SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended August 31, 2003.
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from to
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Commission file number 0-4465
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eLEC Communications Corp.
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( Name of Small Business Issuer as Specified in Its Charter)
New York 13-2511270
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(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
75 South Broadway White Plains, NY 10601
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(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number, Including Area Code 914-682-0214
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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 the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: 16,058,282 shares of
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Common Stock, par value $.10 per share, as of October 1, 2003.
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PART 1. FINANCIAL INFORMATION
------------------------------
Item 1. Financial Statements
----------------------------
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Balance Sheet
August 31, 2003
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $404,466
Accounts receivable, net 649,612
Assets held for sale 1,628,344
Other investments 20,795
Due from related party 333
Prepaid expenses and other current assets 177,196
-----------
Total current assets 2,880,746
Property, plant and equipment, net 34,805
Other assets 69,170
-----------
Total assets $2,984,721
===========
Liabilities and stockholders' equity deficiency
Current liabilities:
Short-term borrowings $350,000
Current maturities of long-term debt and capital lease
obligations 1,125,070
Accounts payable and accrued expenses 4,435,987
Liabilities assumed in sale 5,767,271
Income taxes payable 34,000
-----------
Total current liabilities 11,712,328
-----------
Long-term debt and capital lease obligations, less current
maturities 22,288
-----------
Stockholders' equity deficiency:
Preferred stock, $.10 par value, 1,000,000 shares authorized
Series B issued, 16 shares, liquidation preference $1,000 per
share 2
Common stock $.10 par value, 50,000,000 shares authorized,
16,069,282 shares issued 1,606,928
Capital in excess of par value 25,658,892
Deficit (35,988,217)
Treasury stock at cost, 11,000 shares (27,500)
-----------
Total stockholders' equity deficiency (8,749,895)
-----------
Total liabilities and stockholders' equity deficiency $2,984,721
===========
See notes to the condensed consolidated financial statements
2
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
(Unaudited)
For the Nine Months Ended For the Three Months Ended
Aug. 31, 2003 Aug. 31, 2002 Aug. 31, 2003 Aug. 31, 2002
------------- ------------- ------------- -------------
Revenues $3,776,334 $11,805,200 $1,275,889 $3,629,517
---------- ----------- ---------- ----------
Costs and expenses:
Costs of services 1,986,726 7,789,871 649,597 2,305,277
Selling, general and administrative 3,841,201 7,286,855 1,102,647 2,290,554
Depreciation and amortization 80,850 180,546 17,207 44,327
---------- ----------- ---------- ----------
Total costs and expenses 5,908,777 15,257,272 1,769,451 4,640,158
---------- ----------- ---------- ----------
Loss from operations (2,132,443) (3,452,072) (493,562) (1,010,641)
---------- ----------- ---------- ----------
Other income (expense):
Interest expense (105,509) (386,186) (36,065) (87,283)
Interest and other income (loss) 88,063 (22,237) (34,300) 10,151
Gain on sale of assets 3,511,297 -- 1,254,442 --
Gain on sale of investment securities and
other investments 121,687 1,380,911 37,926 696,678
---------- ----------- ---------- ----------
3,615,538 972,488 1,222,003 619,546
---------- ----------- ---------- ----------
Income (loss) before taxes 1,483,095 (2,479,584) 728,441 (391,095)
Provision for taxes 34,000 -- 34,000 --
---------- ----------- ---------- ----------
Net income (loss) 1,449,095 (2,479,584) 694,441 (391,095)
Other comprehensive income - unrealized
income on marketable securities -- 92,258 -- 28,910
---------- ----------- ---------- ----------
Comprehensive income (loss) $1,449,095 ($2,387,326) $694,441 ($362,185)
========== =========== ========== ==========
Basic and diluted earnings (loss) per share $0.09 ($0.16) $0.04 ($0.03)
========== =========== ========== ==========
Weighted average number of common shares
outstanding
Basic 15,633,829 15,606,818 15,684,369 15,608,282
========== =========== ========== ==========
Diluted 15,664,231 15,606,818 15,733,552 15,608,282
========== =========== ========== ==========
3
See notes to the condensed consolidated financial statements.
