As filed with the Securities and Exchange Commission on June 8, 2005
Registration No. 333-123696
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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AMENDMENT NO. 2
TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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eLEC COMMUNICATIONS CORP.
(Name of Small Business Issuer in Its Charter)
New York 4813 13-2511270
(State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization) Classification Code Number) Identification No.)
75 South Broadway, Suite 302
White Plains, New York 10601
(914) 682-0214
(Address and Telephone Number of Principal Executive Offices)
75 South Broadway, Suite 302
White Plains, New York 10601
(Address of Principal Place of Business or Intended Principal Place of Business)
Paul H. Riss, Chief Executive Officer
eLEC Communications Corp.
75 South Broadway, Suite 302
White Plains, New York 10601
(914) 682-0214
(Name, address and telephone number of agent for service)
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Copies to:
Eric M. Hellige, Esq.
Pryor Cashman Sherman & Flynn LLP
410 Park Avenue
New York, New York 10022-4441
Telephone: (212) 421-4100
Facsimile: (212) 326-0806
Approximate Date of Commencement of Proposed Sale to the Public: From time
to time after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. |X|
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. ____________________
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. ____________________
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. ____________________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. |_|
--------------------------
The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant shall
file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
Subject to Completion, Dated June __, 2005
PROSPECTUS
4,969,046 Shares
ELEC COMMUNICATIONS CORP.
Common Stock
This prospectus relates to the resale of up to 4,969,046 shares of common
stock, of which 4,365,078 shares are issuable upon the conversion of promissory
notes of eLEC Communications Corp. and the payment of the principal amount of,
and interest on, these notes to, or the exercise of outstanding warrants by,
Laurus Master Fund, Ltd., ("Laurus") and 603,918 shares of common stock are
issuable upon the exercise of warrants of eLEC Communications Corp. by certain
selling shareholders identified in this prospectus. All of the shares, when
sold, will be sold by these selling shareholders, including Laurus. The selling
shareholders may sell their common stock from time to time at prevailing market
prices. We will not receive any proceeds from the sale of the shares of common
stock by the selling shareholders.
Our common stock is traded in the over-the-counter market and prices are
reported on the OTC Bulletin Board under the symbol "ELEC."
See "Risk Factors" beginning on page 4 for risks of an investment in the
securities offered by this prospectus, which you should consider before your
purchase any shares.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of the securities or passed upon the
accuracy or adequacy of this prospectus. Any representation to the contrary is a
criminal offense.
The date of this prospectus is __________, 2005
We have not registered the sale of the shares under the securities laws of
any state. Brokers or dealers effecting transactions in the shares of common
stock offered hereby should confirm that the shares have been registered under
the securities laws of the state or states in which sales of the shares occur as
of the time of such sales, or that there is an available exemption from the
registration requirements of the securities laws of such states.
This prospectus is not an offer to sell any securities other than the
shares of common stock offered hereby. This prospectus is not an offer to sell
securities in any circumstances in which such an offer is unlawful.
We have not authorized anyone, including any salesperson or broker, to
give oral or written information about this offering, eLEC Communications Corp.,
or the shares of common stock offered hereby that is different from the
information included in this prospectus. You should not assume that the
information in this prospectus, or any supplement to this prospectus, is
accurate at any date other than the date indicated on the cover page of this
prospectus or any supplement to it.
TABLE OF CONTENTS
Page
Prospectus Summary.......................................................... 1
Risk Factors................................................................ 4
Special Note Regarding Forward-Looking Statements........................... 15
Use of Proceeds............................................................. 15
Market for Common Equity and Related Stockholder Matters.................... 15
Management's Discussion and Analysis or Plan of Operation................... 17
Business.................................................................... 22
Management.................................................................. 29
Principal Stockholders...................................................... 33
Certain Relationships and Related Transactions.............................. 34
Description of Securities................................................... 35
Selling Shareholders........................................................ 37
Plan of Distribution........................................................ 39
Legal Matters............................................................... 40
Experts..................................................................... 40
Where You Can Find Additional Information................................... 40
Index to Financial Statements............................................... 42
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this Prospectus
and may not contain all of the information that you should consider before
investing in the shares. You are urged to read this Prospectus in its entirety,
including the information under "Risk Factors" and our consolidated financial
statements and related notes included elsewhere in this Prospectus.
Our Company
eLEC Communications Corp. is a telecommunications service holding company
with operations in three wholly-owned subsidiaries that focus on delivering
integrated telephone service by leasing landlines as a competitive local
exchange carrier ("CLEC") and by utilizing high-speed Internet connections to
provide Voice over Internet Protocol ("VoIP") services. We offer small
businesses and residential consumers an integrated set of telecommunications
products and services, including local exchange, local access, domestic and
international long distance telephone, VoIP and a full suite of features and
calling plans.
Almost all of the local telephone calls made by our customers in fiscal
2004 and the first quarter of fiscal 2005 were routed over a circuit-switched
network that we lease from Verizon Services Corp. ("Verizon"). Although we plan
to increase the number of local access lines that we route over the Verizon
network during fiscal 2005, we also plan to use other networks by offering local
exchange services on the Qwest Corporation ("Qwest") network in some of the 14
states in which Qwest is the incumbent local exchange carrier ("ILEC") and by
offering VoIP services on an Internet network over which our customers will make
telephone calls through a high-speed Internet connection. When we route a
telephone call by our customers over an Internet network, a carrier other than
Verizon or Qwest will terminate the call for us into the public switched
telephone network ("PSTN"). We also are able to terminate some calls ourselves
that are made by our customers, in which cases we do not incur any marginal
costs for such calls.
We sell virtually all of the additional voice services provided by the
ILECs, such as three-way calling, call waiting, call forwarding and caller ID.
We sell our services at a fee that is at least 10% and as much as 25% less than
the published rate charged by the ILEC. We also offer a bundled package of local
and regional calling minutes with popular voice service features.
Prior to December 31, 2004, both of our CLEC subsidiaries leased lines
from Verizon, using the unbundled network elements platform ("UNE-P") service
offering. UNE-P allowed us to lease the network elements we needed, such as the
local line and the port on a local switch, so that we could provide local dial
tone service to our customers. Based upon the Order on Remand in WC Docket No.
04-313 and CC Docket No. 01-338, released on February 4, 2005 (the "TRO Remand
Order") by the Federal Communications Commission ("FCC"), one of our CLEC
subsidiaries, Telecarrier Services Inc. ("TSI"), can no longer sell new lines or
offer new services to its embedded customer base. TSI's embedded base of
customers will be subject to transitional rate increases established in the TRO
Remand Order. Thereafter, TSI will have until March 2006 to transfer existing
lines from UNE-P to another platform. TSI currently bills approximately 9,000
lines every month, and we plan to transfer those customers to our other CLEC.
We plan to rapidly grow our other CLEC, New Rochelle Telephone Corp.
("NRTC"), which will not be impacted by the regulatory rulings relating to
UNE-P. In February 2005, NRTC signed a wholesale advantage services agreement
with Verizon, effective on January 1, 2005, that provides NRTC with all the
features and functionalities of Verizon's UNE-P service offering, plus certain
additional services. While our costs under the wholesale advantage services
agreement are somewhat higher than
our costs were under UNE-P, the agreement locks in this cost structure for five
years and gives us a significant benefit by eliminating any regulatory
uncertainty about the future of our CLEC business. NRTC will no longer be
impacted by rulings of regulatory bodies relating to UNE-P that might
potentially change pricing or availability of network elements to NRTC. The
agreement allows us to plan for steady high-margin growth in a business that has
been our core business since 1999. At June 3, 2005, NRTC had approximately
21,000 local access lines that it billed under the wholesale advantage services
agreement. Pursuant to the agreement, NRTC is required to keep confidential all
additional terms and conditions of the agreement.
We also provide local and long distance telephone service on a VoIP
platform through our wholly-owned subsidiary, VoX Communications Corp. ("VoX"),
a facilities-based VoIP carrier. Unlike many other CLECs, during the past few
years we avoided buying any circuit-switched equipment and instead leased
circuit-switched lines from ILECs. We believe packet telephony services
represent a significant step in the advancement of telecommunications.
Consequently, we have focused our network building efforts on building packet
telephony technology and, unlike some other VoIP providers, we have written and
own the code to our own software. Ultimately, our goal is to have a wholly-owned
telecommunications network that generates revenues and high margins and does not
require us to lease facilities from an ILEC. By not being dependent upon an
ILEC, we will be able to offer features and services we develop that can be
turned on and off almost instantly without requiring an ILEC employee to
intervene. We will also lower our cost of services when we route a telephone
call over our packet-based network, as we will not be required to pay an ILEC
for line rentals or for call origination, transport and termination.
For the foreseeable future, we will continue to lease lines from the
ILECs, as we have wholesale agreements with Verizon and Qwest that allow us to
lease lines and provide Plain Old Telephone Service ("POTS"). We anticipate that
these agreements will allow us to continue to obtain an acceptable gross margin
on the POTS services we provide. We plan to attract VoIP-only customers on our
packet-switched network and to eventually offer VoIP services to our POTS
customers in NRTC and TSI. Although we believe many of our future customers will
want VoIP-only services, we are finding that several accounts want VoIP services
for the bulk of their telephony needs but still desire to maintain one or two
POTS lines. We plan to be able to satisfy the needs of our customers for both
VoIP and POTS services by maintaining our CLEC status and by continuously
advancing our VoIP product offerings.
Our principal executive offices are located at 75 South Broadway, New
York, Suite 302, White Plains, New York 10601, and our telephone number at that
address is (914) 682-0214. We also maintain a regional office in Celebration,
Florida. We maintain an Internet website at www.elec.net. Information on our
website is not part of this prospectus.
About This Offering
This prospectus relates to the resale of up to 4,969,046 shares of common
stock, of which 4,365,078 shares are issuable upon the conversion of promissory
notes and the payment of the principal amount of, and interest on, these notes
to, or the exercise of outstanding warrants by, Laurus Master Fund, Ltd., and
603,918 shares are issuable upon the exercise of outstanding warrants of eLEC
Communications Corp. by certain selling shareholders identified in this
prospectus. All of the shares, when sold, will be sold by these selling
shareholders, including Laurus. The selling shareholders may sell their common
stock from time to time at prevailing market prices. We will not receive any
proceeds from the sale of the shares of common stock by the selling
shareholders.
Common Stock Offered........................... 4,969,046 shares
Common Stock Outstanding at June 3, 2005(1).... 16,779,282 shares
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Use of Proceeds............................... We will not receive any of the
proceeds from the sale of the
shares by the selling
shareholders, except upon
exercise of certain common stock
purchase warrants.
OTC Bulletin Board Ticker Symbol............... ELEC
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(1) Does not include (i) 2,982,203 shares that are issuable upon the conversion
of outstanding convertible notes, (ii) 4,091,268 shares issuable upon the
exercise of outstanding warrants and non-qualified options, or (iii) 1,796,000
shares issuable upon the exercise of outstanding options granted under our 1995
Equity Incentive Plan.
Selected Financial Information
The selected financial information presented below is derived from and
should be read in conjunction with our consolidated financial statements,
including notes thereto, appearing elsewhere in this prospectus. See "Financial
Statements."
Summary Operating Information
Fiscal Year Ended Three Months Ended
November 30, February 28,
---------------------------- -----------------------------
2004 2003 2005 2004
---- ---- ---- ----
Net revenues ........................... $ 9,557,600 $ 5,568,004 $ 3,863,479 $ 1,873,992
Income (loss) from operations .......... $ (642,150) $ (2,948,352) $ (414,422) $ 53,413
Net income (loss) ...................... $ 170,253 $ 8,323,211 $ (401,685) $ 56,140
Net income (loss) per common share ..... $ .01 $ .53 $ (0.02) $ 0.00
Weighted average number of common shares
Outstanding
Basic ............................... 16,254,282 15,771,219 16,681,726 16,257,667
Diluted ............................. 16,715,808 15,841,941 16,681,726 16,568,565
Summary Balance Sheet Information
November 30, 2004 February 28, 2005
----------------- -----------------
(Unaudited)
Working capital deficit................. $ (1,939,147) $ (1,292,110)
Total assets............................ $ 1,903,802 $ 3,914,678
Total liabilities....................... $ 3,600,243 $ 5,186,477
Stockholders' deficiency................ $ (1,696,439) $ (1,271,799)
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RISK FACTORS
You should carefully consider the risks described below before buying
shares in this offering. The risks and uncertainties described below are not the
only risks we face. These risks are the ones we consider to be significant to
your decision whether to invest in our common stock at this time. We might be
wrong. There may be risks that you in particular view differently than we do,
and there are other risks and uncertainties that are not presently known to us
or that we currently deem immaterial, but that may in fact impair our business
operations. If any of the following risks actually occur, our business, results
of operations and financial condition could be seriously harmed, the trading
price of our common stock could decline and you may lose all or part of your
investment.
Risks Relating to Our Business
We have incurred losses since inception of our telephone business and we may be
unable to achieve profitability or generate positive cash flow.
