UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-KSB
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended November 30, 2002
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to _________.
Commission File No. 0-4465
eLEC COMMUNICATIONS CORP.
(Exact name of Registrant as specified in its charter)
New York 13-2511270
(State or other jurisdiction (IRS employer identification no.)
of incorporation or organization)
543 Main Street, New Rochelle, New York 10801
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (914) 633-6500.
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.10 per share
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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 |_|.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. |_|
State Issuer's revenue for its most recent fiscal year: $14,242,079
As of February 28, 2003, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was $664,813.
As of February 28, 2003, there were 15,619,282 shares outstanding of the
Registrant's Common Stock.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
TABLE OF CONTENTS
PART I
Item 1. Description of Business
Item 2. Description of Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Item 6. Management's Discussion and Analysis or Plan of Operation
Item 7. Financial Statements
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons of the
Company; Compliance with Section 16(a) of the Exchange Act
Item 10. Executive Compensation
Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Shareholder Matters
Item 12. Certain Relationships and Related Transactions
Item 13. Exhibits and Reports on Form 8-K
Item 14. Controls and Procedures
The statements contained in this Report that are not historical facts are
"forward-looking statements" 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 its services to current and new customers and generate
customer demand for its 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.
PART I
In this Annual Report on Form 10-KSB, we will refer to eLEC Communications
Corp., a New York corporation, as "eLEC," the "Company," "we," "us," and "our."
Item 1. - Description of Business
Overview
eLEC Communications Corp. is a full-service telecommunications company
that focuses on developing integrated telephone service in the emerging
competitive local exchange carrier ("CLEC") industry. We offer small businesses
and residential consumers an integrated set of telecommunications products and
services, including local exchange, local access, domestic and international
long distance telephone, data and a full suite of local features and calling
plans. We have built a scalable operating platform that can provision a local
telephone line, provide dial-tone to our customers, read usage records, rate
telephone calls for billing purposes, prepare monthly invoices to customers,
provide real-time on-line customer support services at our inbound call centers,
capture credit and collection data, calculate gross margins for each line and
perform any moves, adds, changes and repairs that a customer requests. We
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utilize universal client technology that enables our employees and agents to
access our system from any PC using any Internet browser.
We believe that the Telecommunications Act of 1996 (the
"Telecommunications Act"), which opened the local exchange market to
competition, has created an attractive opportunity for CLECs. Like most CLECs,
our entry in this industry was dependent upon the provisions of the
Telecommunications Act that allow CLECs to lease various elements of the
networks of the incumbent local exchange carriers ("ILECs") that are necessary
to provide local telephone service in a cost-effective manner. This aspect of
the Telecommunications Act is referred to as "unbundling" the ILEC networks, and
allows us to lease unbundled network elements on an as-needed basis and provide
such elements to our customers at a lower cost than that which the ILEC is
charging.
Although we believe the opportunity for CLECs is attractive, it is also
challenging. We must contend with federal and state government regulators,
rapidly changing technologies, incumbent carriers that are better staffed and
capitalized than us and real-time business partners that also carry our
customer's telephone call, whether it is local, long distance or international.
At the same time that we are managing these challenges, we also must provide
connectivity, superior customer service and a culture of continuous improvement.
Because of the complexity of the business, we have focused our energies on
simplifying our working environment and improving performance through
automation.
Other CLECs have invested a substantial amount of capital to buy
circuit-switched equipment and rollout fiber, only to find that their equipment
is severely underutilized and that there is a significant shortfall in their
revenue stream when compared to their capital investment. We refer to this
strategy as a "facilities-first" strategy, because the CLEC has invested in its
equipment and placed the equipment in service before the CLEC has developed a
customer base. Our strategy is a "customer-first," or a "deferred-build"
strategy. We invested our capital in our Operations Support System ("OSS") to
support our customers and we lease facilities on an as-needed basis from ILECs
while we build our customer base. After we have obtained a substantial
geographical concentration of customers, we will make decisions regarding the
purchase and installation of our own network equipment. This strategy allows us
to be very flexible with our customer base as we grow our business. We can move
our customer base to alternative access, if appropriate, and we do not become a
captive of our own underutilized equipment, as can happen with a
"facilities-first" CLEC. The technological advances in equipment and the
lowering of equipment prices have substantiated our deferred-build strategy and
have enabled us to better utilize our limited capital.
When we lease lines from an ILEC, we use the unbundled network elements
platform ("UNE-P") service offering. UNE-P allows us to lease the network
elements we need, such as the local line and the port on a local switch, so that
we can provide local dial tone service to our customers. We are capable of
providing virtually all of the same additional voice services provided by any
ILEC, such as three-way calling, call waiting, call forwarding and caller ID. We
sell our services at a fee that is at least 10% and as much as 25% less than the
rate charged by the ILEC. We also offer a bundled package of local and regional
calling minutes with popular voice service features.
We believe UNE-P is the preferable platform for any CLEC to operate
under while it is growing and building a customer base. We have designed our OSS
to be flexible and scalable so that any company that wants to begin providing
local exchange services utilizing UNE-P can rely on our OSS. UNE-P has
substantial value because it allows a CLEC to provide service with significantly
lower capital requirements than either fiber-based or wireless systems, and to
offer services to a broader customer base more quickly and at a lower price. The
ability to rapidly provision accounts and to deliver reliable service at a lower
price than offered by the ILECs should provide us with certain competitive
advantages
3
as we market our services to small business and residential customers. Recently,
several ILECs have petitioned the Federal Communications Commission ("FCC") to
make changes to regulatory requirements for the UNE-P service offering. These
ILECs have attempted to lobby the FCC and state public utility commissions to
impose certain restrictions on certain individual network elements that would
destroy the competitive value of the UNE-P. If the ILECs succeed in their
lobbying efforts, it is likely the resulting amendments to the existing UNE-P
structure will significantly harm our operations and gross margins.
In March 2002, UNE-P became more valuable to us when the costs charged to
us for providing local voice services on the UNE-P service offering in New York
State were lowered. We believe current rates are also very attractive in New
Jersey and Pennsylvania. Our original CLEC business, built in our wholly-owned
subsidiary, Essex Communications, Inc. ("Essex"), began as a reseller with
approximately 10% gross margins. This subsidiary was unable to operate
profitably and we sold the Essex customer base and related assets on December
31, 2002. Another CLEC subsidiary that we own, Telecarrier Services, Inc.
("Telecarrier"), is operating under the protection of Chapter 11 of the Federal
Bankruptcy Code. As with Essex, Telecarrier began as a reseller and was unable
to operate profitably. Our primary operating CLEC, New Rochelle Telephone Corp.
("NRTC"), is selling services in New York State only, and is currently achieving
gross margins of approximately 45%. As a start-up CLEC, NRTC is not yet
profitable. If we are able to obtain an appropriate working capital facility, we
project NRTC will be able to reach a breakeven level this year. However, there
can be no assurance that this will occur, nor can there be any assurance we will
be able to obtain the financing we are seeking. Failure to reach a breakeven
level in our operations could cause us to seek to reorganize under applicable
bankruptcy laws.
Development of Business
We were incorporated in the State of New York under the name Sirco
Products Co. Inc. in 1964 and developed a line of high quality handbags, totes,
luggage and sport bags. In 1995, we divested our handbag operations, which had
experienced several years of operating losses. Although we were profitable in
fiscal 1996, declining revenues in our next two fiscal years, combined with
operating losses, forced us to analyze other business opportunities.
In October 1997, we began incubating small high-growth-potential
companies, and we made our first investment in a CLEC, Access One
Communications, Inc. ("Access One"), when we purchased approximately 28% of
Access One's outstanding capital stock. Access One was a newly-formed CLEC with
approximately 2,000 installed local access lines that looked to us for growth
capital to meet its business plan. Our Board of Directors believed that Access
One's "customer-first" growth strategy of obtaining a customer base first and
later building an equipment network around a geographically concentrated
customer base was a compelling strategy that would utilize capital wisely and
yield high valuations in the future. Access One was purchased by Talk America
Holdings Inc. ("Talk"), a publicly-traded telecommunications company, in August
2000, and we received approximately 2.2 million shares of Talk common stock and
warrants in exchange for our investment in Access One.
We commenced operations in the telecommunications industry in fiscal 1998
by acquiring Essex, a newly-formed CLEC formed to attract and retain a
geographically concentrated customer base in the metropolitan New York region,
primarily through the resale of products and services of incumbent and
alternative facilities-based local providers.
Due to our increased focus on developing a full suite of
telecommunications services, and the significant decrease in luggage division
sales, our Board of Directors decided in July 1999 to divest the Company's
luggage division, and we sold the assets of our U.S. luggage operations in
August 1999.
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In January 2000, we acquired Telecarrier, a New Jersey-based CLEC that
operated as a CLEC in the states of Massachusetts, New Jersey, New York and
Rhode Island and provided long distance service in 13 states. Although most of
Telecarrier's operations were merged into Essex after the acquisition was
completed, we maintained several licenses in Telecarrier, and we are now
operating Telecarrier to sell telephone services in New York and New Jersey. On
July 29, 2002, Telecarrier filed a voluntary petition for protection under
Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy
Court for the Southern District of New York. Telecarrier is currently operating
in bankruptcy.
In October 2000, we acquired Line One, Inc. ("Line One"), a telemarketing
firm with approximately 70 seats. Line One became our internal marketing engine
for our telemarketing channel, which contacts small businesses and offers our
telecommunications services. We believe telemarketing is a particularly
effective marketing strategy to utilize because of the ubiquitous reach that the
UNE-P service offering gives us. Line One has also managed third-party
telemarketing firms that we have retained. Due to our limited financial
resources, at February 28, 2003, we were only telemarketing with 15 seats.
On September 3, 2002, we entered into a definitive purchase agreement to
sell certain of the assets of Essex to Essex Acquisition Corp. ("EAC"), a
wholly-owned subsidiary of BiznessOnline.com, Inc. ("Biz"). The sale to EAC was
completed on December 31, 2002. EAC purchased selected assets and assumed
certain liabilities in conjunction with this transaction. Such amounts are
segregated on our November 30, 2002 balance sheet and designated as "assets held
for sale," which amounted to $1,102,103, and "liabilities assumed in sale,"
which amounted to $10,081,382. The transfer of these assets and liabilities to
EAC allowed us to continue in the local exchange business and allowed us to
begin selling local and long distance telephone services through NRTC. As the
creditors of Essex did not consent to the assignment of their claims or
receivables, Essex will remain liable for substantially all the obligations
assumed in the sale until such time as they are paid. The June 30, 2002
unaudited financial statements of Biz indicate that Biz had a stockholders'
equity deficiency of approximately $20,500,000 and had negative working capital
of approximately $3,500,000. The most recent independent auditor's report of Biz
expressed significant doubt about Biz's ability to continue as a going concern.
These factors indicate that there is significant uncertainty as to the ability
of Biz and its subsidiaries to repay the obligations assumed from Essex.
Accordingly, Essex will not record any gain until it is released from the
assumed obligations.
eLEC's Telecommunications Services
We tailor our service offerings to meet the specific needs of small
business and residential customers in our target markets. We primarily market
our services through three different distribution channels. We use an in-house
telemarketing staff to attract small-business accounts (typically less than five
telephone lines for each account), we use third-party telemarketers to attract
small business and residential accounts (typically less than five telephone
lines for each account), and we use agents and direct marketing to attract small
business and residential accounts (typically one to 20 lines in size for each
account). Based upon feedback received from our customers and analysis of the
types of services the entities in each of these groups typically utilize, we
tailor a basic telecommunications service package, which can be promptly
adjusted to the specific needs of individual customers. We creatively package
our services to provide "one-stop shopping" solutions for our customers, so that
they can
5
purchase directly from us all of their communications requirements. Listed below
are the basic categories of services that we offer:
o Local Exchange Services. We offer local exchange services, starting with
local dial tone, plus numerous features, the most common of which are call
waiting, call forwarding, caller ID and dial back features. By offering local
dial tone, when we utilize the UNE-P service offering, we also receive
originating and terminating access charges for interexchange calls placed or
received by our subscribers.
o Long Distance. In addition to our local telephone service, we offer long
distance services as part of a bundled product to customers through agreements
we have with a national long distance carrier. The long distance services
include domestic service, such as interLATA, which are calls that pass from one
"Local Access and Transport Area" or "LATA" to another LATA, and intraLATA,
which are calls that stay within the LATA in which they originated, but are
beyond the distance limits of the local calling plan. Our services also include
toll-free services (800, 888, 877, 866), calling card and other enhanced
services.
o International Calling. While we offer international calling, our typical
customer does not place a significant number of international calls. Most
telephone companies experience a higher bad debt percentage on international
calling than on local services. We believe there are marketing opportunities in
those cases in which we can offer low international calling rates to particular
countries and simultaneously attract more local telephone customers. To reduce
the risk of bad debt exposure, however, we have installed a switch with a debit
card platform in our Orlando facility that can take a prepayment from a customer
when the customer accesses the system and places an international call. No pin
or account numbers are required as the system recognizes the telephone number
from which the call is initiated, including any cell phone number that the
customer programs into the system. Calls must originate in the United States and
can be made to any destination in the world.
o Internet and Data Services. We offer dedicated data lines including
ISDN, T1 and higher speed dedicated connections. In addition, we are considering
various programs to resell DSL and Internet services as a commissioned agent. We
do not plan to offer our own DSL in the near future, nor do we plan to provide
provisioning or customer service for such a product.