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Nine Months Ended
Aug. 31, 2003 Aug. 31, 2002
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Net cash (used in) provided by operating activities: ($1,099,236) $ 2,942,305
---------- -----------
Cash flows from investing activities:
Proceeds from sale of investment securities
and other investments 198,273 1,380,911
Purchase of property and equipment (3,200) --
Proceeds from the sale of property and equipment 16,025 4,000
Proceeds from note 209,102 43,662
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Net cash provided by investing activities 420,200 1,428,573
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Cash flows from financing activities:
Proceeds from short-term note 200,000 --
Repayment of long-term debt (55,026) (4,202,199)
Proceeds from exercise of stock options -- 45,000
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Net cash provided by (used in) financing activities 144,974 (4,157,119)
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(Decrease) increase in cash and cash equivalents (534,062) 213,759
Cash and cash equivalents at beginning of period 938,528 797,616
---------- -----------
Cash and cash equivalents at the end of period $ 404,466 $ 1,011,375
========== ===========
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $ 105,509 $ 386,186
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See notes to the condensed consolidated financial statements.
4
eLEC COMMUNICATIONS CORP.
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Notes To Condensed Consolidated Financial Statements (Unaudited)
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Note 1-Basis of Presentation
----------------------------
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB of Regulation
S-B. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the nine-month period ended August 31, 2003 are
not necessarily indicative of the results that may be expected for the year
ended November 30, 2003. For further information, refer to the consolidated
financial statements and footnotes thereto included in our Annual Report on Form
10-KSB for the year ended November 30, 2002.
Note 2-Principal Financing Arrangements
---------------------------------------
On August 31, 2003, our financing arrangements consisted of a mortgage loan of
$1.1 million due in December 2005, with monthly payments of interest only at the
rate of 11% per annum, and no prepayment penalty, $200,000 in bridge financing,
including $100,000 to a related party, and a $150,000 working capital loan to
our wholly-owned subsidiary, Telecarrier Services, Inc. ("Telecarrier"), which
filed for relief under Chapter 11 of the United States Bankruptcy Code. See Note
6. In conjunction with the sale of our New Rochelle headquarters building on
October 8, 2003, the above referenced mortgage loan and bridge financing was
paid in full. See Note 11.
Note 3-Major Customer
---------------------
During the three and nine months ended August 31, 2003 and 2002, no one customer
accounted for more than 10% of revenue.
Note 4-Income Taxes
-------------------
At November 30, 2002, we 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. We expect that we will be
subject to certain alternative minimum taxes for the year ended November 30,
2003, and have recorded a provision of $34,000 based on the expected tax rate
for the year.
Note 5- Earnings (Loss) Per Common Share
----------------------------------------
Basic earnings (loss) per common share is calculated by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted earnings (loss) per share is calculated by dividing net income
(loss) by the sum of the weighted average number of common shares outstanding
plus all additional common shares that would have been outstanding if
potentially dilutive securities had been issued unless such inclusion reduced
the loss per share. A reconciliation of the shares used in the computation of
our basic and diluted earnings (loss) per common share for the nine and three
months ended August 31, 2003 and 2002 is as follows:
5
Nine Months Ended
August 31,
2003 2002
--------- ----------
Weighted average common shares outstanding 15,633,829 15,606,818
Dilutive effect of securities 30,402 --
---------- ----------
15,664,231 15,606,818
========== ==========
Three Months Ended
August 31,
2003 2002
---------- ----------
Weighted average common shares outstanding 15,684,369 15,608,282
Dilutive effect of securities 49,183 --
---------- ----------
15,733,552 15,608,282
========== ==========
For the nine and three months ended August 31, 2003 and 2002, the computation of
diluted earnings (loss) per share excludes the effect of the assumed exercise of
approximately 1,750,000 and 3,000,000 stock options, warrants and convertible
preferred stock that were outstanding because the effect would be anti-dilutive.