We have not generated operating profits since fiscal 1996. While we
reported net income of $170,253 and $8,323,211 in fiscal 2004 and 2003,
respectively, we reported no income from our telecommunications operations.
Furthermore, in the first quarter of fiscal 2005, we reported a net loss of
$401,685. In fiscal 2004, net income of $170,253 resulted primarily from the
gain of approximately $743,000 resulting from a settlement with creditors in the
bankruptcy proceedings of a subsidiary. In fiscal 2003, net income of $8,323,211
resulted primarily from the gain on the disposition of a subsidiary and the
disposition of property of approximately $11,306,000. In the first quarter of
fiscal 2005, and in fiscal 2004 and 2003, we generated operating losses of
approximately ($414,000), ($642,000) and ($2,948,000), respectively, from our
telecommunications operations. We expect to continue to incur operating losses
until we develop our telecommunications operations to a level at which it
generates sufficient revenues to cover operating expenses.
We have an unproven business model and can give no assurance that our business
model and strategy will be successful.
Our business strategy is unproven and we do not know whether our business
model and strategy will be successful. We intend to lease virtually all of our
telecommunications facilities (such as switches, local loops and other
telecommunications equipment) and to focus on selling directly to residential
consumers and small businesses. In contrast, many of our competitors own their
own facilities or are in the process of building or purchasing such facilities.
To be successful, we must convince prospective customers to entrust their
telephone service to a company without a long and proven track record. We cannot
assure you that our services will be widely accepted. The prices we charge for
services and products may be higher than those charged by our competitors. In
addition, the prices of communications services and products have fallen
historically, and they may continue to fall. We may be required to reduce prices
periodically to respond to competition and to generate adequate sales volume.
Furthermore, our cost of services increased in fiscal 2005 and we anticipate
such costs will continue to rise. The failure to achieve or sustain adequate
pricing levels or to achieve or sustain a profitable business would have a
material adverse effect on our business, financial condition and results of
operations and on the price of our common stock.
We have a need for additional financing.
Due to our recent operating losses and our additional requirements for
working capital to establish and grow our business, over the past several months
we have sold debt and additional shares of capital stock to fund our working
capital needs. We expect that we will continue to sell our capital stock,
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incur additional indebtedness or sell marketable securities we currently own to
fund the anticipated growth of our telecommunications business and implement our
business objectives. There can be no assurance that we will be able to obtain
additional funding when needed, or that such funding, if available, will be
available on terms we find acceptable. If we cannot obtain additional funds when
needed, we may be forced to curtail or cease our activities, which may result in
the loss of all or a substantial portion of your investment.
We depend on incumbent carriers as a key component for our business.
To limit our capital expenditures and support staff, we rely extensively
on third parties. We lease our local exchange network and our long distance
network. As a result, we depend entirely on incumbent carriers for the
transmission of customer telephone calls for our CLEC subsidiaries. The risk
factors inherent in this approach include, but are not limited to, the
following:
o the inability to negotiate and renew favorable wholesale agreements;
o lack of timeliness of the ILEC in processing our orders for
customers seeking to utilize our services;
o dependence on the effectiveness of internal and external
telemarketing services to attract new customers;
o dependence on third-party contractors to install necessary equipment
and wiring at our customers facilities; and
o dependence on a facilities-based carrier to provide our customers
with repair services and new installation services.
We depend on a third-party billing system to bill our customers.
The accurate and prompt billing of our customers is essential to our
operations and future profitability. We utilize a third-party system for
billing, tracking and customer service. The system is designed to provide us
with a high degree of flexibility to handle custom rate plans that provide
consumers discounts from the incumbent local carriers' rate plans or bundled
plans that include various features and long distance services. Although we
believe the system is very functional, it is currently set up to support
approximately 500,000 local lines in six states, and its ability to handle
substantially more customers is not fully tested. In addition, the billing
company we utilize competes with us as a CLEC and may terminate its billing
services at any time. Furthermore, in the most recent audited financial
statements of the billing company we utilize, the report of the independent
public accountants expressed doubt about its ability to continue as a going
concern. This strategy exposes us to various risks that include, but are not
limited to, the following:
o the inability to adapt the billing system to process the number of
customers we are targeting in our marketing plans;
o the failure of the system to provide all of the billing services
that we require;
o the possibility that we may want to provide services in a state that
our billing company has difficulty rating calls and processing data
for us; and
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o the possibility that we may need to quickly engage a new billing
company to process our invoices to our customers, and devote a large
amount of internal resources at one time to work on this transition.
Our business is dependent upon our ability to resell long distance services, for
which we currently rely on only one third-party carrier.
We offer long distance telephone services as part of our service package.
We currently have a wholesale agreement with only one long distance carrier to
provide transmission and termination services for all of our long distance
traffic. Recently, several long distance carriers have encountered financial
difficulties, including the carrier utilized by us. Financial difficulties
encountered by our current carrier or any other carrier with which we are
negotiating could cause disruption to our operations and loss of customers and
revenues.
We could be liable for breaches of security on our web site, fraudulent
activities of our users, or the failure of third-party vendors to deliver credit
card transaction processing services.
A fundamental requirement for operating a customer-friendly CLEC and an
internet-based, worldwide voice service is the secure transmission of
confidential information over public networks. Although we have developed
systems and processes that are designed to protect consumer information and
prevent fraudulent credit card transactions and other security breaches, failure
to mitigate such fraud or breaches may adversely affect our operating results.
The law relating to the liability of providers of online payment services is
currently unsettled. We rely on third party providers to process and guarantee
payments made by our customers up to certain limits, and we may be unable to
prevent our users from fraudulently receiving goods and services. Any costs we
incur as a result of fraudulent transactions could harm our business. In
addition, the functionality of our current billing system relies on certain
third-party vendors delivering services. If these vendors are unable or
unwilling to provide services, we will not be able to charge for our services in
a timely or scalable fashion.
We may face difficulties managing our anticipated rapid expansion.
We are attempting to grow our business rapidly in terms of the number of
services we offer, the number of customers we serve and the regions we serve. In
particular, we are expending substantial sums to expand our POTS business and to
roll out our VoIP initiative. There can be no assurance that our marketing
initiatives will proceed as expected or that they will be successful,
particularly in light of the legal and regulatory and competitive uncertainties
described elsewhere in this report. Furthermore, there is no assurance that we
will successfully manage our efforts to:
o expand, train, manage and retain our employee base;
o expand and improve our customer service and support systems;
o introduce and market new VoIP products and services and new pricing
plans in addition to expanding the number of states in which we
offer POTS service;
o capitalize on new opportunities in the competitive marketplace; or
o control our expenses.
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The strains posed by these new demands are magnified by the emerging
nature of our operations. If we cannot manage our growth effectively, our
results of operations could be adversely affected.
The failure of our customers to pay their bills on a timely basis could
adversely affect our cash flow.
Our target customers consist of residences and small businesses. We
anticipate having to bill and collect numerous relatively small customer
accounts. We may experience difficulty in collecting amounts due on a timely
basis. We have experienced difficulty with residential accounts in the past. Our
failure to collect accounts receivable owed to us by our customers on a timely
basis could have a material adverse effect on our business, financial condition,
results of operations and cash flow.
Acquisitions could divert management's time and attention, dilute the voting
power of existing shareholders and have a material adverse effect on our
business.
As part of our growth strategy, we may continue to acquire complementary
businesses and assets. Acquisitions that we may make in the future could result
in the diversion of time and personnel from our business. We also may issue
shares of common stock or other securities in connection with acquisitions,
which could result in the dilution of the voting power of existing shareholders
and could dilute earnings per share. Any acquisitions would be accompanied by
other risks commonly encountered in such transactions, including the following:
o difficulties integrating the operations and personnel of acquired
companies;
o the additional financial resources required to fund the operations
of acquired companies;
o the potential disruption of our business;
o our ability to maximize our financial and strategic position by the
incorporation of acquired technology or businesses with our product
and service offerings;
o the difficulty of maintaining uniform standards, controls,
procedures and policies;
o the potential loss of key employees of acquired companies;
o the impairment of employee and customer relationships as a result of
changes in management; and
o significant expenditures to consummate acquisitions.
As a part of our acquisition strategy, we may engage in discussions with
various businesses respecting their potential acquisition. In connection with
these discussions, we and each potential acquired business may exchange
confidential operational and financial information, conduct due diligence
inquiries, and consider the structure, terms and conditions of the potential
acquisition. In certain cases, the prospective acquired business may agree not
to discuss a potential acquisition with any other party for a specific period of
time, may grant us certain rights in the event the acquisition is not completed,
and may agree to take other actions designed to enhance the possibility of the
acquisition. Potential acquisition discussions may take place over a long period
of time, may involve difficult business integration and other issues, and may
require solutions for numerous family relationship, management succession and
related matters. As a result of these and other factors, potential acquisitions
that from time to time appear
7
likely to occur may not result in binding legal agreements and may not be
consummated. Our acquisition agreements may contain purchase price adjustments,
rights of set-off and other remedies in the event that certain unforeseen
liabilities or issues arise in connection with an acquisition. These remedies,
however, may not be sufficient to compensate us in the event that any unforeseen
liabilities or other issues arise.
We need to retain key management personnel and hire additional qualified
personnel. We are dependent on the efforts of our executive officers and senior
management and on our ability to hire and retain qualified management personnel.
A small number of key management and operating employees and consultants
manage our telecommunications business. Our loss of such employees or
consultants or their failure to work effectively as a team could materially
adversely impact our telecommunications business. Competition for qualified
executives in the telecommunications and data communication industries is
intense and there are a limited number of persons with applicable experience. We
believe that our future success in the telecommunications business significantly
depends on our ability to attract and retain highly skilled and qualified
telecommunications personnel. We have not entered into employment agreements
with any of our senior officers. The loss of any of Paul H. Riss, our Chief
Executive Officer, Michael Khalilian, our Chief Technology Officer, or Mark
Richards, our Chief Information Officer and the President of our Vox
Communications subsidiary, could adversely affect our business.
We may be unable to adapt to rapid technology trends and evolving industry
standards.
The communications industry is subject to rapid and significant changes
due to technology innovation, evolving industry standards, and frequent new
service and product introductions. New services and products based on new
technologies or new industry standards expose us to risks of technical or
product obsolescence. We will need to use technologies effectively, continue to
develop our technical expertise and enhance our existing products and services
in a timely manner to compete successfully in this industry. We may not be
successful in using new technologies effectively, developing new products or
enhancing existing products and services in a timely manner or that any new
technologies or enhancements used by us or offered to our customers will achieve
market acceptance.
The telecommunications industry is highly regulated and amendments to or repeals
of existing regulations or the adoption of new regulations could adversely
affect our business, financial condition or results of operations.
Federal, state and local regulation may affect our telecommunications
business. Since regulation of the telecommunications industry in general, and
the CLEC industry in particular, is frequently changing, we cannot predict
whether, when and to what extent new regulations will affect us. The following
factors, among others, may adversely affect our business, financial condition
and results of operations:
o delays in obtaining required regulatory approvals;
o new court decisions;
o the enactment of new adverse regulations; and
o the establishment of strict regulatory requirements.
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The communications services industry is highly competitive and we may be unable
to compete effectively.
The communications industry, including Internet and data services, is
highly competitive, rapidly evolving and subject to constant technological
change and intense marketing by providers with similar products and services. We
expect that new competitors are likely to join existing competitors in the
communications industry, including the market for VoIP, Internet and data
services. Many of our current competitors are significantly larger and have
substantially greater market presence as well as greater financial, technical,
operational, marketing and other resources and experience than we do. In the
event that such a competitor expends significant sales and marketing resources
in one or several markets we may not be able to compete successfully in such
markets. We believe that competition will continue to increase, placing downward
pressure on prices. Such pressure could adversely affect our gross margins if we
are not able to reduce our costs commensurate with such price reductions. In
addition, the pace of technological change makes it impossible for us to predict
whether we will face new competitors using different technologies to provide the
same or similar services offered or proposed to be offered by us. If our
competitors were to provide better and more cost effective services than ours,
our business initiatives could be materially and adversely affected.
Industry consolidation could make it more difficult to compete.
Companies offering Internet, data and communications services are, in some
circumstances, consolidating. We may not be able to compete successfully with
businesses that have combined, or will combine, to produce companies with
substantially greater financial, sales and marketing resources, larger client
bases, extended networks and infra-structures and more established relationships
with vendors, distributors and partners than we have. With these heightened
competitive pressures, there is a risk that our financial performance could be
adversely impacted and the value of our common stock could decline.
Risks Relating to Our Proposed VoIP Business
Part of our long-term strategy in building a profitable telephone company
includes the marketing of our technology for VoIP-based telephony applications
through our wholly-owned subsidiary, VoX. VoIP is a new technology that involves
many unique risks, including those set forth below.
The VoIP telephony market is subject to rapid technological change and we depend
on new product introductions in order to grow our VoIP business.