Business Strategy
Our goal is to use our internally developed systems and processes to
operate as a premiere UNE-P focused integrated communications provider. We
intend to take advantage of the UNE-P service offering in states in which the
rates allow a CLEC to obtain an appropriate gross margin, such as New York and
Pennsylvania, and in New Jersey, where there has recently been a significant
reduction in the cost of leasing a port and a loop.
We are taking the following actions to achieve our goal of being a
profitable UNE-P CLEC:
o Target Small-Business and Residential Customers. We focus our CLEC sales
efforts for local and long distance services on small business and residential
consumers having one to 20 local access lines in any one location. We have
elected to focus on this segment because of our ability to obtain under the
UNE-P platform ample gross margins on the services provided to these
6
customers. We also believe that, as compared to larger businesses, the ILECs and
facilities-first CLECs may be less likely to apply significant resources to
obtaining or retaining these customers. We expect to attract and retain these
customers through telemarketers and agents, by offering bundled local and long
distance services, as well as enhanced telecommunication services, at
competitive long distance rates, by responsive customer service and support and
by offering new and innovative products.
o Rapidly Deploy New Customers. As a CLEC, we intend to take advantage of
our ability to rapidly provision new accounts in our existing service areas, and
to rapidly enter new service areas because of our low capital requirements to
enter new states. Our choice of states on which to focus will depend on several
factors, such as the population in the state, our ability to utilize the UNE-P
service offering and the potential gross margin percentage we can achieve in
that particular state.
o Achieve Market Share with Competitive Pricing. We always price our CLEC
services at a discount to the same services provided by an ILEC. We can
ascertain the prices the ILECs charge because we have access to the rates they
have filed with the various state public service commissions, and we typically
review the telephone bill of a potential customer before switching it to our
network to compare the prices it was paying and any contractual obligations to
which it was subject. We anticipate that some ILECs may reduce their prices as
increased competition begins to erode their market share. We believe, however,
that we will be able to compete as prices decrease because of our low network
costs and because we will be providing a variety of bundled telecommunications
services and will not have to rely on price alone to maintain our core customer
base.
o Market in our Own Community. We are taking an active role in the City of
New Rochelle, New York so that local businesses and residents will see our
principal operating subsidiary, NRTC, as "the local phone company." NRTC
operates out of a building we own in the downtown business district of New
Rochelle, and many merchants and city officials have expressed appreciation for
our presence and investment in the downtown business district. In December 2002,
we hosted an open house in the lobby of our building sponsored by the City's
Building Improvement District to further publicize our company and to generate
more shopping in and awareness of the downtown community. We also have an agent
that seeks to obtain local lines by door-to-door marketing in New Rochelle.
There are approximately 120,000 local phone lines just in New Rochelle. Our goal
is to be able to service at least 10% of those lines.
Competition in the Telecommunications Industry
The local telecommunications market is a highly competitive environment
and is dominated by ILECs. Based upon the geographical locations in which we
currently sell services, Verizon is our largest competitor. Verizon has a
"win-back" program through which it approaches former customers lost to a CLEC
or other competitor in an attempt to have the former customers switch back to
its services. Most of our actual and potential competitors, including most of
the facilities-first CLECs, have substantially greater financial, technical,
marketing and other resources (including brand name recognition) than we do.
Furthermore, our established competitors, such as the ILECs, are able to compete
effectively because they have long-term existing relationships with their
customers, strong name recognition, abundant financial resources, and the
ability to cut prices of certain services by subsidizing such services with
revenues generated from other products. Although the Telecommunications Act
reduced barriers to entry
7
into the local market, future regulatory decisions could increase the rates that
CLECs must pay ILECs for use of ILEC facilities, which would result in lower
margins for CLECs and lessen the ability of CLECs to offer consumers a
significant percentage savings on their phone bill.
In addition to competition from ILECs and other CLECs, several other
entities currently offer or are capable of offering local service, such as
wireless service providers, long distance carriers, cable television companies,
electric utilities and microwave carriers. These entities, upon entering into
appropriate interconnection agreements or resale agreements with ILECs, can
offer single source local and long distance services like those we offer. For
example, long distance carriers, such as AT&T Corp., MCI WorldCom and Sprint
Corporation, among other carriers, have each begun to offer local
telecommunications services in major U.S. markets using the unbundled network
elements platform or by reselling the ILECs' services.
The long distance market, in comparison to the local market, has
relatively insignificant barriers to entry and has been populated by numerous
entities that compete for the same customers by frequently offering promotional
incentives and lower rates. We compete with many such companies that do not
offer any service other than long distance, and we compete with established
major carriers such as AT&T Corp. and MCI WorldCom. We believe our bundled
package of local services and a variety of data services will help us compete in
this market. We will also have to maintain high quality and low cost services to
compete effectively. In many instances, we must be in a position to reduce our
rates to remain competitive. Such reduction could be harmful to us if we do not
also provide other services to our long distance customers.
Government Regulation
Local and long distance telecommunications services are subject to
regulation by the FCC and by state regulatory authorities. Among other things,
these regulatory authorities impose regulations governing the rates, terms and
conditions for interstate and intrastate telecommunications services and require
us to file tariffs for interstate and international service with the FCC and
obtain approval for intrastate service provided in the states in which we
currently market our services. We must obtain and maintain certificates of
public convenience and necessity from regulatory authorities in the states in
which we operate. We are also required to file and obtain prior regulatory
approval for tariffs and intrastate services. In addition, we must update or
amend the tariffs and, in some cases, the certificates of public convenience and
necessity, when rates are adjusted or new products are added to the local and
long distance services we offer. Changes in existing laws and regulations,
particularly regulations resulting in increased price competition, may have a
significant impact on our business activities and on our future operating
results. We are also subject to Federal Trade Commission regulation and other
federal and state laws relating to the promotion, advertising and direct
marketing of our products and services. Certain marketing practices, including
the means to convert a customer's local or long distance telephone service from
one carrier to another, have recently been subject to increased regulatory
review of both federal and state authorities. Even though we have implemented
procedures to comply with applicable regulations, increased regulatory scrutiny
could adversely affect the transitioning of customers and the acquisition of new
customer bases. Amendments to existing statutes and regulations, adoption of new
statutes and regulations and expansion of our operations into new geographic
areas and new services could require us to alter our methods of operation or
obtain additional approvals, at costs which could be substantial. There can be
no assurance that we will be able to comply with applicable laws, regulations
and licensing requirements. Failure to comply with applicable laws, regulations
and licensing requirements could result in civil penalties, including
substantial fines, as well as possible criminal sanctions.
8
Employees
At February 28, 2003, we employed 65 employees, of whom 59 were employed
on a full-time basis and 6 were employed on a part-time basis. We are not
subject to any collective bargaining agreement and we believe that our
relationship with our employees is good.
Item 2. - Description of Property
The following table sets forth pertinent facts concerning our material
properties at February 28, 2003, all of which are owned or leased by either us
or one of our subsidiaries:
Property Owned:
Location Use Approximate Square Feet
-------- --- -----------------------
543 Main Street Executive offices; in 45,000
New Rochelle, NY 10801 bound and out bond call
center
We believe the building we own is in good condition and contains more
space than we currently need for our employees. We purchased the property in
December 2000, and financed the purchase, in part, with a mortgage in the amount
of $1,100,000 that matures on December 4, 2005. Our monthly debt service
payments are for interest only and amount to approximately $10,000. Property
taxes amount to approximately $48,000 annually. The exterior of the building is
steel and wood construction with exterior brick veneer on three sides. The main
interior office area is steal columns and beams in an open office configuration.
We purchased the building with the intention of using it as a 250-person
inbound and outbound call center and as our executive offices. At our current
level of employees, which totaled 65 at February 28, 2003, the facility is
underutilized and we are seeking a tenant to lease unused space in the building.
When we consider purchasing property, we have no policy with regard to
limitations of the percentages of assets that may be invested in any one
investment. Our acquisition strategy is dependent on price, property carrying
costs and the corresponding rental rates available to us for facilities that are
of an appropriate size for our current and future needs. Our acquisition of this
asset was for projected operating usage and to save money on rental expense, and
was not for possible capital gain or to generate additional ordinary income.
We have no proposed improvement program for this property and do intend to
make significant improvements, unless such improvements are to be made in
conjunction with signing a lease with a long-term tenant. We believe the
replacement cost of the building is adequately covered by insurance.
Properties Leased:
Approximate Annual
Location Use Square Feet Rent
-------- --- ----------- ----
2500 Silver Star Road Office 1,500 $24,000
Orlando, FL 32804
9
Our leased space in Orlando is a one year lease that we intend to renew.
We pay for the lease, although the company has not signed the lease. An employee
has personally signed the lease. Our owned property is not fully utilized for
the purposes set forth in the table above under the caption "Use." We have been
seeking tenants to rent vacant space in our New Rochelle location. We believe
our existing properties are suitable and adequate for our current business
needs.
Essex may also be contingently liable for leased space in Orlando, Florida
that was abandoned in fiscal 2002. Such space is being rented by another entity
and we no longer consider it as leased space. See notes to financial statements
for additional information.
Item 3. - Legal Proceedings
Other than the license and regulatory proceedings that routinely occur for
telecommunication entities as described under "Government Regulation," we are
not currently a party to any legal proceeding that we believe will have a
material adverse effect on our financial condition or results of operations.
Item 4. - Submission of Matters To a Vote of Security Holders
The 2002 Annual Meeting of Shareholders (the "2002 Annual Meeting") was
duly held on November 26, 2002. All director nominees to the Board of Directors
were duly elected at the 2002 Annual Meeting.
10
PART II
Item 5. - Market for the Company's Common Equity and Related Stockholder Matters
Our common stock currently trades on The OTC Bulletin Board(R) ("OTCBB")
under the symbol ELEC. Prior to our listing on the OTCBB in February 2002, our
common stock traded on The Nasdaq Small Cap Stock Market(R). The high and low
sales price for each quarterly period of our last two fiscal years are listed
below:
High Low
---- ---
Fiscal 2001
1st Quarter $1.297 $0.500
2nd Quarter 0.980 0.500
3rd Quarter 1.020 0.330
4th Quarter 0.670 0.300
Fiscal 2002
1st Quarter $0.610 $0.180
2nd Quarter 0.180 0.020
3rd Quarter 0.050 0.030
4th Quarter 0.090 0.020
The quotations set forth in the table above reflect inter-dealer prices,
without retail mark-up, mark-down or commission, and may not necessarily
represent actual transactions. As of November 30, 2002, there were 232 holders
of record of our common stock and approximately 3,000 beneficial holders.
We have never paid dividends on our common stock and do not expected to do
so in the foreseeable future. Payment of dividends is within the discretion of
our Board of Directors and would depend on, among other factors, our earnings,
capital requirements and operating and financial condition.
11
The following table provides information as of November 30, 2002 with
respect to shares of our common stock that are issuable under equity
compensation plans.
Number of securities
remaining available to
Number of securities future issuance under
to be issued upon Weighted-average equity compensation
exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
warrants and rights warrants and rights column (a))
Plan Category (a) (b) (c)
----------------------------------------- ---------------------- --------------------- ----------------------------
Equity compensation plans
approved by security holders
Employee Stock Option Plan (1) 1,618,453 $ 1.60 607,262
1996 Restricted Stock Plan (2) -- 400,000
---------- ---------
Subtotal 1,618,453 1,007,262
---------- ---------
Equity compensation plans
not approved by security holders
RFC Warrants (3) 200,000 1.54 --
Kaufman Bros. Warrants (4) 350,000 1.88 --
----------
Subtotal 550,000
----------
Total 2,168,453 1,007,262
========== =========
---------------------------
(1) Our Employee Stock Option Plan allows for the granting of share options to
Board members, officers, non-officer employees and consultants.
(2) Our Restricted Stock Plan provides for the issuance of restricted share
grants to officers and non-officer employees
(3) The RFC Warrants were issued in conjunction with a revolving credit
facility. The facility has been retired; however, the warrants will remain
outstanding until exercised or until the expiration date of October 23,
2010.
(4) The Kaufman Bros. Warrants represent two warrant grants for investment
banking services.
12
Item 6. - Management's Discussion and Analysis or Plan of Operation
Certain statements set forth below under this caption constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Please refer to page 2 of this Report for
additional factors relating to such statements.
Plan of Operation
Our ability to continue operating was significantly improved by the sale
on December 31, 2002 to EAC of certain assets and liabilities of Essex. The
transaction relieved significant cash-flow demands on our operations. Prior to
the sale, Essex's vendors were seeking payments of approximately $10,100,000 in
past-due payables, and our principal ILEC supplier was threatening to deny Essex
access to its operating platform, which would have prevented Essex from
servicing its customers. Although these liabilities continue to be carried on
the books of Essex, and, as a result, our consolidated financial statements, EAC
is now responsible for making payment arrangements on these balances, and we
have been able to use our cash balances to build the customer bases of both NRTC
and Telecarrier. We plan to use our existing cash balances primarily to pay for
current operating expenses and new customer acquisition costs. See Item 1. for
additional information regarding Essex's liabilities.
Our primary methods of obtaining new customers will continue to be through
telemarketing and outside sales agents. We believe these are effective low-cost
methods and our past history with these customer acquisition methods is helpful
in planning and budgeting our operations on a going forward basis. Since
November 2002 and January 2003, we have been successfully adding new customers
to the customer bases of both NRTC and Telecarrier, respectively. In February
2003, we billed approximately 4,500 lines. At February 28, 2003, we had a
backlog of approximately 1,500 lines that had been sold and not yet billed.