Note 6-Petition for Relief Under Chapter 11
-------------------------------------------
On July 29, 2002 (the "Petition Date"), our wholly-owned subsidiary,
Telecarrier, which has 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 United 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 Telecarrier in
existence prior to the Petition Date are stayed while Telecarrier 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 equipment leases, and from the
determination by the court (or agreed to by parties in interest) of allowed
claims for contingencies and other disputed amounts.
As of August 31, 2003, Telecarrier had total assets of approximately $591,000
and total liabilities of approximately $1,333,000, of which approximately
$871,000 represented pre-petition liabilities and approximately $462,000
represented post-petition liabilities. Pre-petition liabilities subject to
compromise are reflected below:
Line of credit $150,000
Trade payables 618,000
Other accrued expenses 103,000
6
Note 7-Legal Proceedings
------------------------
On August 31, 2003, our former wholly-owned subsidiary, Essex Communications
Inc. ("Essex") (See Note 11 regarding the sale of Essex on September 11, 2003),
was a party to several legal actions over amounts owed to creditors. While legal
counsel was unable to predict the outcome of these actions, we believed such
actions would not result in a liability that would have a material adverse
effect on our consolidated financial condition. These legal actions were seeking
aggregate damages of approximately $1,600,000 from Essex. Essex had
counterclaims for the actions and it had accrued payables of approximately
$250,000, which the management of Essex believed was an amount sufficient to
settle such claims. See Note 9 below regarding the sale of assets by Essex on
December 31, 2002 and see Note 11 regarding the sale of all of the common shares
of our Essex subsidiary on September 11, 2003.
Note 8-Risks and Uncertainties
------------------------------
We buy substantially all of our telecommunication services from Regional Bell
Operating Companies ("RBOCs"), and are, therefore, highly dependent upon them.
We believe our relationship with the RBOCs from which we purchase services is
satisfactory. We also believe there are less desirable suppliers of
telecommunication services in the geographical locations in which we conduct
business. In addition, we are at risk to price increases in the rates RBOCs
charge us, which are determined by individual state public service commissions.
In light of the foregoing, it is possible that the loss of one or more of our
relationships with the RBOCs or a significant unfavorable change in the state
pricing regulations would have a severe near-term impact on our ability to
conduct our telecommunications business.
Future results of operations involve a number of risks and uncertainties.
Factors that could affect future operating results and cash flows and cause
actual results to vary materially from historical results, include, but are not
limited to:
- Our business strategy with respect to bundled local and long distance
services may not succeed.
- Failure to manage, or difficulties in managing, our growth, operations or
restructurings, including attracting and retaining qualified personnel and
opening up new territories for its service with favorable gross margins.
- Dependence on the availability 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 or long distance service.
- Failure or interruption in our network or information systems.
- Changes in government policy, regulation or enforcement.
- Failure of our collection management system and credit controls efforts for
customers.
- Inability to adapt to technological change.
7
- Competition in the telecommunications industry.
- Inability to manage customer attrition or bad debt expense.
- Adverse change in our relationship with third party carriers.
- Failure or bankruptcy of other telecommunications companies upon which we
rely for services and revenues.
- Our operations are currently using cash, and our cash position is
deteriorating. We may run out of cash and be unable to conduct business.
Note 9-Asset Sale
-----------------
On September 3, 2002, we entered into an agreement with Essex Acquisition Corp.
("EAC"), a wholly-owned subsidiary of BiznessOnline.com, Inc. ("Biz"), to sell
substantially all the assets of Essex (amounting to $1,273,945 at December 31,
2002), for five dollars plus the assumption of certain liabilities of Essex
amounting to $10,552,512 at December 31, 2002, including all obligations due and
payable to Essex's largest vendor, Verizon Services Corp. ("Verizon"). EAC also
paid us $270,000 to reimburse us for amounts paid by us to Essex's former
lender, Textron Financial Corporation.
The agreement with Verizon provides that Essex will remain liable for
substantially all the obligations assumed in the sale until such time as they
are paid by EAC. The last publicly available unaudited financial statements of
Biz as of June 30, 2002 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 for the calendar
year 2001 expressed significant doubt about Biz's ability to continue as a going
concern. These factors indicate there is significant uncertainty as to the
ability of Biz and its subsidiaries to repay the obligations described above.