VoIP telephony is an emerging market that is characterized by rapid
changes in customer requirements, frequent introductions of new and enhanced
products, and continuing and rapid technological advancement. To compete
successfully in this emerging market, we must continue to design, develop and
sell new and enhanced VoIP telephony software products and services that provide
increasingly higher levels of performance and reliability at lower cost. These
new and enhanced products must take advantage of technological advancements and
changes, and respond to new customer requirements. Our success in designing,
developing and selling such products and services will depend on a variety of
factors, including:
o the identification of market demand for new products;
o the scalability of our VoIP telephony software products;
o product and feature selection;
9
o timely implementation of product design and development;
o product performance;
o cost-effectiveness of products under development;
o effective manufacturing processes; and
o success of promotional efforts.
Additionally, we may also be required to collaborate with third parties to
develop our products and may not be able to do so on a timely and cost-effective
basis, if at all. We have in the past experienced delays in the development of
new products and the enhancement of existing products, and such delays will
likely occur in the future. If we are unable, due to resource constraints or
technological or other reasons, to develop and introduce new or enhanced
products in a timely manner, if such new or enhanced products do not achieve
sufficient market acceptance, or if such new product introductions decrease
demand for existing products, our operating results would decline and our
business would not grow.
Future legislation or regulation of the Internet and/or VoIP services could
restrict our business, prevent us from offering service or increase our cost of
doing business.
At present there are few laws, regulations or rulings that specifically
address access to or commerce on the Internet, including Internet Protocol
("IP") telephony. We are unable to predict the impact, if any, that future
legislation, legal decisions or regulations concerning the Internet may have on
our business, financial condition or results of operations. Regulation may be
targeted toward, among other things, assessing access or settlement charges,
imposing taxes related to internet communications, imposing tariffs or
regulations based on encryption concerns or the characteristics and quality of
products and services, imposing additional regulations and requirements related
to the handling of emergency 911 services, any of which could restrict our
business or increase our cost of doing business. The increasing growth of the
broadband IP telephony market and popularity of broadband IP telephony products
and services heighten the risk that governments or other legislative bodies will
seek to regulate broadband IP telephony and the Internet. In addition, large,
established telecommunication companies may devote substantial lobbying efforts
to influence the regulation of the broadband IP telephony market, which may be
contrary to our interests.
Many regulatory actions are underway or are being contemplated by federal
and state authorities, including the FCC and other state regulatory agencies.
The FCC recently issued regulations requiring VoIP carriers to provide 911
emergency services to their customers within approximately 90 days. There is
risk that a regulatory agency may require us to conform to rules that are
unsuitable for VoIP communications technologies or rules that cannot be complied
with due to the nature and efficiencies of IP routing, or are unnecessary or
unreasonable in light of the manner in which we offer service to our customers.
It is not possible to separate the Internet, or any service offered over it,
into intrastate and interstate components. While suitable alternatives may be
developed in the future, the current IP network does not enable us to identify
the geographic nature of the traffic traversing the Internet. There is also risk
that specific E911 requirements imposed by a regulatory agency may impede our
ability to offer service in a manner that conforms to these requirements. While
we are developing technologies that seek to provide access to emergency services
before the effective date set by the FCC, the existing requirements, which are
tethered to and dependent upon the legacy PSTN network, neither work in an IP
environment nor take advantage of the significantly enhanced capabilities of the
IP network.
10
The success of our planned expansion is dependent upon market developments and
usage patterns.
Our purchase of network equipment and placement of our VoIP software will
be based in part on our expectations concerning future revenue growth and market
developments. As we expand our network, we will be required to make capital
expenditures, in addition to making financial commitments for DS-3 circuits and
colocation space, and to add additional employees. If our traffic volume were to
decrease, or fail to increase to the extent expected or necessary to make
efficient use of our network, our costs as a percentage of revenues would
increase significantly, which would have a materially adverse effect on our
financial condition and results of operations.
Potential regulation of Internet service providers could adversely affect our
operations.
To date, the FCC has treated Internet service providers as information
service providers. Information service providers are currently exempt from
federal and state regulations governing common carriers, including the
obligation to pay access charges and contribute to the universal service fund.
The FCC is currently examining the status of Internet service providers and the
services they provide. If the FCC were to determine that Internet service
providers, or the services they provide, are subject to FCC regulation,
including the payment of access charges and contribution to the universal
service funds, it could have a material adverse effect on our business,
financial condition and operating results.
Our success depends on our ability to handle a large number of simultaneous
calls, which our network may not be able to accommodate.
We expect the volume of simultaneous calls to increase significantly as
our VoIP subscriber base grows. Our network hardware and software may not be
able to accommodate this additional volume. If we fail to maintain an
appropriate level of operating performance, or if our VoIP service is disrupted,
our reputation could be hurt and we could lose customers, which could have a
material adverse effect on our business, financial condition and results of
operations.
Our growth in our VoIP business is dependent upon our ability to build new
relationships with VoIP carriers and to bring on new customers.
Our ability to grow through quick and cost effective deployment of our
VoIP services is due, in part, to our ability to create new interconnection
agreements with VoIP carriers that can provide us with telephone numbers and
termination service to sign contracts with new customers, and, in many cases, to
enter into joint venture or strategic agreements with local partners, as well as
to satisfy newly enacted regulatory requirements to operate in emerging markets.
While we pursue several opportunities simultaneously, we might not be able to
create the necessary partnerships and interconnections, expand our customer
base, deploy networks and generate profitable traffic over these networks within
the time frame envisioned.
We are pursuing new business lines, which require specialized skill sets. Our
ability to effectuate our business plan is due, in part, to the roll out of new
services, including PC-to-IP Phone, IP Phone-to-IP Phone and IP
Phone-to-POTS-Phone.
Our ability to deploy new products and services may be hampered by
technical and operational issues which could delay our ability to derive
profitable revenue from these service offerings. These issues include our
ability to competitively price such products and services. In addition, certain
VoIP service offerings are relatively new in our industry and the market
potential is relatively untested. Additionally, our ability to market these
products and service offerings may prove more difficult. To
11
date, we have not significantly focused on selling VoIP services and thus have
derived extremely limited revenue from this offering, and there can be no
assurance that we will increase our current focus and/or derive significant
revenue from this offering.
We rely on third party equipment suppliers.
We are dependent on third party equipment suppliers for equipment, VoIP
phones and adapter devices, including UTStarcom Inc., Cisco Systems, Inc. and
Motorola, Inc. If these suppliers fail to continue product development and
research and development or fail to deliver quality products or support services
on a timely basis, or we are unable to develop alternative sources, if and as
required, it could result in a materially adverse impact on our financial
condition or results of operations.
Risks Relating to Our Common Stock
Disappointing quarterly revenue or operating results could cause the price of
our common stock to fall.
Our quarterly revenue and operating results are difficult to predict and
may fluctuate significantly from quarter to quarter. If our quarterly revenue or
operating results fall below the expectations of investors or security analysts,
the price of our common stock could fall substantially. Our quarterly revenue
and operating results may fluctuate as a result of a variety of factors, many of
which are outside our control, including:
o the amount and timing of expenditures relating to the rollout of our
POTS and VoIP service offerings;
o our ability to obtain, and the timing of, necessary regulatory
approvals;
o the rate at which we are able to attract customers within our target
markets and our ability to retain these customers at sufficient
aggregate revenue levels;
o our ability to deploy our network on a timely basis;
o the availability of financing to continue our expansion;
o technical difficulties or network downtime;
o the availability of incumbent carrier's wholesale service program
for the establishment of our own full-service platform and timing of
the implementation of our VoIP platform; and
o the introduction of new services or technologies by our competitors
and resulting pressures on the pricing of our service.
We do not intend to pay dividends on our common stock in the foreseeable future,
which could cause the market price of our common stock and the value of your
investment to decline.
We expect to retain earnings, if any, to finance the expansion and
development of our business. Our Board of Directors will decide whether to make
future cash dividend payments. Such decision will depend on, among other things,
the following factors:
12
o our earnings;
o our capital requirements;
o our operating condition;
o our financial condition; and
o our compliance with various financing covenants to which we are or
may become a party.
The market for our common stock is thinly traded, which could result in
fluctuations in the value of our common stock.
Although there is a public market for our common stock, the market for our
common stock is thinly traded. The trading prices of our common stock could be
subject to wide fluctuations in response to, among other events and factors, the
following:
o variations in our operating results;
o sales of a large number of shares by our existing shareholders;
o announcements by us or others;
o developments affecting us or our competitors; and
o extreme price and volume fluctuations in the stock market.
Our common stock price is likely to be highly volatile, which could cause the
value of your investment to decline.
The market price of our common stock is likely to be highly volatile as
the stock market in general, and the market for small cap and micro cap
technology companies in particular, has been highly volatile. For example,
during the last 12 months our common stock has traded at prices ranging from
$0.14 to $0.75 per share. Investors may not be able to resell their shares of
our common stock following periods of volatility because of the market's adverse
reaction to volatility. We cannot assure you that our common stock will trade at
the same levels of our stocks in our industry or that our industry stocks in
general will sustain their current market prices. Factors that could cause such
volatility may include, among other things:
o actual or anticipated fluctuations in our quarterly operating
results;
o large purchases or sales or our common stock;
o announcements of technological innovations;
o changes in financial estimates by securities analysts;
13
o investor perception of our business prospects;
o conditions or trends in the telecommunications industry;
o changes in the market valuations of other industry-related
companies;
o the acceptance of market makers and institutional investors of our
business model and our common stock; and
o worldwide economic or financial conditions.
Effect of certain charter provisions.
Authority of Board of Directors to Issue Preferred Stock. Pursuant to the
terms of our charter, our Board of Directors has the authority to issue up to
1,000,000 shares of preferred stock in one or more series. Our Board of
Directors may also determine the prices, rights, preferences, privileges and
restrictions, including voting rights, of the shares within each series without
any further shareholder vote or action. The rights of the holders of our
preferred stock may adversely affect the rights of the holders of common stock.
While the issuance of such preferred stock could facilitate possible
acquisitions and other corporate activities, it could also impede a third
party's ability to acquire control of our company.
Limitation of Liability of Directors. Pursuant to the terms of our charter
and to the extent New York law permits, we and our shareholders may not hold our
directors personally liable for monetary damages in the event of a breach of
fiduciary duty.
Provisions of New York law may discourage a takeover attempt even if doing so
may be beneficial to our shareholders.
Certain anti-takeover provisions of New York law could delay or hinder a
change of control of our company. While such provisions generally facilitate our
Board of Directors' ability to maximize shareholder value, they may discourage
takeovers that could be in the best interest of certain shareholders. Such
provisions could adversely affect the market value of our stock in the future.
We are exposed to potential risks from recent legislation requiring companies to
evaluate internal controls under Section 404 of the Sarbanes Oxley Act of 2002.
We are evaluating and documenting our internal controls systems so that
when we are required to do so, our management will be able to report on, and our
independent auditors to attest to, our internal controls, as required by this
legislation. We will be performing the system and process evaluation and testing
(and any necessary remediation) required in an effort to comply with the
management certification and auditor attestation requirements of Section 404 of
the Sarbanes Oxley Act. As a result, we expect to incur additional expenses and
diversion of management's time. In March 2005, we were advised by our
independent auditors that we have a material weakness in our internal controls
because of a deficiency in the number of qualified personnel in our accounting
department. While we anticipate being able to rectify this weakness and to fully
implement the requirements relating to internal controls and all other aspects
of Section 404 in a timely fashion, we cannot be certain as to the timing of
completion of our evaluation, testing and remediation actions or the impact of
the same on our operations. If we are not able to implement the requirements of
Section 404 in a timely manner or with adequate compliance, we might be subject
to sanctions or investigation by regulatory authorities, such as the Securities
and Exchange
14
Commission. Any such action could adversely affect our financial results and
could cause our stock price to decline.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business," and elsewhere in this prospectus constitute
forward-looking statements. These statements involve risks known to us,
significant uncertainties, and other factors which may cause our actual results,
levels of activity, performance, or achievements to be materially different from
any future results, levels of activity, performance, or achievements expressed
or implied by those forward-looking statements.
You can identify forward-looking statements by the use of the words "may,"
"will," "should," "could," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "intends," "potential," "proposed," or "continue" or
the negative of those terms. These statements are only predictions. In
evaluating these statements, you should specifically consider various factors,
including the risks outlined above. These factors may cause our actual results
to differ materially from any forward-looking statement.
Although we believe that the exceptions reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements.
USE OF PROCEEDS
We will not receive any proceeds from the sale of the shares of our common
stock by the selling shareholders.
We will receive proceeds of up to a maximum of $650,793 upon the due
exercise, if any, of the seven-year warrants granted by us exercisable for an
aggregate of 793,650 shares of common stock. We will receive proceeds up to a
maximum of $656,250 upon the due exercise, if any, of the five-year warrants
granted by us exercisable for an aggregate of 350,000 shares of common stock. We
will receive proceeds of up to a maximum of $160,000 upon the due exercise, if
any, of the four-year warrants granted by us exercisable for an aggregate of
253,968 shares of common stock. We intend to use any such proceeds for working
capital and general corporate purposes.