Since September 2002, we have also been receiving an agent's commission on
approximately 900 lines. We believe we can reach a break-even level at
approximately 12,000 lines and that each new line will cost us approximately $50
in selling expenses. In order to reach profitability, we need cash to spend on
new line acquisition costs and to fund our interim operating losses, which
currently approximate $150,000 a month. Our cash balances at March 14, 2003,
will not carry us to the point at which we reach 12,000 lines.
Since January 2003, we have been seeking working capital financing. Our
billings in the month of February 2003 amounted to approximately $256,000 and we
believe our accounts receivable balances are beginning to reach a level at which
we may be considered an attractive potential customer to an accounts receivable
lender. We have been advised by several potential financing sources that our
customer base is not a good fit for accounts receivable factoring because we
have many invoices that are less than $100 and more than half of our accounts
receivable represent consumer receivables. We believe that 80% financing of our
accounts receivable will be adequate to finance our business going forward. To
finance our operations, we have also been pursuing the sale of one of our
operating subsidiaries or our building in New Rochelle, New York.
We do not expect to purchase any significant assets in the next 12 months.
We believe our back-office systems are adequately developed and functioning
well, and we anticipate only minor expenditures to further automate such systems
during the next 12 months.
13
Fiscal Year 2002 Compared to Fiscal Year 2001
Revenues for fiscal 2002 decreased by approximately $5,451,000, or
approximately 28%, to approximately $14,242,000 as compared to approximately
$19,693,000 reported in fiscal 2001. The decrease in revenue was directly
attributable to the decrease in the number of Essex's customers, including its
largest customer, and the number of access lines it billed each month. Essex had
approximately 21,000 access lines at the end of fiscal 2002 as compared to
approximately 39,000 access lines at the end of fiscal 2001. Due to Essex's poor
financial condition, we were not able to expend the marketing dollars necessary
to obtain new customers to replace the customers that were lost by Essex. With
the sale of substantially all of the assets and liabilities of Essex on December
31, 2002, we have started adding customers and access lines through Telecarrier
and our newly-licensed CLEC, NRTC. We plan to use a major portion of our cash
resources to compensate agents and telemarketing firms for providing us with new
customers to grow our business. As a result of the sale of the Essex customer
base, we anticipate revenues in fiscal 2003 to be significantly less than the
revenues reported in fiscal 2002. If we annualized our monthly billing for
February 2003, our annual revenues would be approximately $3,000,000. We project
that we can reach a monthly revenue level of approximately $400,000 per month
without additional financing.
Our gross profit in fiscal 2002 decreased by approximately
$1,887,000, or approximately 26%, to approximately $5,266,000 from approximately
$7,153,000 reported in fiscal 2001 while our gross profit percentage was 37% in
fiscal 2002 and 36.3% in fiscal 2001. The reduction in gross profit was
attributable to the reduction in our customer base. The increase in gross
profit percentage was attributable to lower buying prices from ILECs that were
established in 2002. We anticipate gross margins to be somewhat higher, at a
level of at least 40%, in fiscal 2003. Our selling strategy in fiscal 2003
is to sell only in states in which we believe we will be able to
achieve a 40% gross margin on our local voice services. In prior years, we
operated in several states in which our gross margins were less than 30%.
Our selling, general and administrative ("SG&A") expenses decreased
by approximately $4,477,000, or approximately 32%, to approximately $9,486,000
as compared to approximately $13,963,000 reported in fiscal 2001. The decrease
is directly attributable to various cost cutting measures, which included, among
other things a reduction in staffing in all areas of our operations and reduced
spending on our marketing efforts. Additionally, we closed our network
operations center in Norwalk, Connecticut as part of this cost cutting effort,
and we no longer offer our own digital subscriber line service. During the first
quarter of fiscal 2003, our SG&A expenses have been running at approximately
$290,000 per month, or approximately $3,500,000 on an annualized basis. This
amount includes approximately $90,000 in selling expenses that were solely for
the acquisition of new lines. Throughout fiscal 2003, we anticipate that our
SG&A expenses will remain at these lower levels, unless we are able to obtain
additional financing and grow our customer base more rapidly.
Depreciation and amortization expense decreased by approximately
$823,000 to approximately $261,000 from approximately $1,084,000 reported in
fiscal 2001. The decrease was attributable to the impairment charge taken in the
fourth quarter of fiscal 2001.
In fiscal 2001, we recorded a loss on impairment of assets in the
amount of approximately $4,707,000 in accordance with SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." No loss on impairment of assets was recorded in fiscal 2002.
14
Interest expense decreased by approximately $303,000 to approximately
$437,000 from approximately $740,000 reported in fiscal 2001 primarily due to
lower average borrowing caused by the payback of and eventual termination of our
credit facility in August 2002. In fiscal 2003, we anticipate we will pay
interest on miscellaneous capital leases and notes, and on a mortgage note. Such
interest expense currently averages approximately $12,000 per month. Interest
expense will remain at this level unless we obtain a lending facility. As noted
in our liquidity and capital resources section that follows, we are seeking
additional debt financing, such as accounts receivable financing or additional
mortgage financing.
Gain on the sale of investment securities and other investments in fiscal
years 2002 and 2001 of approximately $1,454,000 and $918,000, respectively,
resulted primarily from the sale of stock derived from our investment in Talk.
Based upon the remaining shares of marketable securities currently in our
possession, we do not anticipate gains in fiscal 2003 to exceed $150,000.
In November 2001, we sold substantially all of the assets of our
subsidiary, Airline Ventures Inc. ("AVI"). As a result, the operations of AVI
were accounted for as a discontinued operation and we recorded a loss from
discontinued operation of approximately $4,000 in fiscal 2001.
Liquidity and Capital Resources
At November 30, 2002, we had cash and cash equivalents of approximately
$939,000 and negative working capital of approximately $11,214,000 as compared
to cash and cash equivalents of approximately $798,000 and negative working
capital of approximately $8,031,000 at November 30, 2001. Negative working
capital increased primarily due to the loss we incurred. Of such working capital
deficit, approximately $10,100,000 in liabilities have been assumed by Biz and
approximately $1,100,000 in assets have been transferred to Biz.
Net cash provided by (used in) operating activities aggregated
approximately $2,750,000 and ($2,248,000) in fiscal 2002 and 2001, respectively.
The principal source of cash from operating activities in fiscal 2002 was the
increase in accounts payable of approximately $5,188,000 offset by the operating
loss for the period of approximately $3,319,000. The principal uses of cash from
operating activities in fiscal 2001 were the loss for the period of
approximately $12,374,000, which was offset by increases of approximately
$4,130,000 in accounts payable and other accrued expenses, and the charge on
impairment of long-lived assets of approximately $4,707,000.
Net cash provided by investing activities aggregated approximately
$1,631,000 and $816,000 in fiscal 2002 and 2001, respectively. The principal
source of cash from investing activities in fiscal 2002 was the proceeds from
the sale of marketable securities of approximately $1,381,000. The principal
sources of cash from investing activities in fiscal 2001 were the proceeds from
the sale of marketable securities of approximately $1,023,000 and the proceeds
from the sale of real property in Canada of approximately $933,000. The
principal use of cash in fiscal 2001 was for the purchase of property and
equipment amounting to approximately $1,188,000.
Net cash provided by (used in) financing activities aggregated
approximately ($4,240,000) and $1,719,000 in fiscal 2002 and 2001, respectively.
In fiscal 2002, net cash used in financing activities resulted in the repayment
of the revolving credit line. In fiscal 2001, net cash provided by financing
activities resulted from proceeds of a revolving credit facility of
approximately $2,129,000, the proceeds from the exercise of the exercise of
stock options of $100,000, offset by the repayment of long-term debt of
approximately $495,000
15
We had no capital expenditures in fiscal 2002 and we do not anticipate
making any significant capital expenditures in fiscal 2003.
In August 2002, we paid off our loan and security agreement with Textron
Financial, formerly known as RFC Capital Corporation. We have no working capital
facility available to us at this time. Our Telecarrier subsidiary, which is
operating in bankruptcy, has a $150,000 line of credit with a bank. The line is
a pre-petition obligation and the bank has not provided Telecarrier with any
debtor-in-possession financing. The bank claims that the line is secured.
However, we are disputing such claim.
At February 28, 2003, we owned approximately 10,000 shares of Talk
(NASDAQ:TALK) and 83,000 shares of Cordia Corporation (OTCBB:CORG). We have the
right to purchase approximately 95,000 additional shares of Talk if we exercise
a warrant. The warrant exercise price is $6.30 per share and, at February 28,
2003, was not in-the-money, as Talk common stock was trading at approximately
$5.60 per share at such date.
The report of the independent auditors on our 2002 financial statements
indicates there is substantial doubt about our ability to continue as a going
concern. We have worked during the course of the year to improve our financial
condition and, as discussed previously, the sale of most of the assets and
liabilities of our wholly-owned subsidiary, Essex, in December 2002, has helped
us to continue our business operations. However, we do not believe we currently
have enough working capital to build our business to a profitable level. We now
are seeking a working capital facility that will provide us with financing of up
to 80% of our outstanding accounts receivables. We anticipate that with such
financing, we will be able to achieve our plan of becoming profitable before the
end of this fiscal year. In lieu of such asset-based financing, new debt or
equity financing of up to $1 million would be required to fund our operations.
Given the current market price of our common stock and the current market
conditions in the telecom sector, there can be no assurances that we will be
able to obtain such funding when needed, or that such funding, if available,
will be obtainable on acceptable terms. We are also looking at other ways to
raise cash for operations, such as a second mortgage on our building or the sale
or rental of our building. The failure to raise the necessary funds to finance
our operations will have an adverse effect on our ability to carry out our
business plan. The inability to carry out this plan may result in the
continuance of unprofitable operations, and the eventual shut down of vendor
credit facilities, which would adversely affect our ability to continue
operating as a going concern.
New Accounting Standards
The new accounting pronouncements in footnote one of our Consolidated Financial
Statements are incorporated by reference.
Item 7. - Financial Statements
The following consolidated financial statements, notes thereto, and the
related independent auditors' report contained on page F-2 to the Company's
consolidated financial statements are herein incorporated:
Consolidated balance sheets - November 30, 2002 and 2001
Consolidated statements of operations - Years ended November 30, 2002
and 2001
16
Consolidated statements of stockholders' equity deficiency - Years ended
November 30, 2002 and 2001
Consolidated statements of cash flows - Years ended November 30, 2002 and
2001
Notes to consolidated financial statements - Years ended November 30, 2002
and 2001
Item 8. - Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 9. - Directors, Executive Officers, Promoters and Control Persons of the
Company; Compliance with Section 16(a) of the Exchange Act.
The following table contains certain information regarding directors and
executive officers of the Company as of February 28, 2003:
Principal Occupation for Past Five Years and
Name Age Current Public Directorships or Trusteeships
---- --- --------------------------------------------
Joel Dupre 49 Director since 1990; Chairman of the Board since March
1995; President of OneDotSource LLC ("ODS") from March
2000 to present; President of the Sirco Division of
Interbrand L.L.C., a manufacturer and distributor of
apparel accessories and luggage, from August 1999 to
March 2000; Chief Executive Officer of the Company from
March 1995 to August 1999.
Eric M. Hellige 48 Director since 1995 and Secretary of the
Company; Partner for more than five years of Pryor
Cashman Sherman & Flynn LLP ("Pryor Cashman"), counsel
to the Company.
Paul H. Riss 47 Director since 1995; Chief Executive Officer
of the Company since August 1999 and Chief Financial
Officer and Treasurer of the Company since November
1996.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires our directors and executive officers, and persons who
own more than ten percent (10%) of a registered class of our equity securities
("10% Shareholders"), to file with the Securities and Exchange Commission (the
"Commission"), initial reports of ownership and reports of changes in ownership
of our common stock and other equity securities. Our officers, directors and 10%
Shareholders are required by Commission regulation to furnish us copies of all
Section 16(a) forms they file. Based solely on our
17
review of the copies of such reports received by us, we believe that for the
fiscal year 2002, all Section 16(a) filing requirements applicable to our
officers, directors and 10% Shareholders had been met.
Item 10. - Executive compensation
Summary of Cash and Certain Other Compensation
The following table sets forth, for the fiscal years indicated, all
compensation awarded to, earned by or paid to Mr. Paul H. Riss, our Chief
Executive Officer, and to Mr. Joel Dupre, our Chairman of the Board and former
Chief Executive Officer (collectively referred to as the "Named Executives").
None of our other executive officers received more than $100,000 in compensation
during fiscal 2002.
Compensation Table
18
Long-Term
Annual Compensation Compensation Awards
------------------- -------------------
Name and Fiscal Other Annual All Other
Principal Position Year Salary($) Bonus($) Compensation ($) Options(#) Compensation
------------------ ------ --------- -------- ---------------- ---------- ------------
Paul H. Riss(1) 2002 $150,000 None None None None
Chief Executive Officer, 2001 150,000 None None None None
Chief Financial Officer 2000 150,000 $10,225 None 400,000 None
and Treasurer
Joel Dupre 2002 -- None None 10,000 None
Chairman of the Board 2001 -- None None 20,000 None
and former Chief 2000 -- None None None None
Executive Officer
-----------------
(1) Mr. Riss has been Chief Financial Officer and Treasurer of the Company
since November 1996 and was appointed Chief Executive Officer of the
Company in August 1999.
Stock Option Grants
The following table sets forth individual grants of stock options and
stock appreciation rights ("SARs") made by us during fiscal 2002 to each of the
Named Executives.