Accordingly, we only recorded gains on the sale to EAC when Verizon reported to
us that EAC made payments to them to reduce the Essex obligations that were
assumed by EAC. In the nine months ended August 31, 2003, EAC made payments to
Verizon and other of Essex's creditors of $4,785,000, which reduced the
liabilities of Essex and resulted in gains to us of approximately $3,511,000.
Assets and liabilities transferred to EAC, as adjusted, consisted of the
following at December 31, 2002:
Assets:
Cash $44,024
Accounts receivable, net 1,070,013
Property and equipment, net 35,851
Security deposits 124,057
------------
$1,273,945
============
Liabilities:
Accounts payable and accrued expenses $9,671,563
Taxes payable 782,572
Capital lease obligations 98,377
-----------
$10,552,512
============
8
For the nine months ended August 31, 2003, we recorded a gain on the transaction
of approximately $3,511,000. This gain was calculated by taking all liabilities
assumed by EAC that were paid by EAC during the nine months ended August 31,
2003, and subtracting the book value of the assets transferred.
Assumed liabilities paid by EAC $4,785,242
Assets transferred to EAC 1,273,945
------------
Gain $3,511,297
============
For the three months ended August 31, 2003, we recorded a gain on the
transaction of approximately $1,254,000. This gain was calculated by taking all
liabilities assumed by EAC that were paid by EAC during the three months ended
August 31, 2003. We sold all of the capital stock of Essex on September 11,
2003. As a result, during the fourth quarter, we expect to record the remaining
balance of the gain on this transaction, amounting to approximately $5,800,000,
as the liabilities of our former Essex subsidiary are no longer includable in
our consolidated financial statements. See Note 11.
The following unaudited pro forma summary presents consolidated financial
information of our operations for the nine and three-month periods ended August
31, 2003 and 2002, as if the sale of Essex's assets and stock (Note 11) 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 at the
beginning of the periods presented, nor is it necessarily indicative of the
future results at the beginning of of operations of the remaining company:
Unaudited
Nine months ended Aug. 31,
----------------------------
2003 2002
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Revenues $ 2,883,138 $ 204,031
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Net loss ($1,757,858) ($2,598,656)
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Basic and diluted loss per share ($ 0.11) ($ 0.17)
----------- ------------
Unaudited
Three months ended Aug. 31,
----------------------------
2003 2002
------------ ------------
Revenues $ 1,275,889 $ 62,621
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Net loss ($ 535,638) ($ 302,258)
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Basic and diluted loss per share ($ 0.03) ($ 0.02)
------------ ------------
9
Note 10-Reclassifications
-------------------------
Certain amounts in the August 31, 2002 Condensed Consolidated Statements of
Operations and Comprehensive Income (Loss), have been reclassified to conform to
the August 31, 2003 presentation.
Note 11- Subsequent Events
--------------------------
On September 11, 2003, we sold all the outstanding capital stock of Essex to
Glad Holdings LLC, a New Jersey limited liability company, for an aggregate
purchase price of $100. As a result of the sale during the fourth quarter,
approximately $7,000,000 of net liabilities of our former Essex subsidiary are
no longer included in our consolidated financial statements, and accordingly, we
expect to record such amount as gain in the fourth quarter of the current fiscal
year.
On October 8, 2003, we closed on the sale of our corporate headquarters at 543
Main Street, New Rochelle, New York to Bluegill Realty, LLC. In conjunction with
the sale of the building, we received proceeds of $2.2 million and used $1.1
million of such proceeds to retire in full the mortgage note on this property.
We expect to record a gain on the sale of approximately $500,000 in the fourth
quarter of the current fiscal year.