Further, to the extent that any of our obligations under our credit
facilities with Laurus are converted into, or paid in the form of, shares of our
common stock, we will be relieved of such obligations to the extent of such
conversion or payment.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market for Common Stock
Our common stock is traded on the OTC Bulletin Board under the symbol
"ELEC."
The following table contains information about the range of high and low
bid prices for our common stock for each full quarterly period in our last two
fiscal years and for the first three fiscal quarters of 2005 (through June 6),
based upon reports of transactions on the OTC Bulletin Board.
15
High Low
---- ---
Fiscal 2003
-----------
1st Quarter $ 0.08 $ 0.04
2nd Quarter 0.16 0.05
3rd Quarter 0.14 0.08
4th Quarter 0.21 0.08
Fiscal 2004
-----------
1st Quarter $ 0.25 $ 0.13
2nd Quarter 0.26 0.14
3rd Quarter 0.36 0.14
4th Quarter 0.40 0.21
Fiscal 2005
-----------
1st Quarter $ 0.74 $ 0.28
2nd Quarter $ 0.72 $ 0.35
3rd Quarter (through June 6) $ 0.60 $ 0.51
The source of these high and low prices was the OTC Bulletin Board. These
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commissions and may not represent actual transactions. The high and low prices
listed have been rounded up to the next highest two decimal places.
The market price of our common stock is subject to significant
fluctuations in response to variations in our quarterly operating results,
general trends in the market for the products we distribute, and other factors,
over many of which we have little or no control. In addition, board market
fluctuations, as well as general economic, business and political conditions,
may adversely affect the market for our common stock, regardless of our actual
or projected performance. On June 3, 2005, the closing bid price of our common
stock as reported by the OTC Bulletin Board was $0.55 per share.
Holders
As of June 3, 2005, there were approximately 225 holders of record of our
common stock and approximately 4,000 beneficial holders.
Dividend Policy
We have never paid dividends on our common stock and do not expected to do
so in the foreseeable future. Our loan agreement with Laurus Master Funds, Ltd.
("Laurus") does not allow us to directly or indirectly declare or pay any
dividends so long as our secured convertible term note to Laurus remains
outstanding.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
General
When used in this discussion, the words "believes", "anticipates",
"expects" and similar expressions are intended to identify forward-looking
statements. Such statements are subject to certain risks and uncertainties that
could cause actual results to differ materially from those projected.
Our business and results of operations are affected by a wide variety of
factors, including those we discuss under the caption "Risk Factors" and
elsewhere in this prospectus, that could materially and adversely affect us and
our actual results. As a result of these and other factors, we may experience
material fluctuations in future operating results on a quarterly or annual
basis, which could materially and adversely affect our business, financial
condition, operating results and stock price.
Any forward-looking statements herein speak only as of the date hereof. We
undertake no obligation to publicly release the results of any revisions to
these forward-looking statements that may be made to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
Business Outlook
Our financial condition was significantly improved in February 2005, when
we sold to Laurus our fixed rate convertible term note in the principal amount
of $2,000,000 and entered into a wholesale services agreement with Verizon. The
promissory note issued to Laurus has a three-year term, is payable in
thirty-three equal monthly principal installments of $60,606, plus monthly
interest at the rate of prime plus 3% per annum, beginning on May 1, 2005, and
is convertible into shares of our common stock at a conversion price of $0.63
per share, subject to adjustment. As a result of these two transactions, we now
have cash balances that we can use for new customer acquisitions, and a
five-year agreement that will allow us to continue our core business of selling
POTS lines on a leased network.
Our primary methods of obtaining new customer accounts will continue to be
through telemarketing and outside sales agents. We believe these are effective
low-cost methods of building new accounts, and our past history with these
customer acquisition methods is helpful in planning and budgeting our operations
on a going-forward basis. While we believe our cash balances are adequate for
continued growth, our cash balances may not be sufficient to generate the growth
we desire for our VoIP subsidiary. We plan to reassess our cash requirements for
VoIP on a regular basis as we begin adding customers to our platform.
We expect to have controlled capital expenditures for our VoIP products
during the next 12 months. The amount expended will depend on demand for our
products. If we experience higher demand and strong sales growth, we will
require additional equipment expenditures. We believe we will be able to make
such expenditures as we grow our business so that the utilization percentages of
our network equipment will remain high. We do not see a need to purchase network
assets that may remain idle or underutilized.
The following discussion and analysis of financial condition and results
of operations is based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these consolidated financial
statements requires management to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and
17
liabilities. These estimates are based on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.
Results of Operations
Three Months Ended February 28, 2005 Compared To Three Months Ended February 29,
2004
Our revenue for the three-month period ended February 28, 2005 increased
by approximately $1,989,000, or approximately 106%, to approximately $3,863,000
as compared to approximately $1,874,000 reported for the three-month period
ended February 29, 2004. The growth in revenues was directly related to the
growth in our customer base or number of local access lines that we served. We
anticipate revenues for NRTC to continue to increase during fiscal 2005 as we
work to add new customers. On the other hand, we anticipate a decrease in
revenue for TSI as we do not plan to add new customers in TSI as discussed
earlier. However, our revenue growth in NRTC many not be as rapid as in the past
as we are re-evaluating our telemarketing strategy and may determine to call
only businesses and residential prospects who are home owners.
Our gross profit for the three-month period ended February 28, 2005
increased by approximately $814,000 to approximately $1,808,000 from
approximately $994,000 reported in the three-month period ended February 29,
2004. During the same fiscal periods, our gross profit percentage decreased to
46.8% from 53%. The increase in our dollars of gross profit resulted from the
increase in our customer base in first quarter of fiscal 2005 over the first
quarter fiscal 2004. The decrease in our gross profit percentage during the 2005
period resulted from the higher cost of services that we are now incurring under
our wholesale services agreement with Verizon, as compared to the costs we
previously incurred under the UNE-P service offering. Our selling strategy in
fiscal 2005 is to continue to penetrate states that offer the opportunity to
achieve higher margins.
Selling, general and administrative expenses ("SG&A") increased by
approximately $1,284,000, or approximately 137%, to approximately $2,221,000 for
the three-month period ended February 28, 2005 from approximately $937,000
reported in prior year fiscal period. Of this increase, approximately $730,000
was for bad debt expense, approximately $150,000 was for telemarketing costs,
approximately $73,000 was for billing costs, and approximately $212,000 was for
increased personnel costs, of which approximately $80,000 was related to VoX.
Although our marketing has been directed to consumers with acceptable credit
scores, we recently adjusted our marketing strategy for the future in order to
reduce our bad debt expense. We are now telemarketing more actively to small
businesses and have changed our requirements for residential customers so that
we are marketing only to consumers who are homeowners and have proven records of
good credit history. Although this strategy will most likely increase our
acquisition costs per line, we anticipate the extra cost associated with
purchasing homeowner-only leads of credit-worthy customers will decrease our bad
debt expense, which in the most recent quarter was unacceptable to us.
Depreciation expense decreased to approximately $1,000 for the three-month
period ended February 28, 2005 as compared to approximately $4,000 for the
three-month period ended February 29, 2004. Although we have limited VoIP
revenues and are confident that our VoIP platform is functional, we have just
started to amortize the capitalized costs of our VoIP platform in the third
quarter of fiscal 2005, as we have co-located our final live platform in a major
data center.
Interest expense increased by approximately $49,000 to approximately
$52,000 for the three-month period ended February 28, 2005 as compared to
approximately $3,000 for the three-month period
18
ended February 29, 2004, as a result of our recent financing agreements (See
Note 1 to our Unaudited Condensed Consolidated Financial Statements for the
periods ended February 28, 2005 and 2004). Interest and other income decreased
by approximately $12,000, to approximately $17,000 for the three-month period
ended February 28, 2005 as compared to approximately $29,000 for the three-month
period ended February 29, 2004. The decrease resulted primarily from a reduction
in commission income.
For the three-month period ended February 28, 2005, we recorded income of
approximately $47,000, which resulted from the change in the market value of the
warrants issued to Laurus as part of the Laurus financing (See Note 2 to our
Unaudited Condensed Consolidated Financial Statements for the periods ended
February 28, 2005 and 2004). No such income was recorded in the three-month
period ended February 29, 2004.
For the three-month period ended February 29, 2004, reorganization items
included a gain of approximately $51,000 as a result of a court-stipulated
reduction in post-petition liabilities(See Note 6 to our Unaudited Condensed
Consolidated Financial Statements for the periods ended February 28, 2005 and
2004) and approximately $120,000 in professional fees reported by TSI (See Note
6 to our Unaudited Condensed Consolidated Financial Statements for the periods
ended February 28, 2005 and 2004). No such transactions occurred in the
three-month period ended February 28, 2005.
For the three-month period ended February 29, 2004, we recorded a tax
benefit of $45,000, which resulted from the reduction of an estimated accrual of
corporate tax expense for fiscal 2003. No such benefit was recorded for the
three-month period ended February 28, 2005.
Fiscal Year 2004 Compared to Fiscal Year 2003
Our revenues for fiscal 2004 increased by approximately $3,990,000, or
approximately 72%, to approximately $9,558,000 as compared to approximately
$5,568,000 reported for fiscal 2003. The growth in revenues is directly related
to the growth in our customer base or number of local access lines that we
served. We ended fiscal 2004 with 24,034 billed lines, as compared to 10,835
billed lines at November 30, 2003. Although the line count increased by 13,199
lines, or 122%, in fiscal 2004, due to insufficient cash flow to support our
telemarketing costs in the first half of fiscal 2004, most of the increase came
in the second half of our fiscal year. Therefore, annual revenues did not
increase by the same percentage as the percentage increase in our line count.
Several large CLECs that sell in New Jersey, New York and Pennsylvania have
indicated to the public that they are decreasing or discontinuing their selling
efforts to new customers because of the TRO Remand Order. We anticipate that the
reduced competition in these states will be a factor that will help us to retain
our current selling prices in those states, which currently average monthly
revenues of approximately $50 per line. We also believe the decrease in the
number of competitors may make our selling efforts somewhat easier than we have
experienced in the past.
Our gross profit for fiscal 2004 increased by approximately $2,018,000 to
approximately $4,820,000 from approximately $2,802,000 reported in fiscal 2003,
while our gross profit percentage of 50.4% in fiscal 2004 as compared to 50.3%
in fiscal 2003 essentially remained the same from fiscal period to fiscal
period. The increase in our dollars of gross profit resulted from the increase
in our customer base in fiscal 2004 over fiscal 2003. Our gross profit
percentage of approximately 50.4% reflects our sales strategy to sell only in
those states in which we believe we will be able to achieve a gross margin of
over 40%. Our selling strategy in fiscal 2005 is to continue to sell in states
that offer the opportunity to achieve higher margins. However, we do not
anticipate achieving a 50% gross margin in fiscal 2005 because our cost of
services are higher under our wholesale services agreement with Verizon than we
previously experienced while operating under UNE-P. We have passed on this
increase in cost to new customers beginning on October 1, 2004, but we have not
raised our prices to our existing customers
19
and do not intend to do so in the near future. During fiscal 2005, we also plan
to begin selling in localities serviced by Qwest. Although we will begin selling
in areas in which we believe we can achieve a gross margin greater than 40%, we
do not believe we will achieve gross margins of 50%. In addition, we plan to
sell VoIP services nationwide in fiscal 2005. The margins for such services will
be dependent on the cost structures we negotiate with carriers for wholesale
services or to terminate calls made by our VoIP customers to a traditional
landline telephone. Gross margins may also be impacted by product mix in 2005.
If we have success in selling our VoIP to wholesale VoIP customers, our gross
margins will be lower than if we only sell directly to individual end-users.
SG&A decreased by approximately $215,000, or approximately 3.8%, to
approximately $5,447,000 for fiscal 2004 from approximately $5,662,000 reported
in the prior year fiscal period. Although we grew our revenues significantly in
fiscal 2004, we were able to limit our SG&A. Our occupancy costs were
substantially lower in fiscal 2004, as we incurred rental expense of
approximately $6,000 per month under our existing headquarters lease as compared
to the occupancy costs of approximately $22,000 per month we incurred in
operating our former headquarters building, which we sold in the fourth quarter
of fiscal 2003.
Depreciation expense decreased by approximately $74,000, to approximately
$14,000 for fiscal 2004 as compared to approximately $88,000 for fiscal 2003.
The decline in depreciation expense was primarily attributable to the sale of
our headquarters building in the fourth quarter of fiscal 2003 and to the sale
of certain assets to EAC in the first quarter of fiscal 2003.
Interest expense decreased by approximately $172,000, to approximately
$3,000 for fiscal 2004 as compared to approximately $175,000 for fiscal 2003.
The decrease in interest expense was primarily attributable to the repayment of
a mortgage note in conjunction with the sale of our headquarters building in the
fourth quarter of fiscal 2003. We anticipate interest expense for fiscal 2005
will increase due to the interest that we project we will pay on the debt that
we have incurred in 2005.