Option/SAR Grants In Last Fiscal Year
Potential Realizable Value
at Assumed Annual Rates of
Number of Percent of Total Stock Price Appreciation For
Securities Options/SARs Option
Underlying Granted to Exercise or Term(3)
Options/SARs Employees in Base Price Expiration ----------------------------
Name Granted(1) Fiscal Year(2) ($/Share) Date 5% ($) 10% ($)
---- ---------- -------------- --------- ---- ------ -------
Joel Dupre 10,000 50% 0.05 11/26 /06 138 305
-----------------
(1) No SARs were granted by us in fiscal 2002.
(2) In fiscal 2002, we granted options to two members of our Board of
Directors to purchase an aggregate of 20,000 shares and we did not grant
any options to employees.
(3) The amounts shown in these two columns represent the potential realizable
values using the options granted and the exercise price. The assumed rates
of stock price appreciation are set by the Commission's executive
compensation disclosure rules and are not intended to forecast the future
appreciation of our common stock.
19
Stock Option Exercises
The following table contains information relating to the exercise of our
stock options by the Named Executives in fiscal 2002, as well as the number and
value of the unexercised options held by the Named Executives as of November 30,
2002.
Aggregated Option Exercises in Last Fiscal Year
and Fiscal Year-End Option Values
Number of Securities Underlying Value of Unexercised
Unexercised Options at Fiscal In-the-Money Options at Fiscal
Shares Year-End(#)(1) Year -End ($)(2)
Acquired on Value ------------------------------- ------------------------------
Name Exercise (#) Realized($) Exercisable Unexercisable Exercisable Unexercisable
---- ------------ ----------- ----------- ------------- ----------- -------------
Paul H. Riss -- -- 320,000 350,000 -- --
Joel Dupre -- -- 170,000 10,000 -- --
-----------------
(1) The sum of the numbers under the Exercisable and Unexercisable column of
this heading represents each Named Executive's total outstanding options
to purchase shares of common stock.
(2) The dollar amounts shown under the Exercisable and Unexercisable columns
of the heading represent the number of exercisable and unexercisable
options, respectively, that were "In-the-Money" on November 30, 2002,
multiplied by the difference between the closing price of our common stock
on November 30, 2002, which was $0.05 per share, and the exercise price of
the options to purchase our common stock. For purposes of these
calculations, In-the-Money options are those with an exercise price below
$0.05 per share.
Board of Directors Compensation
We do not currently compensate directors for service on our Board of
Directors. On March 20, 2001, our Board of Directors adopted, subject to
shareholder approval, a Non-Employee Director Stock Option Plan (the "Director
Option Plan"). Under the Director Option Plan, each non-employee Director will
be granted a non-statutory option to purchase 10,000 shares of common stock on
the date on which he or she is elected, re-elected or appointed to our Board of
Directors. Options granted pursuant to the Director Option Plan will vest in
full on the one-year anniversary of the grant date, provided the non-employee
Director is still our director at that time. The exercise price granted under
the Director Option Plan is 100% of the fair market value per share of the
common stock on the date of grant as reported on The OTC Bulletin Board.
Employee Retirement Plan
In June 1995, our Board of Directors determined to discontinue benefit
accruals under our tax qualified Employee Retirement Plan (the "Retirement
Plan"). Pursuant to action taken by the Board of
20
Directors at such time, benefits ceased to accrue for all active participants
under the Retirement Plan on June 30, 1995. The Retirement Plan is administered
by our Board of Directors.
Each of our United States-based employees was eligible to participate in
the Retirement Plan. However, effective as of July 1, 1995 and in connection
with the Board's action, the Retirement Plan was amended to provide that no
additional eligible employees may participate in the Retirement Plan and accrue
benefits thereunder. The following table discloses estimated annual benefits
payable upon retirement in specified compensation and years of service
classification.
Projected Benefit at Retirement
Years of Service
--------------------------------------------------------------------------
15 20 25 30 35
--------------------------------------------------------------------------
Salary (1)
$ 20,000 $ 3,750 $ 5,000 $ 6,250 $ 7,500 $ 8,750
25,000 4,625 6,250 7,313 9,375 10,938
30,000 5,625 7,500 9,375 11,250 13,125
35,000 6,563 8,750 10,938 13,125 15,313
40,000 7,500 10,000 12,500 15,000 17,500
50,000 9,980 12,604 15,625 18,750 21,875
75,000 17,105 22,104 26,948 31,986 37,249
100,000 24,730 31,604 38,873 46,236 53,874
125,000 31,355 41,104 50,698 60,406 70,499
150,000(2) 38,480 50,004 62,573 74,736 87,124
175,000 45,605 60,104 74,448 88,986 103,749
200,000 52,730 69,604 86,323 103,236 120,374(3)
-----------------
(1) The annual benefits shown in the Table are integrated with Social Security
benefits and there are no other offsets to benefits.
(2) In general, Section 401(a)(17) of the Internal Revenue Code provides that
compensation used for computing benefits under a tax-qualified employee
pension plan cannot exceed $170,000 (as adjusted).
(3) Under current law, the maximum annual benefit payable under the Retirement
Plan cannot exceed $135,000 (as adjusted).
The Retirement Plan is funded by us on an actuarial basis, and we continue
to contribute annually the minimum amount required to cover the normal cost for
current service and to fund supplemental costs, if any, from the date each
supplemental cost was incurred. Contributions were intended to provide for
benefits attributed to service to date, and also for those expected to vest in
the future. Based on the assumptions used in the actuarial valuation, we must
contribute approximately $80,000 for the current plan year, which started on
July 1, 2002.
The estimated credited years of service for each of the Named Executives
is as follows: Joel Dupre (13 years) and Paul H. Riss (none).
21
Benefits are computed on the basis of a straight-life annuity. Benefits
under the Retirement Plan are integrated with Social Security benefits.
The Retirement Plan will continue to comply with the applicable sections
of the Internal Revenue Code, the Employee Retirement Income Security Act, and
applicable Internal Revenue Services rules and regulations. In accordance with
the terms of the Retirement Plan, distributions will continue to be made to
retired and terminated employees who are participants in the Retirement Plan.
Item 11. - Security Ownership of Certain Beneficial Owners and Management and
Related Shareholder Matters
The following table sets forth, as of February 28, 2003, the names,
addresses and number of shares of common stock beneficially owned by all persons
known to us to be beneficial owners of more than 5% of the outstanding shares of
our common stock, and the names and number of shares beneficially owned by all
of our directors and all of our executive officers and directors as a group
(except as indicated, each beneficial owner listed exercises sole voting power
and sole dispositive power over the shares beneficially owned):
Shares Percent of
Beneficially Outstanding
Owned Common Stock
----- ------------
Name and Address
Joel Dupre .................................... 974,668(1) 6.2%
One Dot Source LLC
509 Westport Avenue
Norwalk, Connecticut 06851
Paul H. Riss................................... 915,010(2) 5.7
c/o eLEC Communications Corp.
543 Main Street
New Rochelle, New York 10801
Geils Ventures LLC............................. 890,350 5.7
54 Danbury Road, Suite 38
Ridgefield, Connecticut 06877
Eric M. Hellige................................ 85,500(3) *
Pryor Cashman Sherman Flynn LLP
410 Park Avenue
New York, New York 10022
All of our directors and executive officers
as a group (three individuals).............. 1,975,178 12.3
------------------
* Less than 1%.
(1) Includes 170,000 shares of common stock subject to options that are
presently exercisable.
22
(2) Includes 320,000 shares of common stock subject to options that are
presently exercisable.
(3) Includes 52,500 shares of common stock subject to options and warrants
that are presently exercisable. Does not include 60,000 shares of common
stock subject to presently-exercisable options held by Pryor Cashman, of
which Mr. Hellige is a member, as to which shares Mr. Hellige disclaims
beneficial ownership.
Item 12. - Certain Relationships and Related Transactions
Eric M. Hellige, a director of the Company, is a member of Pryor Cashman
counsel to the Company. Fees paid by us to Pryor Cashman for legal services
rendered during the fiscal year ended November 30, 2002 did not exceed 5% of
such firm's or our revenues.
Joel Dupre, the Chairman of the Board of Directors, is the President of
ODS. We sold approximately $126,000 of goods and services to ODS during fiscal
2001.
Telecarrier had an agreement, effective January 2, 2002, with Telco
Services, Inc. ("Telco"), a corporation owned by a shareholder, under which
Telco provides Telecarrier with collection, sales and other services. Expenses
incurred in connection with this agreement, which are included in selling,
general and administrative expenses in the consolidated statement of operations,
amounted to $383,944 through November 30, 2002, of which $94,330 had been paid,
and $289,614 was owed to Telco as of November 30, 2002.
During the years ended November 30, 2002 and 2001, the Company billed
Cordia Corporation ("Cordia"), a related party, $93,335 and $44,239 for rent,
telemarketing services, commissions, and other costs. Cordia billed the Company
$52,544 and $30,000 for the years ended November 30, 2002 and 2001 for
telecommunications services and other costs. As of November 30, 2002 and 2001,
Cordia owed the Company $57,909 and $30,772. Cordia is controlled by entities
owned by a shareholder and former employee of the Company and members of his
family.
We believe that all purchases from or transactions with affiliated parties
were on terms and at prices substantially similar to those available from
unaffiliated third parties.
Item 13. - Exhibits and Reports on Form 8-K
(3) Articles of Incorporation and By-laws
(a) Certificate of Incorporation, as amended, incorporated
by reference to the Company's Registration Statement on
Form S-1 filed with the Securities and Exchange
Commission on August 27, 1969 under Registration Number
2-34436.
(b) Certificate of Amendment of the Certificate of
Incorporation, incorporated by reference to the
Company's definitive proxy statement filed with the
Securities and Exchange Commission in connection with
the Company's Annual Meeting of Shareholders held in May
1984.
23
(c) Certificate of Amendment to the Certificate of
Incorporation, incorporated by reference to Exhibit 3(b)
to the Company's Annual Report on Form 10-K for the year
ended November 30, 1988.
(d) Certificate of Amendment to the Certificate of
Incorporation, incorporated by reference to Exhibit 3(e)
to the Company's Annual Report on Form 10-K for the year
ended November 30, 1994, as amended.
(e) Certificate of Amendment of the Certificate of
Incorporation, incorporated by reference to Exhibit 3 to
the Company's Quarterly Report on Form 10-Q for the
quarter ended August 30, 1995.
(f) Certificate of Amendment of Certificate of Incorporation
filed February 17, 1999.
(g) Certificate of Amendment of the Certificate of
Incorporation, incorporated by reference to Exhibit 3.2
to the Company's Quarterly Report on Form 10-Q for the
quarter ended August 31, 1998.
(h) Certificate of Amendment of the Certificate of
Incorporation, incorporated by reference to Exhibit 3(1)
to the Company's Current Report on Form 8-K dated
November 16, 1999.
(i) By-laws, amended and restated as of December 1996,
incorporated by reference to Exhibit 3(e) to the
Company's Annual Report on Form 10-K for the year ended
November 30, 1996.
(10) Material Contracts
(a) 1995 Stock Option Plan, incorporated by reference to
Exhibit 10(I) to the Company's Annual Report on Form
10-K for the year ended November 30, 1995, as amended.
(b) 1996 Restricted Stock Award Plan, incorporated by
reference to Exhibit A to the Company's Proxy Statement
dated October 24, 1996.
(c) Non-Employee Director Stock Option Plan, incorporated by
reference to Exhibit A to the Company's Proxy Statement
dated March 30, 2001.
(22) Subsidiaries - The significant wholly-owned subsidiaries are
as follows:
Name Jurisdiction of Organization
---- ----------------------------
Essex Communications, Inc New York
Line One, Inc. New York
New Rochelle Telephone Corp. New York
TelcoSoftware.com Corp. Delaware
Telecarrier Services, Inc. Delaware
(23) Consent of Nussbaum Yates & Wolpow, P.C.
(b) Reports on Form 8-K.
On October 16, 2002, we filed a Current Report on Form 8-K providing
certifications of our Principal Executive Officer and Principal Financial
Officer with respect to our Quarterly Report on Form 10-QSB for the fiscal
quarter ended August 30, 2002, as required by Section 906 of the Sarbanes-Oxley
Act of 2002.
On November 20, 2002, we filed a Current Report on Form 8-K reporting (i)
the election of all director nominees at our annual meeting of shareholders held
on November 26, 2002 (the "Annual Meeting"), (ii) that no action was taken at
the Annual Meeting with regard to the proposal to sell
24
substantially all the assets of Essex to EAC, a wholly-owned subsidiary of Biz,
and (iii) the adjournment of the Annual Meeting to December 12, 2002.
On January 6, 2003, we filed a Current Report on Form 8-K reporting the
sale of certain assets of Essex to EAC.
Item 14. Controls and Procedures
(a) Within the 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and principal accounting officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rule 13a-14. Based upon the evaluation, our
Chief Executive Officer and principal accounting officer concluded that our
disclosure controls and procedures are effective in timely altering him to
material information relating to our company (including its consolidated
subsidiaries) required to be included in our periodic SEC filings.
(b) There have been no significant changes in our internal controls or in
other factors that could significantly affect our internal controls subsequent
to the date we carried out this evaluation, including any corrective actions
with regard to significant deficiencies and material weaknesses.
25
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 17th day of
March 2003
.
eLEC COMMUNICATIONS CORP.