Note 12- Stock-Based Compensation Plans
---------------------------------------
We issue stock options to our employees and outside directors pursuant to
stockholder-approved stock option programs. We account for our stock-based
compensation plans under the intrinsic value method of accounting as defined by
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. No stock-based employee compensation
cost is reflected in net income (loss) for the three months and nine months
ended August 31, 2003 and 2002, as all options granted under these plans had an
exercise price equal to the fair market value of the underlying common stock on
the date of the grant. For pro forma disclosures, the estimated fair value of
the options are amortized over the vesting period, which range from immediate
vesting to three years. The following table illustrates the effect on net income
(loss) per share if we had accounted for our stock option and stock purchase
plans under the fair value method of accounting under Statement 123, as amended
by Statement 148:
For the Three Months Ended For the Nine Months Ended
Aug. 31, 2003 Aug. 31, 2002 Aug. 31, 2003 Aug. 31, 2002
------------- ------------- -------------- -------------
Net income (loss), as reported $ 694,441 ($ 391,095) $ 1,449,095 ($ 2,479,584)
Deduct: Total stock-based employee
compensation expense determined
under fair value-based method
for all awards, net of related
tax effects (79,929) (90,978) (235,153) (272,935)
---------- ---------- ----------- ------------
Pro forma net income (loss) $ 614,512 ($ 482,073) $ 1,213,942 ($ 2,752,519)
Earnings (loss) per share ---------- ---------- ----------- ------------
Basic, as reported $ .04 ($ .03) $ .09 ($ .16)
Basic, pro forma $ .04 ($ .03) $ .08 ($ .18)
Diluted, as reported $ .04 ($ .03) $ .09 ($ .16)
Diluted, pro forma $ .04 ($ .03) $ .08 ($ .18)
10
Item 2. Management's Analysis and Discussion of Financial Condition and Results
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of Operations
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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 our services to current and new customers and generate
customer demand for our product and services in the geographical areas in which
we operate; (6) our success in gaining regulatory approval to access new
markets; (7) our ability to negotiate and maintain suitable interconnection
agreements with the incumbent carriers; (8) the availability and maintenance of
suitable vendor relationships, in a timely manner, at reasonable cost; (9) the
intensity of competition; and (10) general economic conditions. All written and
oral forward looking statements made in connection with this Report that are
attributable to us or persons acting on our behalf are expressly qualified in
their entirety by these cautionary statements. Given the uncertainties that
surround such statements, prospective investors are cautioned not to place undue
reliance on such forward-looking statements.
Overview
eLEC Communications Corp. is a full-service telecommunications company that
focuses on developing integrated telephone service in the 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 utilize 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 use
universal client technology that enables our employees and agents to access our
system from any PC using any Internet browser.
11
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 back office systems to support our
customers, and we lease network 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 more 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. 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
12
rapidly provision accounts and to deliver reliable service at a lower price than
offered by the ILECs should provide us with certain competitive advantages 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 restrictions on certain individual network elements that would destroy
the competitive value of the UNE-P structure. 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 former subsidiary,
Essex, began as a reseller with approximately 10% gross margins. This former
subsidiary was unable to operate profitably and we sold the Essex customer base
and related assets on December 31, 2002 and subsequently all of the Common Stock
of Essex on September 11, 2003. Another CLEC subsidiary that we own,
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 and Pennsylvania, and is
currently achieving gross margins over 45%. As a start-up CLEC, NRTC is not yet
profitable.
We project that with continued selling of approximately 500 lines a month, we
can reach a breakeven level at 12,000 lines. As of August 31, 2003, NRTC and
Telecarrier had a combined total of 10,790 lines. However we intend to
accelerate our rate of line growth in the short-term so that we can benefit from
increased revenue before the end of the year. The increased selling expenses
that we intend to incur to achieve this accelerated growth will exceed the
associated revenue generated in the fourth quarter. As a result, we anticipate
we will incur an operating loss in the fourth quarter, even though we plan to
end the fourth quarter with more than 12,000 lines. We believe an accelerated
level of growth in the fourth quarter will improve our operating results in
future quarters.