Other income, net for fiscal 2004 was approximately $46,000 as compared to
approximately $164,000 for fiscal 2003. The income for fiscal 2004 resulted
primarily from commission income of approximately $88,000, which was partially
offset by charges for environmental costs of approximately $45,000 directly
related to the sale of our headquarters building in the fourth quarter of fiscal
2003. The income for fiscal 2003 resulted primarily from rental and commission
income of approximately $210,000, which was partially offset by the write-down
of our investment in Cordia Corporation of approximately $71,000.
In fiscal 2004, we reported income of approximately $904,000 from debt
reduction related to the TSI bankruptcy. No such income was reported in fiscal
2003. Bankruptcy reorganization costs for fiscal years 2004 and 2003 of
approximately $161,000 and $70,000, respectively, represented legal cost
associated with the TSI bankruptcy.
In fiscal 2003, we sold assets of our former subsidiary, Essex
Communications, Inc. ("Essex"), Essex stock and our headquarters building. The
sales netted a gain of approximately $11,306,000. We had no such asset sales in
fiscal 2004.
In fiscal 2004, gain on the sale of investment securities and other
investments of approximately $1,000, resulted from the sale of Cordia
Corporation ("Cordia") shares as compared to the gain of approximately $122,000
in fiscal 2003, which resulted from the sale of shares of Cordia and Talk
America Holdings Inc. ("Talk").
20
In fiscal 2004, we recorded a net tax benefit of approximately $48,000
offset by a current year provision of $22,000, which resulted from the reduction
of an estimated accrual of corporate tax expense for fiscal 2003. In fiscal,
2003, we recorded estimated corporate tax expense of approximately $75,000.
Liquidity and Capital Resources
At February 28, 2005, we had cash and cash equivalents of approximately
$1,552,000 and negative working capital of approximately $1,292,000.
Net cash used in operating activities aggregated approximately $771,000
and $59,000 in the three-month periods ended February 28, 2005 and February 29,
2004, respectively. The principal use of cash in fiscal 2005 was the increase in
accounts receivable of approximately $1,157,000, offset by an increase in the
provision for doubtful accounts of approximately $745,000 and the loss for the
period of approximately $402,000. The principal use of cash in fiscal 2004 was
the net change in operating assets and liabilities, which was partially offset
by the income for the period of approximately $56,000.
Net cash used in investing activities in the three-month period ended
February 28, 2005 aggregated approximately $101,000, resulting primarily from
expenditures related to our VoIP initiative. There were no investing activities
in the three-month period ended February 29, 2004.
Net cash provided by (used in) financing activities aggregated
approximately $2,052,686 and ($2,000) in the three-month periods ended February
28, 2005 and February 29, 2004, respectively. In fiscal 2005, net cash provided
by financing activities resulted from the proceeds of short-term and long-term
notes, warrants and stock issuances and the exercise of stock options in the
amounts of approximately $2,018,000 and $34,500, respectively. In fiscal 2004,
net cash used in financing activities resulted from the repayment of debt.
For the three-month period ended February 28, 2005, we had approximately
$101,000 in capital expenditures primarily related to our VoIP initiative. We
made equipment purchases of approximately $100,000 in the second fiscal quarter
of 2005. We expect that other capital expenditures over the next 12 months will
relate primarily to a continued roll-out of VoIP services and will only be
required to support a growing customer base of VoIP subscribers.
We have stock purchase warrants that entitle us to purchase approximately
95,000 shares of Talk America Holdings Inc. ("Talk"). The warrant exercise price
is $6.30 per share and, at June 3, 2005, our warrants were in-the-money, as Talk
common stock was trading at approximately $8.86 per share at such date. We are
currently exploring ways in which we can monetize the gain in these warrants.
We have reported profits in the last two fiscal years, but we have also
sustained net losses from operations during those periods, as we have worked to
build our customer base. Our operating losses have been funded through the sale
of non-operating assets, the issuance of equity securities and borrowings. We
believe that current cash and cash equivalents will be sufficient to finance our
operations through at least the next twelve months. However, we continually
evaluate our cash needs and growth opportunities and we anticipate seeking
additional equity or debt financing in order to achieve our overall business
objectives. There can be no assurance that such financing will be available, or,
if available, at a price that would be acceptable to us. Failure to generate
sufficient revenues, raise additional capital or reduce certain discretionary
spending could have an adverse impact on our ability to achieve our longer-term
business objectives.
21
BUSINESS
Overview
eLEC Communications Corp. is a telecommunications service holding company
with operations in three wholly-owned subsidiaries that focus on delivering
integrated telephone service by leasing landlines as a competitive local
exchange carrier ("CLEC") and by utilizing high-speed Internet connections to
provide Voice over Internet Protocol ("VoIP") services. We offer small
businesses and residential consumers an integrated set of telecommunications
products and services, including local exchange, local access, domestic and
international long distance telephone, VoIP and a full suite of features and
calling plans.
Almost all of the local telephone calls made by our customers in fiscal
2004 and the first quarter of fiscal 2005 were routed over a circuit-switched
network that we lease from Verizon Services Corp. ("Verizon"). Although we plan
to increase the number of local access lines that we route over the Verizon
network during fiscal 2005, we also plan to use other networks by offering local
exchange services on the Qwest Corporation ("Qwest") network in some of the 14
states in which Qwest is the incumbent local exchange carrier ("ILEC") and by
offering VoIP services on an Internet network over which our customers will make
telephone calls through a high-speed Internet connection. When we route a
telephone call by our customers over an Internet network, a carrier other than
Verizon or Qwest will terminate the call for us into the public switched
telephone network ("PSTN"). We also are able to terminate some calls ourselves
that are made by our customers, in which cases we do not incur any marginal
costs for such calls.
We sell virtually all of the additional voice services provided by the
ILECs, such as three-way calling, call waiting, call forwarding and caller ID.
We sell our services at a fee that is at least 10% and as much as 25% less than
the published rate charged by the ILEC. We also offer a bundled package of local
and regional calling minutes with popular voice service features.
Prior to December 31, 2004, both of our CLEC subsidiaries leased lines
from Verizon, using the UNE-P service offering. UNE-P allowed us to lease the
network elements we needed, such as the local line and the port on a local
switch, so that we could provide local dial tone service to our customers. Based
upon the TRO Remand Order in WC Docket No. 04-313 and CC Docket No. 01-338,
released on February 4, 2005 by the FCC, one of our CLEC subsidiaries, TSI, can
no longer sell new lines or offer new services to its embedded customer base.
TSI's embedded base of customers will be subject to transitional rate increases
established in the TRO Remand Order. Thereafter, TSI will have until March 2006
to transfer existing lines from UNE-P to another platform. TSI currently bills
approximately 9,000 lines every month, and we plan to transfer those customers
to our other CLEC.
We plan to rapidly grow our other CLEC, NRTC, which will not be impacted
by the regulatory rulings relating to UNE-P. In February 2005, NRTC signed a
wholesale advantage services agreement with Verizon, effective on January 1,
2005, that provides NRTC with all the features and functionalities of Verizon's
UNE-P service offering, plus certain additional services. While our costs under
the wholesale advantage services agreement are somewhat higher than our costs
were under UNE-P, the agreement locks in this cost structure for five years and
gives us a significant benefit by eliminating any regulatory uncertainty about
the future of our CLEC business. NRTC will no longer be impacted by rulings of
regulatory bodies relating to UNE-P that might potentially change pricing or
availability of network elements to NRTC. The agreement allows us to plan for
steady high-margin growth in a business that has been our core business since
1999. At June 3, 2005, NRTC had approximately 21,000 local access lines that it
billed under the wholesale advantage services agreement. Pursuant to the
agreement, NRTC is required to keep confidential all additional terms and
conditions of the agreement.
22
We also provide local and long distance telephone service on a VoIP
platform through our wholly-owned subsidiary, VoX, a facilities-based VoIP
carrier. Unlike many other CLECs, during the past few years we avoided buying
any circuit-switched equipment and instead leased circuit-switched lines from
ILECs. We believe packet telephony services represent a significant step in the
advancement of telecommunications. Consequently, we have focused our network
building efforts on building packet telephony technology and, unlike some other
VoIP providers, we have written and own the code to our own software.
Ultimately, our goal is to have a wholly-owned telecommunications network that
generates revenues and high margins and does not require us to lease facilities
from an ILEC. By not being dependent upon an ILEC, we will be able to offer
features and services we develop that can be turned on and off almost instantly
without requiring an ILEC employee to intervene. We will also lower our cost of
services when we route a telephone call over our packet-based network, as we
will not be required to pay an ILEC for line rentals or for call origination,
transport and termination.
For the foreseeable future, we will continue to lease lines from the
ILECs, as we have wholesale agreements with Verizon and Qwest that allow us to
lease lines and provide Plain Old Telephone Service ("POTS"). We anticipate that
these agreements will allow us to continue to obtain an acceptable gross margin
on the POTS services we provide. We plan to attract VoIP-only customers on our
packet-switched network and to eventually offer VoIP services to our POTS
customers in NRTC and TSI. Although we believe many of our future customers will
want VoIP-only services, we are finding that several accounts want VoIP services
for the bulk of their telephony needs but still desire to maintain one or two
POTS lines. We plan to be able to satisfy the needs of our customers for both
VoIP and POTS services by maintaining our CLEC status and by continuously
advancing our VoIP product offerings.
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. Between 1995 and 1999, we divested our handbag and
luggage operations, which had experienced several years of operating losses.
We commenced operations in the telecommunications industry in fiscal 1998
by acquiring Essex Communications, Inc. ("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.
In January 2000, we acquired TSI, a CLEC that operated in the states of
Massachusetts, New Jersey, New York and Rhode Island and provided long distance
service in 13 states. Most of TSI's operations were merged into Essex after the
acquisition was completed, and we maintained TSI's licenses even though it was
an inactive subsidiary. On July 29, 2002, TSI commenced a case under chapter 11
of the Bankruptcy Code. In February 2004, TSI filed a plan of reorganization
pursuant to which the capital stock of a reorganized TSI would be sold by
competitive bid and the proceeds from the sale of such stock would be used to
make distributions to creditors of TSI. In April 2004, the court accepted our
plan to purchase all the stock of a reorganized TSI for a price of $325,000.
In October 2000, we acquired Line One, Inc. ("Line One"), a telemarketing
firm with approximately 70 seats. We believe telemarketing is a particularly
effective marketing strategy to utilize because of the ubiquitous reach that
wholesale leasing arrangements give us. Due to our limited financial resources,
we decreased the operations of Line One at the beginning of 2003 to 15 seats. At
this level of operations, our line acquisition cost became higher than the cost
we would pay if we outsourced our telemarketing operation. We consequently
discontinued internal telemarketing in June 2003. Line One is
23
now an inactive subsidiary and we outsource all of our telemarketing activities
on a successful efforts basis.
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. The remaining shell of
Essex was sold to Glad Holdings, LLC on September 11, 2003. As a result of such
sale, we recorded a gain of approximately $7,314,000 in the fourth quarter of
the fiscal 2003.
In November 2002, we began the operations of NRTC, as a start-up CLEC.
Since the intellectual know-how and internal systems we had developed in
creating Essex were still owned by us, we were able to rebuild our customer base
to a total of approximately 27,000 lines in NRTC and TSI combined, as of
February 28, 2005.
On August 4, 2004, we incorporated VoX as our wholly-owned VoIP
subsidiary. VoX owns technology that enables voice communications over the
Internet through the compression of voice into data packets that are transmitted
over data networks and then converted back into voice signals at the other end
of a telephone conversation.
On February 8, 2005, we sold a $2,000,000 convertible note and we have
used a substantial portion of the cash proceeds of approximately $1,744,000 from
such sale for line growth in NRTC and the completion of our first VoIP
Point-of-Presence in Orlando, Florida.
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 two different distribution channels. 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. To
further help our customers manage their accounts, our customers can view our
invoices, including unbilled telephone calls in the current month, and make
payments to us of their invoices, on a secure customer web site. Customers can
also input requests for repair orders, moves, adds and changes via the web site,
and check their voice mail. We creatively package our services to provide
"one-stop shopping" solutions for our customers, so they can 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 and International. In addition to our local
telephone service, we offer long distance and international 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
24
"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 VoIP Calling. Through our wholly-owned subsidiary, VoX, we offer
VoIP services to the small business, residential and wholesale
marketplace. In addition to low prices, our VoIP calling plans offer a
variety of features, such as Call Hold, Call Waiting, Caller ID, Call
Transfer, Hunt Groups, Do Not Disturb, Call Forward, International Call
Blocking, Call Return, Repeat Dialing/Redial, Extension Dialing, Anonymous
Call Rejection and email notification of voicemail, all at no additional
charge. Add-on features include: Multibox Voicemail, Music on Hold,
Corporate Conference calling, Reassign Phone, Find me/Follow me, and Auto
Attendant, among others.
Business Strategy
Our objective is to build a profitable telephone company with minimal
network costs and a stable and scalable platform. Our strategies to accomplish
this objective encompass the proper management of our core CLEC
telecommunications services on leased networks and the development and marketing
of our own technology for VoIP-based telephony applications.