(Company)
By: /s/ Paul H. Riss
------------------------------
Paul H. Riss
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated.
Signature Title Date
-------------------------- ------------------------------- --------------
/s/ Paul H. Riss Chief Executive Officer March 17, 2003
----------------------- Chief Financial Officer
Paul H. Riss (Principal Accounting Officer)
Director
/s/ Joel Dupre Chairman of the Board of Directors March 17, 2003
-----------------------
Joel Dupre
/s/ Eric M. Hellige Director March 17, 2003
-----------------------
Eric M. Hellige
26
Sarbanes-Oxley Act Section 302(a) Certification
I, Paul H. Riss, certify that:
1. I have reviewed this annual report on Form 10-KSB of eLEC Communications
Corp.
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. I am responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. I have disclosed, based on my most recent evaluation, to the registrant's
auditors and the audit committee of registrant's board of directors (or persons
performing the equivalent functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls;
and;
6. I have indicated in this annual report whether or not there were significant
changes in internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: March 17, 2003
By: /s/ Paul H. Riss
-------------------------------
Paul H. Riss
Chief Executive Office and
Chief Financial Officer
27
FORM 10-KSB
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
YEARS ENDED NOVEMBER 30, 2002 AND 2001
The following consolidated financial statements of eLEC Communications
Corp. and Subsidiaries are included in Item 7:
Report of Independent Certified Public Accountants F-2
Consolidated balance sheets - November 30, 2002 and 2001 F-3 - F-4
Consolidated statements of operations - Years ended November 30,
2002 and 2001 F-5
Consolidated statements of stockholders' equity deficiency -
Years ended November 30, 2002 and 2001 F-6 - F-7
Consolidated statements of cash flows - Years ended November 30,
2002 and 2001 F-8 - F-9
Notes to consolidated financial statements - Years ended November
30, 2002 and 2001 F-10 - F-38
F-1
Report of Independent Certified Public Accountants
The Board of Directors and Shareholders
eLEC Communications Corp.
New Rochelle, New York
We have audited the accompanying consolidated balance sheets of eLEC
Communications Corp. and Subsidiaries as of November 30, 2002 and 2001, and the
related consolidated statements of operations, stockholders' equity
(deficiency), and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of eLEC
Communications Corp. and its subsidiaries as of November 30, 2002 and 2001, and
the consolidated results of their operations and cash flows for the years then
ended, in conformity with accounting principles generally accepted in the United
States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As further discussed in Note 2, the
Company is experiencing difficulty in generating sufficient cash flow to meet
its obligations and sustain its operations and has incurred significant
recurring losses from its operations, has negative working capital and a
stockholders' deficiency. In addition, as described in Note 13, on December 31,
2002, the Company sold substantially all the assets of Essex Communications,
Inc., a wholly-owned subsidiary that accounted for substantially all of the
Company's revenue for the years ended November 30, 2002 and 2001. On July 29,
2002, another wholly-owned subsidiary, Telecarrier Services, Inc., filed a
voluntary petition for relief under Chapter 11 of the Federal Bankruptcy Laws.
These factors, among others, raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 2. The financial statements do not include any
adjustments that might result from the outcome of these uncertainties.
NUSSBAUM YATES & WOLPOW, P.C.
Melville, New York
February 11, 2003
F-2
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
NOVEMBER 30, 2002 AND 2001
ASSETS
2002 2001
---------- ----------
Current assets:
Cash and cash equivalents $ 938,528 $ 797,616
Accounts receivable, net of allowance of
$14,166 and $2,079,000 in 2002 and 2001 226,324 2,771,150
Investment securities 80,231 441,846
Other investments 137,558 240,000
Prepaid expenses and other current assets 144,829 306,508
Due from related party 57,909 30,772
Assets held for sale 1,102,103 --
---------- ----------
Total current assets 2,687,482 4,587,892
---------- ----------
Property, plant and equipment, net 1,826,835 2,167,506
---------- ----------
Other assets 371,036 526,080
---------- ----------
Total assets $4,885,353 $7,281,478
========== ==========
(Continued)
See accompanying notes to consolidated financial statements.
F-3
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
LIABILITIES AND STOCKHOLDERS' EQUITY DEFICIENCY
2002 2001
------------ ------------
Current liabilities:
Short-term borrowings $ 150,000 $ 312,170
Current portion of long-term debt and capital
lease obligations 57,379 4,206,326
Accounts payable and accrued expenses 3,323,593 7,661,596
Taxes payable -- 438,832
Due to related parties 289,614 --
Liabilities assumed in sale 10,081,382 --
------------ ------------
Total current liabilities 13,901,968 12,618,924
------------ ------------
Long-term debt and capital lease obligations, less
current portion 1,145,005 1,288,222
------------ ------------
Stockholders' equity deficiency:
Preferred stock, $.10 par value; 1,000,000 shares
authorized, Series B issued, 16 shares in 2002
and 2001, liquidation preference $1,000 per share 2 2
Common stock, $.10 par value; 50,000,000 shares
authorized; 15,619,282 and 15,418,782 shares
issued in 2002 and 2001 1,561,928 1,541,878
Capital in excess of par value 25,671,342 25,546,342
Deficit (37,437,314) (34,117,927)
Treasury stock at cost, 11,000 shares (27,500) (27,500)
Accumulated other comprehensive income, unrealized
gain on securities 69,922 431,537
------------ ------------
Total stockholders' equity deficiency (10,161,620) (6,625,668)
------------ ------------
Total liabilities and stockholders' equity deficiency $ 4,885,353 $ 7,281,478
============ ============
See accompanying notes to consolidated financial statements.
F-4
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED NOVEMBER 30, 2002 AND 2001
2002 2001
------------ ------------
Revenues $ 14,242,079 $ 19,692,720
------------ ------------
Costs and expenses:
Costs of services 8,976,201 12,539,334
Selling, general and administrative 9,485,592 13,962,732
Depreciation and amortization 261,436 1,084,120
Asset impairment charge -- 4,707,100
------------ ------------
Total costs and expenses 18,723,229 32,293,286
------------ ------------
Loss from operations (4,481,150) (12,600,566)
------------ ------------
Other income (expense):
Interest expense (437,119) (740,456)
Interest income and other 83,588 52,953
Gain on extinguishment of debt 61,025 --
Gain on sale of investment securities
and other investments 1,454,269 918,476
------------ ------------
Total other income (expense) 1,161,763 230,973
------------ ------------
Loss from continuing operations (3,319,387) (12,369,593)
------------ ------------
Discontinued operations:
Gain (loss) from discontinued operations -- 34,900
Loss on disposal of discontinued operations -- (39,000)
------------ ------------
Loss from discontinued operations -- (4,100)
------------ ------------
Net loss ($ 3,319,387) ($12,373,693)
------------ ------------
Basic and diluted loss per share:
Continuing operations ($.21) ($.83)
Discontinued operations -- --
------------ ------------
Net loss ($.21) ($.83)
------------ ------------
Weighted-average number of common shares
outstanding 15,607,183 14,911,393
============ ============
See accompanying notes to consolidated financial statements.
F-5
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY DEFICIENCY
YEARS ENDED NOVEMBER 30, 2002 AND 2001
Preferred Stock Common Stock Capital
--------------- ----------------------- in Excess of Treasury
Shares Amount Shares Amount Par Value Deficit Stock
------ ------ ---------- ---------- ------------ ------------ --------
Balance, November 30, 2000 116 $12 14,642,421 $1,464,242 $25,319,457 ($21,744,234) ($27,500)
Net loss (12,373,693)
Unrealized loss on investment
securities arising during the period
Less reclassification adjustment for
gains realized in net loss
Comprehensive loss
Issuance of common stock related
to prior equity offering 61,361 6,136 (6,136)
Exercise of stock options 400,000 40,000 60,000
Stock issued for services 15,000 1,500 7,200
Stock issued for investment in
Cordia Corporation 200,000 20,000 120,000
Options granted for services 55,811
Conversion of Series B preferred
stock to common stock (100) (10) 100,000 10,000 (9,990) -- --
---- --- ---------- ---------- ----------- ------------ --------
Balance, November 30, 2001 16 $ 2 15,418,782 $1,541,878 $25,546,342 ($34,117,927) ($27,500)
==== === ========== ========== =========== ============ ========
Accumulated Total
Other Stockholders'
Comprehensive Equity
Income (Loss) Deficiency
------------- -------------
Balance, November 30, 2000 $ 3,619,822 $ 8,631,799
------------
Net loss (12,373,693)
Unrealized loss on investment
securities arising during the period (2,269,809) (2,269,809)
Less reclassification adjustment for
gains realized in net loss (918,476) (918,476)
------------
Comprehensive loss (15,561,978)
Issuance of common stock related
to prior equity offering --
Exercise of stock options 100,000
Stock issued for services 8,700
Stock issued for investment in
Cordia Corporation 140,000
Options granted for services 55,811
Conversion of Series B preferred
stock to common stock -- --
----------- -----------
Balance, November 30, 2001 $ 431,537 ($6,625,668)
=========== ===========
(Continued)
See accompanying notes to consolidated financial statements.
F-6
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY DEFICIENCY (CONTINUED)
YEARS ENDED NOVEMBER 30, 2002 AND 2001
Preferred Stock Common Stock Capital
--------------- ----------------------- in Excess of Treasury
Shares Amount Shares Amount Par Value Deficit Stock
------ ------ ---------- ---------- ------------ ------------ --------
Balance, November 30, 2001 16 $ 2 15,418,782 $1,541,878 $25,546,342 ($34,117,927) ($27,500)
Net loss (3,319,387)
Unrealized gain on investment
securities arising during the period
Less reclassification adjustment for
gains realized in net loss
Comprehensive loss
Exercise of stock options -- -- 200,500 20,050 25,000 -- --
Expiration of warrants granted for
services -- -- -- 100,000 -- --
--- ---- ---------- ---------- ----------- ------------ --------
Balance, November 30, 2002 16 $ 2 15,619,282 $1,561,928 $25,671,342 ($37,437,314) ($27,500)
=== ==== ========== ========== =========== ============ ========
Accumulated Total
Other Stockholders'
Comprehensive Equity
Income (Loss) Deficiency
------------- -------------
Balance, November 30, 2001 $ 431,537 ($ 6,625,668)
------------
Net loss (3,319,387)
Unrealized gain on investment
securities arising during the period 1,019,296 1,019,296
Less reclassification adjustment for
gains realized in net loss (1,380,911) (1,380,911)
----------
Comprehensive loss (3,681,002)
Exercise of stock options -- 45,050
Expiration of warrants granted for
services -- 100,000
------------ ------------
Balance, November 30, 2002 $ 69,922 ($10,161,620)
============ ============
See accompanying notes to consolidated financial statements.
F-7
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED NOVEMBER 30, 2002 AND 2001
2002 2001
----------- ------------
Operating activities:
Net loss ($3,319,387) ($12,373,693)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization of long-lived assets 261,436 1,149,439
Amortization of loan discount -- 104,484
Loss on impairment of long-lived assets -- 4,707,100
Gain on sale of investment securities (1,380,911) (918,476)
Gain on sale of other investments (73,358) --
Loss on sale of equipment 24,842 --
Gain on extinguishment of debt (61,025) --
Stock issued for services -- 8,700
Options granted for services -- 55,811
Loss on sale of net assets of specialty retail segment -- 39,000
Provision for losses on accounts receivable 649,085 1,512,000
Changes in operating assets and liabilities:
Accounts receivable 1,023,648 (1,479,262)
Inventories -- 529,933
Prepaid expenses and other current assets 77,622 137,260
Other assets 96,828 150,259
Accounts payable, accrued expenses and taxes 5,188,287 4,129,829
Related party, net 262,477 --
----------- ------------
Net cash provided by (used in) operating activities 2,749,544 (2,247,616)
----------- ------------
Investing activities, net of effects of acquisitions:
Purchase of investment securities -- (10,309)
Proceeds from sale of investment securities 1,380,911 1,023,043
Proceeds from sale of other investments 177,770 --
Purchases of property, plant and equipment -- (1,188,049)
Proceeds from sale of property, plant and equipment 14,500 933,239
Proceeds from note 58,216 58,216
----------- ------------
Net cash provided by investing activities 1,631,397 816,140
----------- ------------
(Continued)
See accompanying notes to consolidated financial statements.
F-7
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2002 AND 2001
2002 2001
----------- -----------
Financing activities:
Proceeds from (repayment of) revolving credit
line, net ($3,998,700) $ 2,129,031
Repayment of secured short-term borrowings (101,145) (14,163)
Repayment of long-term debt, net of exchange rate (185,234) (495,433)
Proceeds from exercise of stock options 45,050 100,000
----------- -----------
Net cash provided by (used in) financing activities (4,240,029) 1,719,435
----------- -----------
Increase in cash and cash equivalents 140,912 287,959
Cash and cash equivalents at beginning of year 797,616 509,657
----------- -----------
Cash and cash equivalents at end of year $ 938,528 $ 797,616
----------- -----------
Cash paid during the year for:
Interest $ 469,513 $ 629,965
----------- -----------
Income taxes $ -- $ --
=========== ===========
Supplemental disclosure of non-cash investing and financing activities:
See Notes 4, 6, 7 and 11.
See accompanying notes to consolidated financial statements.