Nine Months Ended August 31, 2003 vs. Nine Months Ended August 31, 2002
-----------------------------------------------------------------------
Our net revenues for the nine months ended August 31, 2003 decreased by
approximately $8,029,000, or approximately 68%, to approximately $3,776,000 as
compared to approximately $11,805,000 reported for the nine months ended August
31, 2002. The decrease in sales was directly attributable to the sale of Essex's
customer base on December 31, 2002, as discussed above. For the nine months
ended August 31, 2003, Essex's sales were approximately $893,000, which
represented the sales of this former subsidiary for the period December 1, 2002
to December 31, 2002, the date on which certain of its assets were sold to EAC
(See Note 9). After the sale of the customer base on December 31, 2002, Essex
did not have any additional sales. Sales of $893,000 represent a decrease in
Essex's sales for the nine months ended August 31, 2003 of approximately
$10,708,000, or 92%, as compared to approximately $11,601,000 reported for the
nine months ended August 31, 2002. The decrease in Essex's sales was offset, in
part, by aggregate sales of approximately $2,752,000 reported by NRTC and
Telecarrier, each of which had no comparable sales for the nine months ended
13
August 31, 2002. We anticipate sales for NRTC and Telecarrier to continue to
increase in the fourth quarter of fiscal 2003, as noted above.
Our gross profit for the nine months ended August 31, 2003 decreased by
approximately $2,225,000 to approximately $1,790,000 from approximately
$4,015,000 reported for the nine months ended August 31, 2002, and the gross
profit percentage increased to 47.4% from 34.0% reported in the prior fiscal
period. The decrease in gross profit is directly related to the sale of the
Essex customer base as discussed above. The increase in gross profit percentage
reflects our sales strategy to sell in only those states in which we believe we
will be able to achieve a margin of at least 40%. In the first nine months of
fiscal 2003, NRTC and Telecarrier sold telephone service in New York, New Jersey
and Pennsylvania. We are currently negotiating for an interconnection agreement
to provide NRTC's service offerings to business and residential consumers in
Michigan.
Selling, general and administrative expenses ("SG&A") decreased by approximately
$3,446,000, or approximately 47%, to approximately $3,841,000 for the nine
months ended August 31, 2003 from approximately $7,287,000 reported in the prior
fiscal period. This decrease in expense was directly related to the curtailment
of our Essex operations and our on going efforts to implement various
cost-cutting measures, which included, among other things, a reduction in
staffing. SG&A expenses incurred by Essex represented approximately $650,000 of
the $3,841,000 in SG&A costs for the period ended August 31, 2003. Currently,
our SG&A costs, exclusive of Essex, have averaged approximately $350,000 per
month for the first nine months of fiscal 2003, approximately $80,000 of which
represented new line acquisition expenses. In the third quarter of fiscal 2003,
we curtailed our in-house billing and telemarketing efforts, and reduced staff
and associated overhead costs, such as rent, salaries and telephone expense. We
have outsourced our billing operation and believe this is a more effective way
to limit our costs as we only pay a fee based on the number of our customers
that are billed. We will focus on third-party telemarketing firms to generate
new sales, as we believe this is a more efficient means of generating new sales
as we only pay for lines that we accept. We continue to evaluate our operations
for efficiencies, and we are looking for ways to implement further SG&A
reductions in the remainder of fiscal 2003.
Depreciation and amortization expense decreased by approximately $100,000, to
approximately $81,000 for the nine months ended August 31, 2003 as compared to
approximately $181,000 for the nine months ended August 31, 2002. The decline in
depreciation expense was partially attributable to the sale of certain assets to
EAC on December 31, 2002.
Interest expense decreased by approximately $280,000, to approximately $106,000
for the nine months ended August 31, 2003 as compared to approximately $386,000
for the nine months ended August 31, 2002. The decrease in interest expense
resulted from the termination of our credit facility that was in place in the
prior period.
Interest and other income (loss) for the nine months ended August 31, 2003
increased by approximately $110,000 from amounts reported in the prior fiscal
period resulting primarily from commission and rental income.
Gain on the sale of assets for the nine months ended August 31, 2003 was
approximately $3,511,000 (See Note 9).
14
Gain on the sale of investment securities and other investments for the nine
months ended August 31, 2003 was approximately $122,000, which resulted from the
sale of Cordia Corporation ("Cordia") and Talk America Holdings Inc. ("Talk")
shares, as compared to $1,381,000 for the nine months ended August 31, 2002,
which resulted from the sale of Talk shares.