VoIP is a new technology that is threatening the established
circuit-switched businesses of the ILECs. We are looking to be a rapidly-growing
second-mover in the VoIP marketplace. We believe the first-movers have helped to
validate the technology and create the market, and that some of the initial VoIP
providers have exited the market as quickly as they have entered it. Other
first-movers have demonstrated rapid market entry and unique product variants as
they rush to capture market share.
We believe a normal speed second-mover into a market is often an imitator,
and in lieu of innovation, tends to offer lower pricing. We do not intend to be
a normal speed or slow speed second-mover into the VoIP market. We plan to be
fast, owning and mastering our own technology, adjusting product designs and
marketing efforts and doing many things that a first-mover does, all while
continuing to run our CLEC business, which is currently our core business. We
believe we have the resources and know-how, and the contractual commitments with
two ILECs, to continue operating a CLEC business that can generate acceptable
gross margins and cash flow for further growth. We plan to continue in this
fashion while we develop our VoIP business.
In establishing our VoIP business, we do not plan to compete on price, as
we believe we have a stable product, and that there is enough demand for the
feature-rich service we can provide so as to allow us to distinguish ourselves
from lower-priced VoIP alternatives. Furthermore, a VoIP line offers substantial
savings to any customer who is switching from a circuit-switched line. In
addition to enjoying a retail price for an unlimited local and national calling
plan of approximately $20 less per month than the cost of a POTS line, the VoIP
consumer also can save approximately $10 a month in telecom taxes, as VoIP
generally is considered data communications and is subject to substantially
fewer taxes than a POTS line. If we need to lower our prices in the future to
capture market share, we believe that option will be available to us.
We are taking the following actions to grow our CLEC and our VoIP
businesses:
o Target Small-Business and Residential Customers for CLEC Services.
We focus our CLEC sales efforts for local and long distance services on
small business and
25
residential consumers having one to five local access lines in any one
location. We have elected to focus on this segment because of our ability
to obtain an ample gross margin on the services provided to these
customers, and because we can rapidly sell, provision and bill these
accounts with electronic feeds from third-party verification companies. We
also believe that the ILECs and facilities-based CLECs may be less likely
to apply significant resources to obtaining or retaining these smaller
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 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 by accessing the rates they have
filed with the various state public service commissions. Our two largest
CLEC competitors have announced they are in the process of being purchased
by an ILEC. We anticipate that these purchases may help to eliminate some
of our competition as a CLEC.
o Market VoIP Services to ILEC Customers. We believe we are very
good at selling POTS lines one at a time. We generally can provision and
bill these lines within approximately three days of the sale. Similarly,
we plan to sell VoIP lines one at a time to residential consumers, as
there are many advantages in both speed and simplicity when we only have
to provision one line per location.
o Offer VoIP on a Wholesale Basis. We believe our VoIP platform is
scalable and stable. We designed and built our platform with the intention
of carrying more than one million customers. We plan to allow other
entities that want to offer VoIP to an existing customer base to use our
platform on a wholesale basis. An independent cable company, for example,
may not have the technological expertise to build its own VoIP platform,
or may realize that any efforts to do so would take more than a year to
accomplish. We plan to attract several wholesale accounts by offering our
platform on a private label basis.
o Utilize our Technological Expertise in VoIP to Add New Products.
We have developed a robust VoIP platform that we intend to use to develop
further product enhancements. By adding new features and technologically
innovative products, we believe we can continue to attract new customers
and provide additional incentives for current customers to continue using
our services.
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 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 of 1996 reduced barriers to entry into the local market,
future regulatory
26
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 telephone
bill. Our CLEC subsidiary, TSI, is facing some of these regulatory challenges.
However, our other CLEC subsidiary, NRTC, has commercial agreements with two
ILECs and should not be subject to future regulatory decisions involving the
prices that these ILECs can charge.
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
and electric utilities. 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, MCI and Sprint Corporation, among other
carriers, have each successfully implemented local telecommunications services
in major U.S. markets using UNE-P 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 and MCI. We believe our bundled package of local
services and our attentive customer service department 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 reductions could adversely impact our results
of operations if we do not also provide other services to our long distance
customers.
We also compete with wholesale DSL carriers, including companies such as
Covad Communications Group, Inc., that offer DSL services and other data related
products. Many DSL carriers have significant strategic equity investors,
marketing alliances and product development partners, and have obtained licenses
to operate as a CLEC. Additionally, many of these competitors are offering, or
may soon offer, VoIP services that may take business away from our CLECs or from
VoX. VoIP competitors include the brands AT&T, Lingo, Net2phone, Packet8 and
Vonage, as well as several ILECs.
Government Regulation
Local and long distance telecommunications services provided by CLECs 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 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
27
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.
The use of the Internet and VoIP networks as a way of providing voice
services is a relatively recent development. Although the provisioning of such
services is currently permitted by United States law and is largely unregulated
within the United States, several foreign governments have adopted laws and/or
regulations that could restrict or prohibit the provisioning of voice
communications services over the Internet. Various regulatory actions are
underway or are being contemplated by federal, state and local authorities,
including the FCC, state regulatory agencies and local governments. To date, the
FCC has treated Internet service providers as information service providers.
Information service providers are currently exempt from federal and state
regulations governing legacy telecommunication carriers, including the
obligation to pay access charges and contribute to the universal service fund.
More aggressive domestic or international regulation of the Internet in general,
and Internet telephony providers and services specifically, may materially and
adversely affect our business plan, financial condition and future prospects,
particularly if increased numbers of governments impose regulations restricting
the use and sale of Internet telephony services.
Employees
At June 3, 2005, we employed 56 employees, of whom 46 were employed on a
full-time basis and ten were employed on a part-time basis. We are not subject
to any collective bargaining agreement and we believe our relationship with our
employees is good.
Properties
The following table sets forth pertinent facts concerning our office leases at
June 3, 2005.
Location Use Approximate Square Feet Annual Rent
-------- --- ----------------------- -----------
75 South Broadway Office 4,000 $72,000
White Plains, NY 10601
118 Celebration Avenue Office 2,000 $51,600
Celebration, FL 34747
The lease for our office space in White Plains, New York is a five-year
lease that began on December 1, 2003 and our lease for our office space in
Celebration, Florida is a three-year lease that began on February 1, 2005. We
believe we need additional space for our current operating needs. We have no
other leased or owned properties.
28
MANAGEMENT
Management And Board Of Directors
The following sets forth the name, age and position of each of our
directors and executive officers as of June 3, 2005.
Principal Occupation for Past Five Years and
Name Age Current Public Directorships or Trusteeships
---- --- --------------------------------------------
Paul H. Riss 49 Director since 1995; acting Chairman of our
Board of Directors since March 2005; our Chief
Executive Officer since August 1999 and our
Chief Financial Officer and Treasurer since
November 1996.
Greg M. Cooper 46 Director since April 2004; partner for more than
five years of Cooper, Neiman & Co., CPAs, LLP,
certified public accountants; and member of the
board of directors of Mid Hudson Cooperative
Insurance Company in Montgomery New York, a
privately-held insurance company.
Gayle Greer 64 Director since January 2005; Ms. Greer retired
in 1998 from Time Warner Entertainment after
serving over 20 years in a number of executive
positions, including most recently Senior Vice
President of Time Warner Cable; co-founder of
GS2.Net, a business service provider, and served
as its Chairwoman from 1999 to April 2001;
co-founder of the National Association of
Minorities in Cable and Telecommunications and
served as its Chairwoman from 1981 to
1985;director of ING North America Financial
Services Company, an insurance and financial
services company since 1997.
Michael H. Khalilian 42 Director and Chief Technology Officer since
October 2004; director and Chief Technology
Officer of eLEC and VoX Communications, Inc.,
our wholly-owned subsidiary, since October 2004;
Chairman of the Board of Directors and President
of International Packet Communications
Consortium, an industry VoIP forum of which Mr.
Khalilian is a founding member, since July 2001;
Chief Technology Officer and director of Volo
Communications Inc., a wholesale VoIP service
provider, from January 2003 to July 2004; Chief
Technologist and advisor for the Telecom
Business Groups at NTT from January 2002 to June
2003; Senior Engineer and Senior Director for
the Cable, Communications and Telecom business
groups at Time Warner Communications from March
1996 to May 2002.
Mark Richards 45 President of our wholly-owned subsidiary, VoX
Communications, Inc., since October 2004; Acting
Chief Executive Officer of Epicus Communications
Inc., a publicly-held CLEC, from January 2002 to
January 2004; Chief Information Officer of
Epicus Communications Inc. from 2000 to January
2002.
All directors serve for one year and until their successors are elected
and qualified. All officers serve at the pleasure of the Board of Directors.
There are no family relationships among any of the officers and directors.
29
Executive 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, Mr. Michael H. Khalilian, our Chief Information Officer, and
Mr. Mark Richards, the President of Vox Communications, Inc., our wholly-owned
subsidiary (collectively, the "Named Executives"). None of our other executive
officers received more than $100,000 in compensation during fiscal 2004.
Compensation Table
Long-Term
Annual Compensation Compensation Awards
-------------------
Name and Fiscal Other Annual All Other
Principal Position Year Salary($) Bonus($) Compensation ($) Options(#) Compensation
------------------ ------ --------- -------- ---------------- ---------- ------------
Paul H. Riss 2004 $150,000 None None 100,000 None
Chief Executive Officer, 2003 150,000 None None 250,000 None
Chief Financial Officer 2002 150,000 None None None None
and Treasurer
Michael H. Khalilian(1) 2004 $ 12,000 None None 900,000 None
Chief Technology 2003 None None None None None
Officer 2002 None None None None None
Mark Richards(2) 2004 $ 22,569 None None 1,000,000 None
President of Vox 2003 None None None None None
Communications, Inc. 2002 None None None None None
-----------------------------
(1) Mr. Khalilian became our Chief Technology Officer in October 2004 and
receives an annual salary of $120,000 for such services.
(2) Mr. Richards became the President of our wholly-owned subsidiary, Vox
Communications, Inc., in October 2004 and receives an annual salary of
$120,000 for such services.
30
Stock Option Grants
The following table sets forth individual grants of stock options and
stock appreciation rights ("SARs") made during fiscal 2004 to the Named
Executives.
Option/SAR Grants In Last Fiscal Year
Number of Percent of Total
Securities Options/SARs
Underlying Granted to
Options/SARs Employees in Exercise or Base Expiration
Name Granted(1) Fiscal Year(2) Price ($/Share) Date
---- ---------- -------------- --------------- ----
Paul H. Riss........... 100,000 4.6% $0.18 04/08/09
Michael Khalilian...... 900,000 41.2% $0.23 10/26/09
Mark Richards.......... 1,000,000 45.8% $0.25 10/14/09
---------------
(1) No SARs were granted in fiscal 2004.
(2) In fiscal 2004, we granted options to seven employees, certain members of
our board of directors and the former Chairman of our Board of Directors
to purchase an aggregate of 2,185,000 shares of our common stock.
Stock Option Exercises
The following table contains information relating to the exercise of our
stock options by the Named Executives in fiscal 2004, as well as the number and
value of their unexercised options as of November 30, 2004.
Aggregated Option Exercises in Last Fiscal Year
and Fiscal Year-End Option Values
Number of Securities Value of Unexercised
Shares Underlying Unexercised In-the-Money Options at Fiscal
Acquired on Value Options at Fiscal Year-End(#)(1) Year-End ($)(2)
Name Exercise (#) Realized($) Exercisable Unexercisable Exercisable Unexercisable
---- ------------ ----------- ----------- ------------- ----------- -------------
Paul H. Riss -- -- 370,000 450,000 $47,500 $ 11,000
Michael Khalilian -- -- -- 900,000 -- 54,000
Mark Richards -- -- -- 1,000,000 -- 40,000
----------------
(1) The sum of the numbers under the Exercisable and Unexercisable column of
this heading represents the Named Executives' 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, 2004,
multiplied by the difference between the closing price of the common stock
on
31
November 30, 2004, which was $0.29 per share, and the exercise price of
the options. For purposes of these calculations, In-the-Money options are
those with an exercise price below $0.29 per share.
32
PRINCIPAL STOCKHOLDERS
The following table sets forth, as of March 15, 2005, the names, addresses
and number of shares of our 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). As of March 15, 2005, we
had a total of 16,759,282 shares of common stock outstanding:
Number of Shares Percent of Shares
Name and Address Beneficially Owned Beneficially Owned
---------------- ------------------ ------------------
Paul H. Riss
eLEC Communications Corp. 1,470,000(1) 8.5%
75 South Broadway, Suite 302
White Plains, New York 10601
Joel Dupre
Cordia Communications Corp. 999,668(2) 5.4%
445 Hamilton Avenue
White Plains, New York 10601
Greg M. Cooper
Cooper, Neiman & Co., CPAs, LLP 65,000(3) *
PO Box 190
Mongaup Valley, New York 12762
Michael H. Khalilian 125,000 *
478 E. Altamonte Drive, Suite 108-480
Altamonte Springs, Florida 32701
Gayle Greer -0- -
75 South Broadway, Suite 302
White Plains, New York 10601
Mark Richards 100,000(4) *
610 Sycamore Street
Celebration, Florida 34747
All directors and executive officers
as a group (five individuals) 1,760,000 10.8%
------------------
* Less than 1%.