F-9
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED NOVEMBER 30, 2002 AND 2001
1. Description of Business and Summary of Accounting Principles
Description of Business and Concentration of Credit Risk
eLEC Communications Corp. ("eLEC" or the "Company") is a full-service
telecommunications company that focuses on developing integrated telephone
service in the emerging competitive local exchange carrier ("CLEC")
industry. The Company offers small and medium-sized businesses an
integrated set of telecommunications products and services, including
local exchange, local access, and domestic and international long distance
telephone.
The Company presently operates in one business segment. The principal
focus of the Company, as a competitive local exchange carrier is to resell
and provide low cost alternative telecommunication services and other
bundled services, focusing on small and medium-sized business users.
Trade receivables potentially subject the Company to credit risk. The
Company extends credit to its customers based upon an evaluation of the
customer's financial condition and credit history and generally does not
require collateral. Approximately $406,000 (including assets held for
sale) and $502,000 as of November 30, 2002 and 2001 represented net
amounts due (after allowance for doubtful collection) from entities in the
telecommunications industry related to intercarrier compensation.
During the fiscal year ended November 30, 2002, the Company entered into
an agreement to sell substantially all the assets of Essex Communications,
Inc. ("Essex"), a wholly-owned subsidiary that accounted for substantially
all of the revenue of the Company (see Note 13).
During the fiscal year ended November 30, 2001, the Company discontinued
the operations of its specialty retail segment that sold travel products,
uniforms and study guides via retail stores, E-commerce sites and a Web
site primarily to professional airline crewmembers (see Note 14).
F-10
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
1. Description of Business and Summary of Accounting Principles (Continued)
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries after elimination of significant
intercompany balances and transactions. Investments in 20% to 50% owned
affiliated companies are accounted for on the equity method. Investments
in less than 20% owned companies that do not have readily determinable
fair values are carried at cost.
Investment Securities
In accordance with generally accepted accounting principles, the Company
follows Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities", which requires
that investment securities be classified as trading, held-to-maturity or
available-for-sale. Investment securities consist of equity securities
classified as available-for-sale and are carried at fair value with
unrealized gains or losses to be reported in a separate component of
shareholders' equity.
Property, Plant and Equipment and Depreciation
Property, plant and equipment are recorded at cost. Depreciation is
computed primarily by use of accelerated and straight-line methods over
the estimated useful lives of the assets. The estimated useful lives are
thirty-nine years for buildings, twenty years for building improvements,
five to ten years for machinery and equipment, and the life of the lease
for leasehold improvements.
The Company accounts for internal-use computer software under Statement of
Position ("SOP") 98-1, "Accounting for the Cost of Computer Software
Developed or Obtained for Internal Use." SOP 98-1 requires computer
software costs related to internal software that are incurred in the
preliminary project stage to be expensed as incurred. When the
capitalization criteria of SOP 98-1 have been met, costs of developing or
obtaining internal-use computer software are capitalized. The Company
capitalized approximately $525,000 of employee salary and related costs
for internally developed software for the year ended November 30, 2001.
The costs were written off in 2001 as part of the impairment evaluation
(Note 19).
F-11
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
1. Description of Business and Summary of Accounting Principles (Continued)
Income Taxes
The Company accounts for income taxes according to the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting
for Income Taxes." Under the liability method specified by SFAS 109,
deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities as
measured by the enacted tax rates which will be in effect when these
differences reverse and the effect of net operating loss carryforwards.
Deferred tax expense is the result of changes in deferred tax assets and
liabilities. A valuation allowance has been established to eliminate the
deferred tax assets as it is more likely than not that such deferred tax
assets will not be realized.
Revenue Recognition
Revenues from voice, data and other telecommunication-related services are
recognized in the period in which subscribers use the related services.
Revenues from equipment sales and related installation charges, which have
not been significant to date, are recognized upon delivery and completion
of the installation of the related equipment and acceptance by the
customer, at which point legal title passes to the customer. Revenues for
carrier interconnection and access are recognized in the period in which
the service is provided.
The Securities and Exchange Commission ("SEC") issued Staff Accounting
Bulletin ("SAB") 101, Revenue Recognition in Financial Statements, in
December 1999. The SAB summarizes certain of the SEC staff's views in
applying generally accepted accounting principles to revenue recognition
in financial statements. The Company has performed a comprehensive review
of its revenue recognition policies and determined that they are in
compliance with SAB 101.
F-12
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
1. Description of Business and Summary of Accounting Principles (Continued)
Collectibility of Accounts Receivable
In order to record the Company's accounts receivable at their net
realizable value, the Company must assess their collectibiilty. A
considerable amount of judgment is required in order to make this
assessment, including an analysis of historical bad debts and other
adjustments, a review of the aging of the Company's receivables, and the
current creditworthiness of the Company's customers. The Company has
recorded allowances for receivables which it considered uncollectible,
including amounts for the resolution of potential credit and other
collection issues such as disputed invoices, customer satisfaction claims
and pricing discrepancies. However, depending on how such potential issues
are resolved, or if the financial condition of any of the Company's
customers was to deteriorate and their ability to make required payments
became impaired, increases in these allowances may be required. The
Company actively manages its accounts receivable to minimize credit risk
and, as of November 30, 2002, the Company had no individual customer that
constituted more than 10% of its accounts receivable.
During the years ended November 30, 2002 and 2001, the Company recorded
bad debt expense of $643,000 and $1,512,000.
Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing net income by the
weighted-average number of shares outstanding. Diluted earnings (loss) per
share includes the dilutive effect of stock options, warrants and
convertible preferred stock. Such options, warrants and convertible
preferred stock have not been included in the computations as they were
antidilutive in 2002 and 2001, but may become dilutive in the future.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
Goodwill and Other Intangible Assets
The excess cost over net assets acquired (goodwill) was being amortized on
a straight-line basis over seven years. Goodwill and other intangible
assets are periodically reviewed for impairment based on an assessment of
current and future levels of operating income and cash flows, as well as
other factors. Goodwill and other intangible assets were deemed to be
impaired in 2001, and were written down to zero value at November 30, 2001
(Note 19).
F-13
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
1. Description of Business and Summary of Accounting Principles (Continued)
Impairment of Long-Lived Assets
The Company reviews long-lived assets and certain identifiable intangibles
for impairment whenever events or changes in circumstances indicate that
the carrying amount 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 discounted cash flows
or appraised values, depending upon the nature of the assets. The Company
recognized an impairment of $4,707,100 related to long-lived assets during
the year ended November 30, 2001 (Note 19).
Use of Estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
the disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Advertising
Advertising costs are expensed as incurred. Advertising expense amounted
to approximately $207,000 in 2002 and $202,000 in 2001.
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value
of each class of significant financial instruments:
o Cash and Cash Equivalents
The carrying amount approximates fair value because of the short
maturity of those instruments.
F-14
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
1. Description of Business and Summary of Accounting Principles (Continued)
Fair Value of Financial Instruments (Continued)
o Investment Securities
The fair value of the Company's investment in marketable equity
securities is based upon the quoted market price.
o Long-Term Debt
The fair value of the Company's long-term debt is estimated based on
current rates offered to the Company for debt of the same remaining
maturities and approximates the carrying amount.
The Company has no instruments with significant off-balance-sheet risk.
Recent Accounting Pronouncements
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets",
effective December 1, 2001, which did not have a material impact on the
Company's consolidated results of operations and financial position. SFAS
144 establishes a single accounting model for the impairment or disposal
of long-lived assets, including discontinued operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections," which is effective for fiscal years beginning
after May 15, 2002. This statement rescinds the indicated statements and
amends other existing authoritative pronouncements to make various
technical corrections, clarify meanings, or describe their applicability
under changed conditions. SFAS No. 145 encourages early adoption of the
provision of this standard that rescinds SFAS No. 4, "Reporting Gains and
Losses from Extinguishments of Debt." Accordingly, the Company elected to
early adopt this provision during fiscal 2002, and has classified the
early retirement of debt as other income (expense) in its Consolidated
Statements of Operations. The adoption of the remaining provisions of this
new standard did not have a material impact on the Company's results of
operations or financial position.
F-15
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
1. Description of Business and Summary of Accounting Principles (Continued)
Recent Accounting Pronouncements (Continued)
In June 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS
146 requires that a liability for a cost associated with an exit or
disposal activity be recognized when the liability is incurred. SFAS 146
requires that the initial measurement of a liability be at fair value. The
Company elected to early adopt this SFAS 146 during fiscal 2002 and the
adoption did not have a material impact on its consolidated results of
operations and financial position.
Reclassification
Certain amounts in the November 30, 2001 financial statements have been
reclassified to conform to the November 30, 2002 presentation.
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,
the Company has sustained substantial losses from its continuing
operations in recent years and has negative working capital and a
stockholders' equity deficiency. In addition, the Company is experiencing
difficulty in generating sufficient cash flow to meet its obligations and
sustain its operations. Further, the Company sold substantially all the
assets of Essex, which accounted for substantially all of the Company's
revenue for the years ended November 30, 2002 and 2001. Another
subsidiary, Telecarrier Services, Inc. ("TSI"), filed a voluntary petition
for relief under Chapter 11 of the Federal Bankruptcy Laws.
In view of the matters described in the preceding paragraph,
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 the Company's ability to
meet its financing requirements on a continuing basis, and to succeed in
its 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 the Company be unable to continue in existence.
F-16
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
2. Going Concern Matters and Realization of Assets (Continued)
Management has taken the steps described below to revise its operating and
financial requirements, which it believes are sufficient to provide the
Company with the ability to continue in existence; however, there can be
no assurance that management's plans can be accomplished.
1) The Company has undertaken steps to reduce selling, general and
administrative expenses, and is seeking to sublease portions of its
facility.
2) The Company may seek additional mortgage financing on its New
Rochelle, New York headquarters property.
3) The Company plans to continue operations as a CLEC in certain
targeted geographic locations through its TSI and New Rochelle
Telephone Corp. subsidiaries.
4) The Company is seeking a working capital facility to finance its
accounts receivable.
3. Investment Securities
At November 30, 2002:
Fair Unrealized
Cost Value Holding Gain
------- --------- ------------
Equity securities $10,309 $ 80,231 $ 69,922
At November 30, 2001:
Fair Unrealized
Cost Value Holding Gain
------- --------- ------------
Equity securities $10,309 $441,846 $431,537
F-17
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
3. Investment Securities (Continued)
The Company's investment securities consisted of 10,143 and 420,805 common
shares of Talk America Holdings, Inc. ("Talk"), valued at $7.91 and $1.05
per share at November 30, 2002 and 2001, as adjusted for a one-for-three
reverse split in October 2002. At November 30, 2001, 333,333 of such
shares were held in escrow by a lender to secure long-term debt (see Note
7). At November 30, 2001, the related debt was in default and treated as a
current liability. Accordingly, the investment was classified a current
asset. In addition, the Company holds a non-marketable warrant to purchase
95,238 Talk shares at $6.30 per share, expiring in 2005. The Talk shares
have been subject to significant market fluctuations. During the years
ended November 30, 2002 and 2001, the Company sold 410,662 shares and
184,499 shares, resulting in gains of $1,380,911 and $918,476.
4. Other Investments
On February 2, 2001, the Company, as part of an effort to focus on its core
businesses, announced that it had entered into an agreement to sell and
thereby divest itself of all of its holdings in RiderPoint, Inc.
("Riderpoint") (carried under the equity method), Webquill Internet
Services LLC (a wholly-owned subsidiary) ("Webquill") and Skyclub
Communications Holding Corp. (an investment carried under the cost method)
and 200,000 shares of the Company's unregistered common stock (valued at
$140,000) in exchange for 280,000 unregistered common shares of Cordia
Corporation ("Cordia"), as adjusted for a 1-for-5 reverse stock split,
approximately 5% of the total shares then outstanding. Prior to the sale,
the Company had merged the employees and businesses of Webquill into
Essex's operations; thus the sale of Webquill represented only the sale of
its name, and an inactive entity. Cordia is controlled by entities owned by
a shareholder and former employee of the Company and members of his family.
Cordia is a publicly-held company whose shares are quoted in the
over-the-counter bulletin board market.
Due to the thinly-traded nature of the Cordia shares, such shares have not
been accounted for as a marketable equity security in accordance with
Statement of Financial Accounting Standards No. 115. Until such time as
Cordia has a significant level of trading activity, thereby establishing a
true market value (or evidence indicating a permanent impairment), the
Company will carry its investment in Cordia at its cost of $240,000 at
November 30, 2001 and $137,558 at November 30, 2002.
During the year ended November 30, 2002, the Company sold 127,000 shares
of Cordia stock, resulting in a gain of $73,358. The shares were sold at a
significant discount to published market prices.
F-18
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
5. Property, Plant and Equipment
2002 2001
---------- ----------
Land $ 225,000 $ 225,000
Building 1,302,498 1,302,498
Building improvements 221,175 424,790
Machinery and equipment 679,307 921,529
Computer equipment and software 1,508,157 1,638,817
Furniture and fixtures 253,880 391,853
---------- ----------
4,190,017 4,904,487
Less accumulated depreciation and amortization 2,363,182 2,736,981
---------- ----------
$1,826,835 $2,167,506
========== ==========
6 Short-Term Borrowings
2002 2001
---------- ----------
Short-term borrowings consist of the following:
Line of credit agreement with a bank, up to $150,000, due on demand with
interest payable monthly at the prime lending rate plus 2% (6 1/4% at
November 30, 2002). The bank claims that the line is secured by
substantially all assets of a subsidiary of the Company.