Three Months Ended August 31, 2003 vs. Three Months Ended August 31, 2002
-------------------------------------------------------------------------
Our net revenues for the three months ended August 31, 2003 decreased by
approximately $2,354,000, or approximately 65%, to approximately $1,276,000 as
compared to approximately $3,630,000 reported for the three months ended August
31, 2002. The decrease in sales was directly attributable to the sale of Essex's
customer base on December 31, 2002, as discussed above. For the three months
ended August 31, 2003, Essex had no sales as compared to approximately
$3,567,000 reported for the three months ended August 31, 2002. The decrease in
Essex's sales was offset, in part, by aggregate sales of approximately
$1,255,000 reported by NRTC and Telecarrier, each of which had no comparable
sales for the three months ended August 31, 2002. We anticipate sales for NRTC
and Telecarrier to continue to increase in the fourth quarter of fiscal 2003, as
we work to add new customers. See the discussion on liquidity below.
Our gross profit for the three months ended August 31, 2003 decreased by
approximately $698,000 to approximately $626,000 from approximately $1,324,000
reported in the three months ended August 31, 2002, and the gross profit
percentage increased to 49.1% from 36.5% reported in the prior fiscal period.
The decrease in gross profit is directly related to the sale of Essex's customer
base as discussed above. The increase in gross profit percentage reflects our
sales strategy to sell in only those states in which we believe we will be able
to achieve a margin of at least 40%, as discussed above.
Selling, general and administrative expenses ("SG&A") decreased by approximately
$1,188,000, or approximately 52%, to approximately $1,103,000 for the three
months ended August 31, 2003 from approximately $2,291,000 reported in prior
fiscal period. As discussed above, this decrease in expense was directly related
to the curtailment of our Essex operations and our on-going efforts to implement
various cost-cutting measures, which included, among other things, a reduction
in staffing.
Depreciation and amortization expense decreased by approximately $27,000, to
approximately $17,000 for the three months ended August 31, 2003 as compared to
approximately $44,000 for the three months ended August 31, 2002. The decline in
depreciation expense was partially attributable to the sale of certain assets to
EAC on December 31, 2002.
Interest expense decreased by approximately $51,000 to approximately $36,000 for
the three months ended August 31, 2003 as compared to approximately $87,000 for
the three months ended August 31, 2002. The decrease in interest expense
resulted from the termination of our credit facility that was in place in the
prior period.
Interest and other income (loss) for the three months ended August 31, 2003
decreased by approximately $44,000 from amounts reported in the prior fiscal
period, primarily due to the write down of certain fixed assets associated with
the curtailment of our telemarketing and billing efforts, as discussed above.
15
Gain on the sale of assets for the three months ended August 31, 2003 was
approximately $1,254,000 (See Note 9).
Gain on the sale of investment securities and other investments for the
three-month periods ended August 31, 2003 and 2002 of approximately $38,000 and
$697,000, respectively, resulted from the sale of Talk shares.
Liquidity and Capital Resources
-------------------------------
At August 31, 2003, we had cash and cash equivalents of approximately $404,000,
including approximately $226,000 in Telecarrier, and negative working capital of
approximately $8,831,000. Approximately $7,000,000 of the working capital
deficit represents liabilities relating to our former Essex subsidary. With the
sale of this subsidiary on September 11, 2003, these liabilities are no longer
recorded on our books in the fourth quarter.
Net cash (used in) provided by operating activities aggregated approximately
($1,099,000) and $2,942,000 in the nine-month periods ended August 31, 2003 and
2002, respectively. The principal source of cash in fiscal 2003 was the net
profit for the period of approximately $1,483,000, which was offset by a
non-cash item, the net effect of the gain on the transfer of assets to EAC of
approximately $3,511,000 and an increase in accounts payable of approximately
$680,000. The principal use of cash in fiscal 2002 was the loss for the period
of approximately $2,480,000, which was offset by the increase in accounts
payable, principally through the delaying of payments to vendors, and the
reduction in accounts receivable of approximately $4,978,000 and $482,000,
respectively.