(1) Includes 470,000 shares of common stock subject to options that are
presently exercisable or exercisable within 60 days after March 15, 2005.
(2) Includes 130,000 shares of common stock subject to options that are
presently exercisable or exercisable within 60 days after March 15, 2005.
33
(3) Includes 25,000 shares of common stock subject to options that are
exercisable within 60 days after March 15, 2005.
(4) Represents shares of common stock subject to options that are presently
exercisable.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We believe all purchases from or transactions with affiliated parties were
on terms and at prices substantially similar to those available from
unaffiliated third parties.
34
DESCRIPTION OF SECURITIES
Our authorized capital stock consists of 50,000,000 shares of common
stock, par value $.10 per share, and 1,000,000 shares of preferred stock, par
value $.10 per share. As of June 3, 2005, 16,779,282 shares of common stock were
issued and outstanding and no shares of preferred stock were issued and
outstanding. In addition, at such date, 8,659,046 shares of common stock were
reserved for issuance upon the exercise of outstanding options and warrants and
the conversion of outstanding convertible indebtedness.
Common Stock
Voting, Dividend and Other Rights. Each outstanding share of common stock
will entitle the holder to one vote on all matters presented to the shareholders
for a vote. Holders of shares of common stock will have no preemptive,
subscription or conversion rights. All shares of common stock to be outstanding
following this offering will be duly authorized, fully paid and non-assessable.
Our Board of Directors will determine if and when distributions may be paid out
of legally available funds to the holders. We have not declared any cash
dividends during the past fiscal year with respect to the common stock. Our
declaration of any cash dividends in the future will depend on our Board of
Directors' determination as to whether, in light of our earnings, financial
position, cash requirements and other relevant factors existing at the time, it
appears advisable to do so. In addition, our loan agreement with Laurus does not
allow us to directly or indirectly declare or pay any dividends so long as our
secured convertible term note to Laurus remains outstanding.
Rights Upon Liquidation. Upon liquidation, subject to the right of any
holders of the preferred stock to receive preferential distributions, each
outstanding share of common stock may participate pro rata in the assets
remaining after payment of, or adequate provision for, all our known debts and
liabilities.
Majority Voting. The holders of a majority of the outstanding shares of
common stock constitute a quorum at any meeting of the shareholders. A plurality
of the votes cast at a meeting of shareholders elects our directors. The common
stock does not have cumulative voting rights. Therefore, the holders of a
majority of the outstanding shares of common stock can elect all of our
directors. In general, a majority of the votes cast at a meeting of shareholders
must authorize shareholder actions other than the election of directors.
However, the Business Corporation Law of the State of New York provides that
certain extraordinary matters, such as a merger or consolidation in which we are
a constituent corporation, a sale or other disposition of all or substantially
all of our assets, and our dissolution, require the vote of the holders of
two-thirds of all outstanding voting shares. Most amendments to our certificate
of incorporation require the vote of the holders of a majority of all
outstanding voting shares.
Preferred Stock
Authority of Board of Directors to Create Series and Fix Rights. Under our
certificate of incorporation, as amended, our Board of Directors can issue up to
1,000,000 shares of preferred stock from time to time in one or more series. The
Board of Directors is authorized to fix by resolution as to any series the
designation and number of shares of the series, the voting rights, the dividend
rights, the redemption price, the amount payable upon liquidation or
dissolution, the conversion rights, and any other designations, preferences or
special rights or restrictions as may be permitted by law. Unless the nature of
a particular transaction and the rules of law applicable thereto require such
approval, the Board of Directors has the authority to issue these shares of
preferred stock without shareholder approval. Our Board of Directors has not
authorized the issuance of any shares of preferred stock.
35
Potential Dilution of Share Value; Preferences. Any issuance of shares of
preferred stock could dilute the earnings per share and book value of existing
shares of common stock. Because our Board of Directors has the authority to fix
the voting rights for any series of preferred stock, the holders of shares of a
series of preferred stock could be entitled to vote separately as a class in
connection with the approval of certain extraordinary corporate transactions
where New York law does not require such class vote, or might be given a
disproportionately large number of votes. The issuance of shares of preferred
stock could also result in a class of securities outstanding that would have
certain preferences (for example, with respect to dividends or liquidation), or
would enjoy certain voting rights in addition to those of the common stock.
Potential Frustration in Change of Control. Although we currently have no
such intention, we could use authorized but unissued shares of preferred stock
to hinder a change in control of our company. Any issuance of shares of
preferred stock could dilute the stock ownership of persons seeking to gain
control. Shares of a new series of preferred stock could also be convertible
into a large number of shares of common stock or have other terms that might
make more difficult or costly the acquisition of a controlling interest in our
company. Under certain circumstances, such shares could be used to create voting
impediments or to frustrate persons attempting to effect a takeover or otherwise
gain control. Such shares could be privately placed with purchasers who might
side with the Board of Directors in opposing a hostile takeover bid. In
addition, the Board of Directors could authorize holders of a series of
preferred stock to vote as a class, either separately or with the holders of the
common stock, on any merger, sale or exchange of assets by us or any other
extraordinary corporate transactions. The ability of the Board of Directors to
take such actions might be considered as having an effect of discouraging any
attempt by another person or entity to acquire control of our company.
Transfer Agent and Registrar
The registrar and transfer agent for our common stock is Registrar and
Transfer Company, 10 Commerce Drive, Cranford, New Jersey 07016.
36
SELLING SHAREHOLDERS
The following table sets forth information with respect to the maximum
number of shares of common stock beneficially owned by the selling shareholders
named below and as adjusted to give effect to the sale of the shares offered
hereby. The shares beneficially owned have been determined in accordance with
rules promulgated by the SEC, and the information is not necessarily indicative
of beneficial ownership for any other purpose. The information in the table
below is current as of March 25, 2005. All information contained in the table
below is based upon information provided to us by the selling shareholders and
we have not independently verified this information. The selling shareholders
are not making any representation that any shares covered by the prospectus will
be offered for sale. The selling shareholders may from time to time offer and
sell pursuant to this prospectus any or all of the common stock being
registered.
For purposes of this table, beneficial ownership is determined in
accordance with SEC rules, and includes voting power and investment power with
respect to shares and shares owned pursuant to warrants exercisable within 60
days. The "Number of Shares Beneficially Owned After Offering" column assumes
the sale of all shares offered.
As explained below under "Plan of Distribution," we have agreed with the
selling shareholders to bear certain expenses (other than broker discounts and
commissions, if any) in connection with the registration statement, which
includes this prospectus.
Number of Shares Number of Shares
Beneficially Owned Number of Shares Beneficially Owned
Selling Shareholder Prior to Offering(1) Offered After Offering(2)
------------------- -------------------- ---------------- -------------------
Laurus Master Fund, Ltd.(3) 836,288(4) 4,365,078 -0-
Kaufman Bros., L.P. 350,000(5) 350,000 -0-
W. Todd Coffin 63,492 63,492(6) -0-
Ted Flomenhaft 121,492 63,492(6) 58,000
David Harris 5,079 5,079(6) -0-
Russell Newton 22,857 22,857(6) -0-
Bruce Ryan 22,857 22,857(6) -0-
Jeffrey Silverman 82,699 12,699(6) 70,000
TT Capital, LLC 63,492 63,492(6) -0-
(1) Unless otherwise indicated, the selling shareholders have sole voting and
investment power with respect to its shares of common stock. The inclusion
of any shares in this table does not constitute an admission of beneficial
ownership for the selling shareholders. Includes shares of common stock
that the selling shareholder has the right to acquire beneficial ownership
of within 60 days.
(2) Assumes the sale of all shares of common stock offered hereby and no other
transactions in the common stock by the selling shareholders or their
affiliates. Shareholders are not required to sell their shares.
(3) Laurus Master Fund, Ltd. ("Laurus") is a New York City-based institutional
fund specializing in providing financing to small capitalization
publicly-traded companies. Control of all investment
37
decisions are vested with its investment manger, Laurus Capital Management
LLC. The directors of Laurus Capital Management LLC are David and Eugene
Grin. By virtue of their position as directors of Laurus Capital
Management LLC, Messrs. Grin exercise voting control over the shares of
our common stock owned by Laurus.
(4) Laurus holds a note that is convertible into 3,174,603 shares of common
stock and warrants to purchase 793,650 shares of common stock. The note
and warrants contain provisions known as "exercise caps," which prohibit
the holder of the note and warrants (and its affiliates) from converting
such note or exercising such warrants to the extent that giving effect to
such conversion or exercise, such holder would beneficially own in excess
of 4.99% of our outstanding common stock. The holder can waive the 4.99%
limit, but such waiver will not become effective until the 76th day after
such notice is delivered to us. The figures set forth above as the
ownership prior to the offering and the ownership after the offering
reflect the operation of such exercise caps in that we have not included
3,131,965 shares of common stock issuable pursuant to such convertible
note and warrants as Laurus has advised us that it does not beneficially
own such shares due to the fact that it cannot exercise its right to
receive these shares at this time. In the absence of such caps, Laurus
would have the right to receive all the shares issuable upon conversion of
the note and exercise of the warrants and would have a beneficial
ownership percentage of 19.14%.
(5) Represents 100,000 shares issuable upon the exercise of outstanding
warrants that expire on July 21, 2005 and are exercisable at a price of
$2.50 per share, subject to certain anti-dilution adjustments and 250,000
shares issuable upon the exercise of outstanding warrants that expire on
February 22, 2006 and are exercisable at a price of $1.63 per share,
subject to certain anti-dilution adjustments.
(6) Represents shares issuable upon the exercise of outstanding warrants that
expire on February 8, 2009 and are exercisable at a price of $0.63 per
share, subject to certain anti-dilution adjustments.
Kaufman Bros., L.P. provided us investment banking services during our
2000 and 2001 fiscal years, for which it received warrants as a portion of its
compensation for services rendered. We currently utilize Source Capital Group,
Inc. ("Source Capital") as a financial advisor under the terms of an agreement
that expires on July 31, 2005. Source Capital instructed us to grant the
253,9687 options to which it was entitled as part of its advisory fee to the
seven selling shareholders listed above who received warrants expiring on
February 8, 2009.
Except as provided above, no affiliate of any of the selling shareholders
has held any position or office with us or any of our affiliate and none of the
selling shareholders has had any other material relationship with us or any of
our affiliates within the past three years other than as a result of its
ownership of shares of equity security.
No affiliate of any of the selling shareholders has held any position or
office with us or any of our affiliates and none of the selling shareholders has
had any other material relationship with us or any of our affiliates within the
past three years other than as a result of its ownership of shares of equity
securities.
38
PLAN OF DISTRIBUTION
The selling shareholders may, from time to time, sell any or all of
their shares of common stock on any stock exchange, market or trading facility
on which the shares are traded or in private transactions. These sales may be at
fixed or negotiated prices. The selling shareholders may use any one or more of
the following methods when selling shares:
o ordinary brokerage transactions and transactions in which the
broker-dealer solicits purchasers;
o block trades in which the broker-dealer will attempt to sell the
shares as agent but may position and resell a portion of the block
as principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
o an exchange distribution in accordance with the rules of the
applicable exchange; o privately negotiated transactions;
o short sales after this registration statement becomes effective;
o broker-dealers may agree with the selling shareholders to sell a
specified number of such shares at a stipulated price per share;
o a combination of any such methods of sale; and o any other method
permitted pursuant to applicable law.
The selling shareholders may also sell shares under Rule 144 under the
Securities Act of 1933, if available, rather than under this prospectus.
The selling shareholders may also engage in short sales against the box
after this registration statement becomes effective, puts and calls and other
transactions in our securities or derivatives of our securities and may sell or
deliver shares in connection with these trades.
Broker-dealers engaged by the selling shareholders may arrange for other
broker-dealers to participate in sales. Broker-dealers may receive commissions
or discounts from the selling shareholders (or, if any broker-dealer acts as
agent for the purchaser of shares, from the purchaser) in amounts to be
negotiated. The selling shareholders do not expect these commissions and
discounts to exceed what is customary in the types of transactions involved. Any
profits on the resale of shares of common stock by a broker-dealer acting as
principal might be deemed to be underwriting discounts or commissions under the
Securities Act of 1933. Discounts, concessions, commissions and similar selling
expenses, if any, attributable to the sale of shares will be borne by a selling
stockholder. The selling shareholders may agree to indemnify any agent, dealer
or broker-dealer that participates in transactions involving sales of the shares
if liabilities are imposed on that person under the Securities Act of 1933.