The Company is objecting to the bank's claim (See Note 9). $ 150,000 $ 150,000
Equipment note, payable in monthly installments of $15,339, including
interest at 8%, through October 5, 2002. The note was secured by
certain related equipment. During the year ended November 30, 2002, the
lender agreed to accept principal payments of $101,145 in settlement of
the note resulting in a gain of $61,025 -- 162,170
---------- ----------
$ 150,000 $ 312,170
========== ==========
F-19
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
7. Long-Term Debt and Capital Lease Obligations
On October 23, 2000, the Company converted the existing receivable sales
agreement between Textron Financial, formerly known as RFC Capital
Corporation ("RFC"), and Essex to a loan and security agreement with RFC.
The loan agreement provided for a loan facility of up to $5,000,000 based
upon a borrowing eligibility formula contained in the agreement. Loans
under the agreement bore interest at a rate per annum equal to the prime
rate plus 4.5%, and the agreement required an annual fee of $75,000. The
loan agreement contained various financial and operating covenants on the
part of Essex, including restrictions on borrowings, payment of dividends,
asset dispositions and capital expenditures. Effective November 30, 2001,
the Company was in default of the agreement. All amounts payable under the
loan agreement were secured by substantially all of the assets of Essex.
eLEC, and all of its subsidiaries, had guaranteed the repayment of all
borrowings under the loan agreement, and had pledged as collateral for
such guarantee 1,000,000 shares of common stock of Talk. The loan
agreement had a termination date of the earlier of (a) October 23, 2003;
(b) the occurrence of a termination event (as defined); (c) the occurrence
of an event of seller default (as defined); or (d) 90 days following
payment by Essex of a termination fee (as defined). In addition, upon
execution of the loan agreement, the Company granted RFC warrants to
purchase 200,000 shares of its common stock at $1.54 per share. The
warrants expire on October 23, 2010. The fair market value of the warrants
granted to RFC of $313,449 was determined by the use of the Black-Scholes
method and was to have been accounted for as additional interest expense
over the term of the agreement. However, since the loan was in default,
the loan was treated as a current liability at November 30, 2001, and the
unamortized portion of $200,258 was deemed to be impaired at November 30,
2001 and was written-off (Note 19).
On February 14, 2002, the loan facility was amended to change the
borrowing eligibility formula requiring the Company to have additional
collateral on amounts borrowed which resulted in decreased eligibility
under the facility. In conjunction with the amendment, the Company was
charged a $200,000 fee and the interest rate was increased three
percentage points by RFC.
On April 3, 2002, RFC entered into a forbearance agreement with the
Company whereby RFC agreed not to terminate the facility or initiate
action against the Company or collateral, except for the sale of Talk
Stock, prior to May 31, 2002, provided the Company was not in default of
any other provisions of the loan or forbearance agreements. The
forbearance agreement required the Company to enter into an agreement with
a third party to sell the business of Essex by May 11, 2002.
F-20
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
7. Long-Term Debt and Capital Lease Obligations (Continued)
In June 2002, RFC directed that all pledged shares of Talk stock be sold
to repay a portion of the borrowings under the agreement. On July 17,
2002, the Company received notice from RFC that RFC would no longer make
cash advances under the loan agreement and demanding full repayment of all
amounts outstanding by August 15, 2002. The loan was repaid in full during
August 2002.
On December 7, 2000, the Company acquired a building in New Rochelle, New
York, which serves as the Company's headquarters. The purchase price of
the building was $1,500,000, of which $1,100,000 was evidenced by a
mortgage from the seller, and the remainder of the purchase price was paid
in cash at closing. The mortgage requires interest payments only on a
monthly basis through December 2005, when the entire principal balance
becomes due. The interest rate is 10% through December 2001, and 11% for
the remaining period.
Line One, Inc., a wholly-owned subsidiary, had a $140,000 line of credit
with a bank bearing interest at prime plus 1% that was repaid in full
during the year ended November 30, 2001.
The Company's Canadian subsidiary had a real property mortgage of
approximately $284,000. The mortgage was repaid in December 2000 as the
property was sold.
Long-term debt consists of the following:
2002 2001
---------- ----------
Loan payable to RFC $ -- $3,998,700
Mortgage note payable 1,100,000 1,100,000
Equipment loans payable in aggregate
monthly installments of $1,497
including interest ranging from 4.90% to 5.90%
maturing at various dates through 2004 32,187 42,516
Capital lease obligations (Note 11) 70,197 353,332
---------- ----------
1,202,384 5,494,548
Less current maturities 57,379 4,206,326
---------- ----------
$1,145,005 $1,288,222
========== ==========
F-21
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
7. Long-Term Debt and Capital Lease Obligations (Continued)
Principal payments are due as follows:
Years ended November 30,
------------------------
2003 $ 57,379
2004 35,385
2005 9,620
2006 1,100,000
----------
$1,202,384
==========
8. Income Taxes
At November 30, 2002, the Company had net operating loss carryforwards for
Federal income tax purposes of approximately $24,000,000 expiring in the
years 2003 through 2022. There is an annual limitation of approximately
$187,000 on the utilization of approximately $1,500,000 of such net
operating loss carryforwards under the provisions of Internal Revenue Code
Section 382.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets and
liabilities as of November 30, 2002 and 2001 are as follows:
2002 2001
----------- -----------
Deferred tax assets:
Net operating loss carryforwards $ 8,160,000 $ 7,200,000
Allowance for doubtful accounts and accruals 930,000 770,000
Depreciation and impairment charge 280,000 530,000
----------- -----------
9,370,000 8,500,000
Valuation allowance (9,370,000) (8,500,000)
----------- -----------
Net deferred tax assets $ -- $ --
=========== ===========
F-22
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
8. Income Taxes (Continued)
The following is a reconciliation of the tax provisions for the two years
ended November 30, 2002 with the statutory Federal income tax rates:
Percentage of Pre-Tax Income
----------------------------
2002 2001
------------- -------------
Statutory Federal income tax rate (34.0%) (34.0%)
Operating losses generating no current tax
benefit, United States 34.0 34.0
------ ------
-- --
====== ======
9. Petition for Relief Under Chapter 11
On July 29, 2002, TSI, which had licenses to resell local and long distance
service in four states, filed a voluntary petition for relief under Chapter
11 of the Federal Bankruptcy Laws in the Untied States Bankruptcy Court for
the Southern District of New York and was assigned Case No. 02-20379 (ASH).
Under Chapter 11, certain claims (liabilities subject to compromise)
against TSI in existence prior to the filing of the petition for relief
under the Federal Bankruptcy Laws, are stayed while TSI continues business
operations as a debtor-in-possession. Additional claims (liabilities
subject to compromise) may arise subsequent to the filing date, resulting
from rejection of executory contracts, including leases, and from the
determination of the Court (or agreed to by parties-in-interest) of allowed
claims for contingencies and other disputed amounts. The claim, which the
bank maintains is secured by TSI's assets (See Note 6), is also stayed,
although the claimant has the right to move the Court for relief from the
stay.
F-23
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
9. Petition for Relief Under Chapter 11 (Continued)
As of November 30, 2002, TSI had total assets of approximately $374,000
and total liabilities of approximately $947,000, of which approximately
$899,000 represented pre-petition liabilities and approximately $48,000
represented post-petition liabilities. Pre-petition liabilities subject to
compromise are reflected below:
Line of credit $150,000
Trade payables and due
to related parties (Note 12) 646,000
Other accrued expenses 103,000
10. Pension Plans
The Company has a defined benefit plan covering two active and a number of
former employees. The benefits provided are primarily based upon years of
service and compensation, as defined. The Company's funding policy is to
contribute annually the minimum amount required to cover the normal cost
and to fund supplemental costs, if any, from the date each supplemental
cost was incurred. Contributions were intended to provide not only for
benefits attributed to service to date, but also for those expected to be
earned in the future. Plan assets consist primarily of investments in
money market funds.
Effective June 30, 1995, the plan was frozen, ceasing all benefit accruals
and resulting in a plan curtailment.
F-24
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
10. Pension Plans (Continued)
Net periodic pension cost (gain) included the following components:
2002 2001
-------- --------
Interest cost on projected benefit obligation $ 48,591 $ 48,325
Return on assets (38,287) (43,293)
Net amortization of (gain) or loss 20,743 10,364
-------- --------
$ 31,047 $ 15,396
-------- --------
Following is a summary of significant actuarial assumptions used:
2002 2001
------ ------
Weighted-average discount rates 7.0% 7.0%
Rates of increase in compensation levels 5.0% 5.0%
Expected long-term rate of return on assets 8.0% 8.0%
The following table sets forth the Plan's funded status and amounts
recognized in the Company's statement of financial position at:
November 30,
2002 2001
--------- ---------
Accumulated benefit obligation, including vested
benefits of $736,717 and $699,741 at November
30, 2002 and 2001, respectively ($736,717) ($699,741)
--------- ---------
Projected benefit obligation for service rendered
to date ($736,717) ($699,741)
Plan assets at fair value 417,601 456,045
--------- ---------
Plan assets in excess of (deficiency in) unfunded
projected benefit obligation (319,116) (243,696)
--------- ---------
Accrued pension cost ($319,116) ($243,696)
========= =========
The Company has a 401(k) profit sharing plan for the benefit of all
eligible employees, as defined. The plan provides for voluntary
contributions not to exceed the statutory limitation provided by the
Internal Revenue Code. The Company may make discretionary contributions.
For the year ended November 30, 2001, the Company contributed $65,000, and
there was no contribution made for the year ended November 30, 2002.
F-25
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
11. Commitments
Operating Leases
The Company conducted a substantial portion of its operations utilizing
leased facilities. Rent expense was $355,000 and $534,000 in 2002 and
2001, respectively. In addition to the annual rent, the Company pays real
estate taxes, insurance and other occupancy costs on its leased
facilities.
The minimum annual rental commitments under all operating leases that have
remaining non-cancelable terms in excess of one year are approximately as
follows:
Year ended November 30,
-----------------------
2003 $70,000
2004 2,000
-------
$72,000
=======
On April 5, 2001, Essex entered into a lease for office space in Orlando
Florida. The term of the lease was through May 2008, and required aggregate
rentals of approximately $915,000 for the entire term of the lease. Essex
abandoned the space during the year ended November 30, 2002. Essex has not
paid rent since the date of abandoning the facility, and the remaining
lease obligation aggregates approximately $819,000. The Company believes
that the landlord has leased the space to a new tenant for a rental amount
at least equal to Essex's commitment, and has not requested any additional
rent from Essex accordingly no accrual has been made for any portion of the
remaining lease obligation.
Capital Lease Obligations
The Company leases certain machinery and equipment with lease terms
through 2005. Obligations under capital leases have been recorded in the
accompanying financial statements at the present value of future minimum
lease payments, discounted at interest rates ranging from 12.40% to
26.41%. The capitalized cost and accumulated depreciation included in
property and equipment is as follows:
2002 2001
-------- --------
Cost $253,276 $505,032
Accumulated depreciation 226,436 417,168
-------- --------
$ 26,840 $ 87,864
======== ========
F-26
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
11. Commitments
Capital Lease Obligations (Continued)
The future minimum lease payments under the capital lease and net present
value of future minimum lease payments for the ensuing years are
summarized as follows:
Year ended November 30,
-----------------------
2003 $49,854
2004 23,273
2005 12,051
-------
85,178
Less amount representing interest 14,981
-------
Present value of future minimum
lease payments (Note 7) $70,197
=======
12. Related Party Transactions
TSI has an agreement, effective January 2, 2002, with Telco Services, Inc.
("Telco"), a corporation owned by a shareholder, under which Telco
provides TSI with collection, sales and other services. Expenses incurred
in connection with this agreement, which are included in selling, general
and administrative expenses in the consolidated statement of operations,
amounted to $383,944 through November 30, 2002, of which $94,330 had been
paid, and $289,614 was owed to Telco as of November 30, 2002 (Note 9).
During the years ended November 30, 2002 and 2001, the Company billed
Cordia, a related party (see Note 4), $93,335 and $44,239 for rent,
telemarketing services, commissions, and other costs. Cordia billed the
Company $52,544 and $30,000 for the years ended November 30, 2002 and 2001
for telecommunications services and other costs. As of November 30, 2002
and 2001, Cordia owed the Company $57,909 and $30,772.
F-27
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
12. Related Party Transactions (Continued)
During the year ended November 30, 2001, the Company wrote off, as
uncollectible, $211,000 of prior year amounts charged to Riderpoint, a
wholly-owned subsidiary of Cordia, and which had been guaranteed by Cordia
based on the financial condition of Cordia.
During the year ended November 30, 2001, the Company sold approximately
$126,000 of goods to a company controlled by its Chairman, which is
included in discontinued operations.
13. Asset Sale
On September 3, 2002, the Company entered into an agreement with Essex
Acquisition Corp. ("EAC"), a wholly-owned subsidiary of BiznessOnline.com,
Inc. ("Biz"), to sell substantially all the assets of Essex (amounting to
$1,102,103 at November 30, 2002), for five dollars plus the assumption of
certain liabilities of Essex, amounting to $10,081,382 at November 30,
2002, including all obligations due and payable to Essex's largest vendor,
Verizon Services Corp. ("Verizon"). EAC also paid the Company $270,000 to
reimburse the Company for amounts paid by the Company to Essex's lender,
RFC. The sale, which closed on December 31, 2002, is expected to result in
a potential gain of approximately $9,000,000. EAC entered into an
agreement with Verizon that provides a payment schedule for the
liabilities assumed from Essex. Verizon granted EAC a discount on the
assumed liabilities provided EAC adheres to the payout schedule.