Net cash provided by investing activities aggregated approximately $420,000 and
$1,429,000 in the nine-month periods ended August 31, 2003 and 2002,
respectively. The principal sources of cash in fiscal 2003 were the proceeds
from the sale of investment securities and other investments of approximately
$198,000 and the proceeds from a note of approximately $209,000. In fiscal 2002,
the principal source of cash was the proceeds from the sale of investment
securities and other investments of approximately $1,381,000.
Net cash provided by (used in) financing activities aggregated approximately
$145,000 and ($4,157,000) in the nine-month periods ended August 31, 2003 and
2002, respectively. In fiscal 2003, net cash provided by financing activities
resulted from proceeds from short-term notes of $200,000 offset by the repayment
of long-term debt of approximately $55,000. In fiscal 2002, net cash used in
financing activities resulted from the repayment of short and long-term debt of
approximately $4,202,000, which was partially offset by the proceeds from the
exercise of stock options of approximately $45,000.
For the nine-month period ended August 31, 2003, we had no significant capital
expenditures. We do not expect to make any significant capital expenditures over
the next twelve months.
At August 31, 2003, we owned 83,180 shares of Cordia (OTCBB:CORG). We have the
right to purchase approximately 95,000 shares of Talk if we exercise a warrant.
The warrant exercise price is $6.30 per share and, at August 31, 2003, was
in-the-money, as Talk common stock was trading at approximately $12.86 per share
at such date.
16
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 former wholly-owned subsidiary, Essex, in December 2002 and
the subsequent sale of all the Common Stock of Essex on September 11, 2003, has
helped strengthen our financial condition. The sale of our corporate
headquarters building has further improved our financial position and has left
us with approximately $1,000,000 in cash to pay past due payables and to spend
on marketing efforts to obtain new customers. We believe the use of the
remaining cash from the sale of our building for marketing expenses and the
payment of certain past due payables will leave us with sufficient financial
resources to reach profitability and continue our business operations. The
inability to carry out this plan may result in the continuance of unprofitable
operations, and the eventual inability to pay our operating expenses, which
would adversely affect our ability to continue operating as a going concern.
Item 3. 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
that evaluation, our Chief Executive Officer and principal accounting
officer concluded that our disclosure controls and procedures are effective
in timely alerting 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.
17
PART II-OTHER INFORMATION
-------------------------
Item 1. Legal Proceedings
-------------------------
See Note 7-Legal Proceedings
Item 2. Changes in Securities
-----------------------------
In August 2003, we issued an aggregate of 450,000 shares of our common
stock in conjunction with certain financing agreements as a fee to
consultants and as interest expense. Such shares were issued in reliance
upon the exemption from registration provided by Section 4(2) of the
Securities Act of 1933, as amended, on the basis that such issuances did
not involve a public offering, no underwriter fees or commissions were paid
in connection with such issuances and the recipiants were `accredited
investors' as defined in Regulation D under the Securities Act of 1933, as
amended.
Item 6. Exhibits and Reports on Form 8-K
----------------------------------------
(a) Exhibits.
31.1 Certification of Principal Executive Officer and Principal
Financial Officer Pursuant to 18 U.S.C. 1350 (Section 302 of
the Sarbanes-Oxley Act of 2002)
32.1 Certification of Principal Executive Officer and Principal
Financial Officer Pursuant to 18 U.S.C. 1350 (Section 906 of
the Sarbanes-Oxley Act of 2002)
(b) Reports on Form 8-K
None
18
Signatures
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
eLEC Communications Corp.
October 14, 2003 By: /s/ Paul H. Riss
-------------------- ------------------------------------
Date Paul H. Riss
Chief Executive Officer
(Principal Financial and
Accounting Officer)
19
CERTIFICATION
-------------
Pursuant to 18 U.S.C. 1350
(Section 302 of the Sarbanes-Oxley Act of 2002)
I, Paul H. Riss, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of eLEC Communications
Corp.;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. I am responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for
the registrant and I have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under my
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. I have disclosed, based on my most recent evaluation of internal control
over financial reporting, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent functions):
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: October 14, 2003
/s/ Paul H. Riss
--------------------------------
Paul H. Riss
Chief Executive Officer and
Principal Financial and
Accounting Officer
20