Act of 2002) |
| |
| I, Paul H. Riss, Chief Executive Officer and Chief Financial Officer of eLEC Communications |
| Corp., certify that: |
| |
| 1. |
|
I have reviewed this quarterly report on Form 10-Q of eLEC Communications Corp.; |
| |
| 2. |
|
Based on my knowledge, this report does not contain any untrue statement of a material |
| fact or omit to state a material fact necessary to make the statements made, in light of the |
| circumstances under which such statements were made, not misleading with respect to the period |
| covered by this report; |
| |
| 3. |
|
Based on my knowledge, the financial statements, and other financial information |
| included in this report, fairly present in all material respects the financial condition, results of |
| operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| |
| 4. |
|
I am responsible for establishing and maintaining disclosure controls and procedures (as |
| defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and I have: |
| |
| |
|
(a) |
|
Designed such disclosure controls and procedures, or caused such disclosure |
| |
|
controls and procedures to be designed under my supervision, to ensure that material |
| |
|
information relating to the registrant, including its consolidated subsidiaries, is made |
| |
|
known to me by others within those entities, particularly during the period in which this |
| |
|
report is being prepared; |
| |
| |
|
(b) |
|
Evaluated the effectiveness of the registrant’s disclosure controls and procedures |
| |
|
and presented in this report our conclusions about the effectiveness of the disclosure |
| |
|
controls and procedures, as of the end of the period covered by this report based on such |
| |
|
evaluation; and |
| |
| |
|
(c) |
|
Disclosed in this report any change in the registrant’s internal control over |
| |
|
financial reporting that occurred during the registrant’s most recent fiscal quarter that has |
| |
|
materially affected, or is reasonably likely to materially affect, the registrant’s internal |
| |
|
control over financial reporting; and |
| |
| 5. |
|
I have disclosed, based on my most recent evaluation of internal control over financial |
| reporting, to the registrant’s auditors and the audit committee of the registrant’s board of |
| directors (or persons performing the equivalent functions): |
| |
| |
|
(a) |
|
All significant deficiencies and material weaknesses in the design or operation of |
| |
|
internal control over financial reporting which are reasonably likely to adversely affect |
| |
|
the registrant’s ability to record, process, summarize and report financial information; |
| |
|
and |
| EXHIBIT 32.1 |
| |
| CERTIFICATION |
| Pursuant to 18 U.S.C. 1350 |
| (Section 906 of the Sarbanes-Oxley Act of 2002) |
| |
| In connection with the Quarterly Report on Form 10-Q of eLEC Communications Corp. |
| (the "Company") for the quarter ended May 31, 2007, as filed with the Securities and Exchange |
| Commission on the date hereof (the "Report"), Paul H. Riss, as Chief Executive Officer and |
| Chief Financial Officer of the Company, hereby certifies, pursuant to 18 U.S.C. §1350, as |
| adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that: |
| |
| (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of |
| the Securities Exchange Act of 1934, as amended; and |
| |
| (2) The information contained in the Report fairly presents, in all material |
| respects, the financial condition and results of operations of the Registrant. |
| |
| |
| |
| Date: July 23, 2007 |
|
By: |
|
/s/ Paul H. Riss |
| |
|
|
|
Paul H. Riss |
| |
|
|
|
Chief Executive Officer and |
| |
|
|
|
Chief Financial Officer |
| |
| |
| |
| |
| This certification accompanies each Report pursuant to § 906 of the Sarbanes-Oxley Act |
| of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be |
| deemed filed by the Company for purposes of §18 of the Securities Exchange Act of 1934, as |
| amended. |
| |
| A signed original of this written statement required by Section 906 has been provided to |
| the Company and will be retained by the Company and furnished to the Securities and Exchange |
| Commission or its staff upon request. |