As the creditors of Essex did not consent to the assignment of their
claims for receivable, Essex will remain liable for substantially all the
obligations assumed in the sale until such time as they are paid. The June
30, 2002 unaudited financial statements of Biz indicate that Biz had a
stockholders' equity deficiency of approximately $20,500,000 and had
negative working capital of approximately $3,500,000. The most recent
independent auditor's report of Biz expressed significant doubt about Biz's
ability to continue as a going concern. These factors indicate that there
is significant uncertainty as to Biz and its subsidiaries' ability to repay
the obligations described above. Accordingly, the Company will not record
any gain until Essex is released from the assumed obligations.
F-28
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
13. Asset Sale (Continued)
The Company has been billed for certain amounts from its service providers
in certain states, which are disputed by the Company. The Company contends
that the related invoicing of taxes, subscriber line charges, other fees
and features are not in accordance with the agreements between the Company
and the service providers. At November 30, 2002 and 2001, Essex has not
paid for or accrued approximately $3,200,000 and $3,900,000 of such
disputed amounts. Substantially all of the disputed liabilities are with
Verizon, and have been transferred pursuant to the asset sale. Management
of the Company believes that Essex would prevail in these disputes if the
liability ultimately becomes payable by Essex and not EAC.
Assets and liabilities transferred to EAC consisted of the following at
November 30, 2002:
Assets:
Cash $ 109,134
Accounts receivable, net 872,092
Property and equipment, net 36,820
Security deposits 84,057
-----------
$ 1,102,103
===========
Liabilities:
Accounts payable and accrued expenses $ 9,194,427
Taxes payable 778,725
Capital lease obligations 108,230
-----------
$10,081,382
===========
The following unaudited pro forma summary presents information as if the
sale of Essex's assets had occurred at the beginning of each period
presented. The pro forma amounts include certain adjustments that
eliminate all the operations of Essex for the periods presented. The pro
forma information does not necessarily reflect the actual results that
would have occurred had the sale taken place for the periods presented,
nor is it necessarily indicative of the future results of operations of
the remaining company:
F-29
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
13. Asset Sale (Continued)
Unaudited
--------------------------
2002 2001
--------- ------------
Revenues $ 284,197 $ 1,422,304
--------- ------------
Loss from continuing operations (878,598) (10,251,108)
--------- ------------
Net loss ($878,598) ($10,255,208)
========= ============
Basic and diluted loss per share ($.06) ($.69)
========= ============
14. Discontinued Operations
During the year ended November 30, 2001, the Board of Directors of the
Company adopted a plan to discontinue the Company's specialty retail
related travel products segment. On November 30, 2001, the Company entered
into an agreement to sell substantially all non-cash assets of the segment
and assigned substantially all liabilities to the purchaser. The sale
resulted in a loss of approximately $39,000 and proceeds, which amounted
to $440,225, subject to adjustments, was paid on November 30, 2001. The
initial purchase price is subject to certain adjustments as defined upon
the realization and settlement of assets and liabilities and additional
consideration to be made upon the attainment of specified sales levels of
the sold business.
The operating results and remaining assets of the discontinued operations
as of and for the year ended November 30, 2001 are summarized as follows:
Sales $ 1,932,988
===========
Net gain (loss) ($4,100)
===========
Current assets $ 113,782
===========
F-30
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
15. Segment Reporting
The Company evaluates the performance of its operating segments based on
the operating income of the respective business units. Geographical
information is not presented, as the continuing operations of the Company
operate solely within the United States. A summary of business data for
the Company's reportable segments, including assets held for sale (Note
13) for the fiscal years 2002 and 2001 are as follows:
Discontinued
Operations
of Retail
Related
Telecom- Travel Total
munications Products Company
----------- ------------- ------------
Revenue (external 2002 $ 14,242,079 $ -- $ 14,242,079
customers) 2001 $ 19,692,720 $ 1,932,988 21,625,708
Segment loss 2002 (3,319,387) -- (3,319,387)
2001 (12,369,593) (4,100) (12,373,693)
Segment assets 2002 4,885,353 -- 4,885,353
2001 7,167,696 113,782 7,281,478
Depreciation and
amortization of 2002 261,436 -- 261,436
long-lived assets 2001 1,084,120 65,319 1,149,439
Interest expense 2002 437,119 -- 437,119
2001 740,456 -- 740,456
Segment capital 2002 -- -- --
expenditures 2001 2,806,158 -- 2,806,158
F-31
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
15. Segment Reporting (Continued)
Significant Sales Concentrations and Loss of Major Customer
For the year ended November 30, 2001, one customer accounted for
approximately $3,500,000, or 18% of the telecommunication segment revenue.
In October 2001, this customer began to utilize other service providers
and did not account for any significant revenues in 2002.
16. Stockholders' Equity
The Company accounts for its stock option awards under the intrinsic value
based method of accounting prescribed by APB Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations including FASB
Interpretation No. 44, "Accounting for Certain Transactions Including
Stock Compensation," an interpretation of APB Opinion No. 25. Under the
intrinsic value based method, compensation cost is the excess, if any, of
the quoted market price of the stock at grant date or other measurement
date over the amount an employee must pay to acquire the stock. The
Company makes pro forma disclosures of net income and earning per share as
if the fair value based method of accounting had been applied as required
by SFAS No. 123, "Accounting for Stock-Based Compensation."
The Company's Stock Option Plan (the "Plan") provides for the grant of up
to 3,400,000 incentive stock options, non-qualified stock options, tandem
stock appreciation rights, and stock appreciation rights of shares of
common stock. Under the plan, options may be granted at no less than the
fair market value of the Company's stock on the date of grant, and in the
case of an optionee who owns directly or indirectly more than 10% of the
outstanding voting stock ("an Affiliate"), 110% of the market price on the
date of grant. As of November 30, 2002, approximately 600,000 option
shares remain available for future issuance.
F-32
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
16. Stockholders' Equity (Continued)
During 1999, the Company established a new series of stock, Series B
Preferred stock, $.10 par value. The Company was authorized to issue up to
1,300 shares of the Series B Preferred stock, and such stock is entitled
to receive dividends when as, and if dividends are declared by the Company
on its common stock. Each holder of Series B preferred stock has the
right, at the option of the holder, to convert each share of such stock
into 1,000 shares of common stock. The Company has the right to convert
each share of Series B preferred stock into common stock at the same
conversion ratio. The conversion price of shares of Series B preferred
stock is subject to adjustment in the event of any reclassification,
subdivision or combination of the Company's outstanding common stock into
a greater or smaller number of shares by a stock split, stock dividend or
other similar event. In the event of a dissolution, liquidation or winding
up of the Company, the holders of Series B preferred stock are entitled to
receive, if available, prior and in preference to the holders of common
stock, an amount equal to $1,000 per share. Thereafter, any remaining
assets, if any, would be distributed ratably to the holders of common
stock. The holders of shares of Series B preferred stock are entitled to
that number of votes on all matters presented to shareholders equal to the
number of shares of common stock then issuable upon conversion of such
shares of preferred stock. Without the approval of the holders of at least
a majority of the Series B preferred stock then outstanding voting
separately as a class, the Company may not amend its Certificate of
Incorporation in any way that adversely affects the rights and preferences
of the holders of the Series B preferred stock as a class. During 2001,
certain of the Series B shareholders elected to convert their shares to
common shares, resulting in the issuance of 100,000 shares of common
stock.
F-33
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
16. Stockholders' Equity (Continued)
The following is a summary of outstanding options:
Weighted-
Average
Number Exercise Price Exercise
of Shares Per Share Price
---------- --------------- --------
Outstanding November 30, 2000 3,027,215 $1.19 - $4.88 $ 1.68
Granted during year ended
November 30, 2001 859,000 $ .25 - $ .97 $ .42
Exercised during year ended
November 30, 2001 (400,000) $.25 $ .25
Canceled during year ended
November 30, 2001 (555,886) $1.19 - $4.19 $ 1.60
----------
Outstanding November 30, 2001 2,930,329 $ .25 - $4.88 $ 1.52
Granted during year ended
November 30, 2002 20,000 $.05 $ .05
Exercised during year ended
November 30, 2002 (200,000) $.25 $ .25
Canceled during year ended
November 30, 2002 (1,131,876) $.72 - $4.19 $ 1.59
----------
Outstanding November 30, 2002 1,618,453 $.05 - $4.88 $ 1.60
==========
Options exercisable, November
30, 2001 1,622,727 $ .25 - $4.88 $ 1.47
==========
Options exercisable, November
30, 2002 1,037,452 $.58 - $4.89 $ 1.69
==========
F-34
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
16. Stockholders' Equity (Continued)
The following table summarizes information about the options outstanding
at November 30, 2002:
Options Outstanding Options Exercisable
---------------------------------------- ---------------------------
Weighted-
Average Weighted- Weighted-
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life (Years) Price Outstanding Price
------------- ----------- ------------ ---------- ----------- ---------
$ .05 - $ .97 205,500 3.34 $ .77 107,167 $ .90
$1.19 - $1.75 1,122,959 2.55 $1.37 687,625 $1.36
$2.00 - $4.88 289,994 1.83 $3.10 242,660 $2.97
For disclosure purposes, the fair value of each stock option grant is
estimated on the date of grant using the Black Scholes option-pricing
model with the following weighted-average assumptions used for stock
options granted: annual dividends of $0.00 for all years, expected
volatility of 125% for 2001 and 143% for 2002, risk-free interest rate of
4.63% for 2001 and 1.72% for 2002, and expected life of five years for all
grants. The weighted-average fair value of stock options granted in 2002
and 2001 was $.04 and $.70, respectively.
Under the above model, the total value of stock options granted in 2002
and 2001 was $895 and $162,825, respectively, which would be amortized
ratably on a pro forma basis over the related vesting periods, which
generally range from five to ten years. Had the Company determined
compensation cost for these plans in accordance with SFAS No. 123, the
Company's pro forma net loss would have been ($3,725,742) in 2002 and
($13,079,759) in 2001, and the Company's pro forma loss per share would be
($.24) for 2002 and ($.88) for 2001.
On October 24, 1996, the shareholders of the Company adopted the eLEC
Communications Corp. 1996 Restricted Stock Award Plan (the "Restricted
Stock Award Plan"). An aggregate of 400,000 shares of common stock of the
Company has been reserved for issuance in connection with awards granted
under the Restricted Stock Award Plan. Such shares may be awarded from
either authorized and unissued shares or treasury shares. The maximum
number of shares that may be awarded under the Restricted Stock Award Plan
to any individual officer or key employee is 100,000. No shares were
awarded during 2002 and 2001.
F-35
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
16. Stockholders' Equity (Continued)
As of November 30, 2002 and 2001, warrants were outstanding to purchase up
to 550,000 shares of the Company's common stock at prices ranging from
$1.54 to $2.50. The warrants expire through October 23, 2010.
On February 13, 2002, the Company received notification from NASDAQ that
its stock was delisted from the NASDAQ Small Cap Market effective February
14, 2002. The Company's stock now trades on the OTC Bulletin Board.
17. Risks and Uncertainties
The Company buys substantially all of the telecommunication services that
it resells from Regional Bell Operating Companies ("RBOC's"), and is,
therefore, highly dependent upon them. Management of the Company believes
that its relationship with them is satisfactory. Management of the Company
believes that there are less desirable suppliers of telecommunication
services in the geographical location in which the Company conducts
business. In addition, the Company is at risk to regulatory agreements
that govern the rates to be charged to the Company. In light of the
foregoing, it is reasonably possible that the loss of the Company's
relationship with the RBOC's or a significant unfavorable change in the
regulatory agreements structure would have a severe near-term impact on
the Company's ability to conduct its telecommunications business.
Future results of operations involve a number of risks and uncertainties.
Factors that could affect future operating results and cash flows and
cause actual results to vary materially from historical results include,
but are not limited to:
- The Company's business strategy with respect to bundled local and
long distance services may not succeed.
- Failure to manage, or difficulties in managing, the Company's growth
operations or restructurings including attracting and retaining
qualified personnel and opening up new territories for its service
with favorable gross margins.
F-36
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
17. Risks and Uncertainties (Continued)
- 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 the Company's network and information
systems.
- Changes in government policy, regulation and enforcement.
- Failure of the Company's 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 Company's relationship with third party carriers.
- Failure or bankruptcy of other telecommunications companies whom the
Company relies upon for services and revenues.
- Lack of capital, borrowing capacity, and inability to generate cash
flow.
18. Quarterly Financial Data (Unaudited)
During the fourth quarter of 2001, the Company recorded impairment charges
of $4,707,100 (Note 19) and increases in the provision for doubtful
accounts of approximately $852,000.
F-37
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOVEMBER 30, 2002 AND 2001
19. Asset Impairments
During the year ended November 30, 2001, the Company recorded an
impairment charge of $4,707,100, of which $2,750,823 was associated with
the writedown of goodwill purchased in various acquisitions, and
$1,956,277 was associated with the writedown of other long-lived assets,
primarily property and equipment, leases and the unamortized loan discount
described in Note 6. SFAS 121, "Accounting for the Impairment of
Long-Lived Assets to be Disposed of," requires the evaluation of
impairment of long-lived assets and identifiable intangibles whenever
events or circumstances indicate that the carrying amount of an asset may
not be recoverable. Management determined that goodwill and other
long-lived assets were impaired and should be written-off due to
significant operating losses, and negative cash flows generated from
acquisitions and operations, among other factors. Management also
determined that the property and equipment was impaired and should be
reduced to reflect its estimated net realizable value.
F-38