The selling shareholders may from time to time pledge or grant a security
interest in some or all of the shares of common stock owned by them and, if they
default in the performance of their secured obligations, the pledgees or secured
parties may offer and sell the shares of common stock from time to time under
this prospectus after we have filed an amendment to this prospectus under Rule
424(b)(3) or other applicable provision of the Securities Act of 1933 amending
the list of selling shareholders to include the pledgee, transferee or other
successors in interest as selling shareholders under this prospectus.
The selling shareholders also may transfer the shares of common stock in
other circumstances, in which case the transferees, pledgees or other successors
in interest will be the selling beneficial owners for purposes of this
prospectus and may sell the shares of common stock from time to time under this
prospectus after we have filed an amendment to this prospectus under Rule
424(b)(3) or other applicable
39
provision of the Securities Act of 1933 amending the list of selling
shareholders to include the pledgee, transferee or other successors in interest
as selling shareholders under this prospectus.
We are required to pay all fees and expenses incident to the registration
of the shares of common stock. We have agreed to indemnify the selling
shareholders against certain losses, claims, damages and liabilities, including
liabilities under the Securities Act of 1933.
Each of the selling shareholders acquired the securities offered hereby in
the ordinary course of business and has advised us that they have not entered
into any agreements, understandings or arrangements with any underwriters or
broker-dealers regarding the sale of their shares of common stock, nor is there
an underwriter or coordinating broker acting in connection with a proposed sale
of shares of common stock by any selling stockholder. If we are notified by any
selling stockholder that any material arrangement has been entered into with a
broker-dealer for the sale of shares of common stock, if required, we will file
a supplement to this prospectus. If the selling shareholders use this prospectus
for any sale of the shares of common stock, they will be subject to the
prospectus delivery requirements of the Securities Act.
The anti-manipulation rules of Regulation M under the Securities Exchange
Act of 1934 may apply to sales of our common stock and activities of the selling
shareholders.
LEGAL MATTERS
The legality of the issuance of the shares offered in this prospectus will
be passed upon for us by Pryor Cashman Sherman & Flynn LLP, New York, New York
10022. Pryor Cashman Sherman & Flynn LLP holds options to purchase 55,000 shares
of our common stock at an exercise prices ranging from $0.10 to $0.97 per share.
In addition, a member of Pryor Cashman Sherman & Flynn LLP holds 233,000 shares
of our common stock.
EXPERTS
The consolidated financial statements as of November 30, 2004 and for the
years ended November 30, 2004 and 2003 included in this prospectus have been
audited by Nussbaum Yates & Wolpow, P.C., independent registered pubic
accountants, as stated in its report appearing herein and elsewhere in this
Registration Statement, and have been so included in reliance upon the report of
this firm given upon their authority as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form SB-2 (including exhibits) under the Securities Act, with
respect to the shares to be sold in this offering. This prospectus does not
contain all the information set forth in the registration statement. For further
information with respect to our company and the common stock offered in this
prospectus, reference is made to the registration statement, including the
exhibits filed thereto, and the financial statements and notes filed as a part
thereof. With respect to each such document filed with the SEC as an exhibit to
the registration statement, reference is made to the exhibit for a more complete
description of the matter involved.
40
We file quarterly and annual reports, proxy statements and other
information with the SEC. You may read and copy any document that we file at the
public reference facilities of the SEC in Washington, D.C. You may call the SEC
at 1-800-SEC-0330 for further information on the public reference rooms. Our SEC
filings are also available to the public from the SEC's website at
http//www.sec.gov.
41
eLEC COMMUNICATIONS CORP.
INDEX TO FINANCIAL STATEMENTS
Page
Unaudited Condensed Consolidated Balance Sheet for the period ended
February 28, 2005....................................................................... F-1
Unaudited Condensed Consolidated Statements of Operations for the periods
ended February 28, 2005 and February 29, 2004........................................... F-2
Unaudited Condensed Consolidated Statements of Cash Flows for the periods
ended February 28, 2005 and February 29, 2004........................................... F-3
Notes to Unaudited Condensed Consolidated Financial Statements for the periods
ended February 28, 2005 and February 29, 2004........................................... F-4
Reports of Independent Public Accountants............................................... F-11
Consolidated Balance Sheet as of November 30, 2004...................................... F-12
Consolidated Statements of Operations for the years ended November 30, 2004
and 2003................................................................................ F-13
Consolidated Statements of Stockholders' Equity Deficiency for the years ended
November 30, 2004 and 2003.............................................................. F-14
Consolidated Statements of Cash Flows for the years ended November 30, 2004
and 2003................................................................................ F-15
Notes to Consolidated Financial Statements for the years ended November 30, 2004
and 2003................................................................................ F-17
42
PART 1. FINANCIAL INFORMATION
-----------------------------
Item 1. Financial Statements
------- --------------------
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Balance Sheet
Feb. 28, 2005
-------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 1,552,349
Accounts receivable, net 1,660,152
Prepaid expenses and other current assets 12,849
------------
Total current assets 3,225,350
Property, plant and equipment, net 291,967
Other assets 55,204
Deferred finance costs 342,157
------------
Total assets $ 3,914,678
============
Liabilities and stockholders' equity deficiency
Current liabilities:
Short-term borrowings $ 280,320
Current maturities of long-term debt and capital lease obligations 638,161
Accounts payable and accrued expenses 2,399,209
Taxes payable 755,741
Due to related party 36,363
Deferred revenue 407,666
------------
Total current liabilities 4,517,460
------------
Long-term debt 669,017
Stockholders' equity deficiency:
Common stock $.10 par value, 50,000,000 shares authorized,
16,759,282 shares issued 1,675,928
Capital in excess of par value 26,400,644
Deficit (29,345,535)
Accumulated other comprehensive loss, unrealized loss on securities (2,836)
------------
Total stockholders' equity deficiency (1,271,799)
------------
Total liabilities and stockholders' equity deficiency $ 3,914,678
============
See notes to the condensed consolidated financial statements.
F-1
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
(Unaudited)
For the Three Months Ended
Feb. 28, 2005 Feb. 29, 2004
------------- -------------
Revenues $ 3,863,479 $ 1,873,992
------------ ------------
Costs and expenses:
Costs of services 2,055,539 880,075
Selling, general and administrative 2,221,007 936,646
Depreciation and amortization 1,355 3,858
------------ ------------
Total costs and expenses 4,277,901 1,820,579
------------ ------------
Income (loss) from operations (414,422) 53,413
------------ ------------
Other income (expense):
Interest expense (51,616) (2,762)
Change in warrant valuation 47,089 --
Interest and other income 17,264 29,081
------------ ------------
Total other income 12,737 26,319
------------ ------------
Income (loss) before bankruptcy reorganization items and
income tax benefit (401,685) 79,732
------------ ------------
Reorganization items:
Gain on settlement with creditors -- 51,474
Professional fees -- (120,066)
------------ ------------
-- (68,592)
------------ ------------
Income (loss) before income tax benefit (401,685) 11,140
Income tax benefit -- (45,000)
------------ ------------
Net income (loss) (401,685) 56,140
Other comprehensive loss - unrealized
loss on marketable securities (585) --
------------ ------------
Comprehensive income (loss) ($402,270) $ 56,140
============ ============
Basic and diluted earnings (loss) per share ($0.02) $ 0.00
============ ============
Weighted average number of common shares outstanding
Basic 16,681,726 16,257,667
============ ============
Diluted 16,681,726 16,568,565
============ ============
See notes to the condensed consolidated financial statements.
F-2
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Three Months Ended
Feb. 28, 2005 Feb. 29, 2004
------------- -------------
Net cash used in operating activities: ($771,279) ($58,581)
----------- ---------
Cash flows used in investing activities:
Purchase of property and equipment (100,910) --
----------- ---------
Net cash used in investing activities (100,910) --
----------- ---------
Cash flows from financing activities:
Repayment of long-term debt (1,731)
Proceeds form the exercise of options 34,500 --
Proceeds from notes, warrants and common stock issuances 2,018,186 --
----------- ---------
Net cash provided by (used in) financing activities 2,052,686 (1,731)
----------- ---------
Increase (decrease) in cash and cash equivalents 1,180,497 (60,312)
Cash and cash equivalents at beginning of period 371,852 669,022
----------- ---------
Cash and cash equivalents at the end of period $ 1,552,349 $ 608,710
=========== =========
See notes to the condensed consolidated financial statements.
F-3
eLEC COMMUNICATIONS CORP.
-------------------------
Notes To Condensed Consolidated Financial Statements (Unaudited)
----------------------------------------------------------------
Note 1-Basis of Presentation
----------------------------
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB of Regulation
S-B. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three-month period ended February 28, 2005
are not necessarily indicative of the results that may be expected for the year
ended November 30, 2005. For further information, refer to the consolidated
financial statements and footnotes thereto included in our Annual Report on Form
10-KSB for the year ended November 30, 2004.
Note 2-Principal Financing Arrangements
---------------------------------------
On December 17, 2004, we sold a promissory note (the "Note") in the principal
amount of approximately $328,767 and 160,000 shares of our restricted common
stock to an unaffiliated party for $300,000 of which $32,000 has been allocated
to common stock issuances. The Note is payable on December 17, 2005 and is
unsecured. The Note requires us to spend the proceeds of the Note on sales and
marketing efforts. We recorded costs of $36,314 in connection with the issuance
of the Note which are being amortized over the term of the Note. Amortization of
these costs for the three-month period ended February 28, 2005 was $13,850, of
which $7,362 was included in our selling, general and administrative expenses
("SG&A") as financing costs and $6,488 allocated to the $32,000 debt discount
was included in interest expense using the effective interest method.
On February 8, 2005, we entered into a secured financing arrangement with Laurus
Master Fund, Ltd. ("Laurus"). The financing consists of a $2 million secured
convertible term note (the "Convertible Note") that bears interest at the rate
of prime (as published in the Wall Street Journal), plus three percent (8.5% as
of February 28, 2005) that was initially scheduled to mature on February 8, 2006
but was subsequently extended to February 8, 2008. The Convertible Note is
convertible into shares of our common stock at an initial fixed price of $0.63
per share. The fixed conversion price of the Convertible Note is subject to
anti-dilution protection, on a weighted-average basis, upon our issuance of
additional shares of our common stock at a price that is less than the fixed
conversion price.
In connection with the financing, Laurus was also issued warrants to purchase up
to 793,650 shares of our common stock. The warrants are exercisable as follows:
264,550 shares at $0.72 per share; 264,550 shares at $0.79 per share and the
balance at $0.95 per share. The underlying contracts contained certain
provisions where there is a provision for a cash settlement. EITF 00-19
precludes classifying the warrants as equity, since all of the conditions stated
in paragraphs 14-32 of EITF 00-19 were not satisfied, and accordingly, the
warrants have been classified as debt. The proceeds of the Convertible Note were
allocated first to the fair value of the warrants (liability) and the remainder
to the debt instrument. We computed the beneficial conversion feature embedded
in
F-4
the debt instrument using the effective conversion price in accordance with EITF
98-5, EITF 00-19 and EITF 00-27. We recorded (i) debt discounts of $504,128 for
the valuation of the 793,650 warrants issued with the Convertible Note (computed
using a Black-Scholes model with an interest rate of 2.31%, volatility of 158%,
zero dividends and expected term of seven years); (ii) $610,628 for the
beneficial conversion feature inherent in the Convertible Note and (iii)
$106,500 for debt issue costs paid to affiliates of the lender. In addition, we
issued to Source Capital Group Inc., an investment banking firm, warrants to
purchase up to 253,968 shares of our common stock as additional debt issue
costs. These warrants were valued at $149,783 using the Black-Scholes model as
above. Total debt issuance costs incurred to third parties for arranging the
financing aggregated $313,363, including the value of the warrants to Source
Capital Group Inc. Amortization of these costs for the three-month period ended
February 28, 2005 was $57,452, of which $18,157 was included in SG&A as
financing costs and $39,295 was included in interest expense. Discounts are
being amortized over one year, the initial term of the Convertible Note, using
the effective interest method. The warrant liability is adjusted at each
reporting date to fair market value using the Black-Scholes model with a
corresponding charge or credit to income.
To secure the payment of all obligations to Laurus, we entered into a Master
Security Agreement that assigns and grants to Laurus a continuing security
interest in all of the following property now owned or at any time acquired by
us or our subsidiaries, or in which any assignor now has or at any time in the
future may acquire any right, title or interest: all cash, cash equivalents,
accounts, deposit accounts, inventory, equipment, goods, documents, instruments
(including, without limitation, promissory notes), contract rights, general
tangibles, chattel paper, supporting obligations, investment property,
letter-of-credit rights, trademarks, trademark applications, patents, patent
applications, copyrights, copyright applications, and any other intellectual
property, in each case, in which any assignor now has or may acquire any right,
title or interest, all proceeds and products thereof (including, without
limitation, proceeds of insurance) and all additions, accessions and
substitutions. In the event any assignor wishes to finance an acquisition in the
ordinary course of business of any hereafter-acquired equipment and has obtained
a commitment from a financing source to finance such equipment from an unrelated
third party, Laurus has agreed to release its security interest on such
hereafter-acquired equipment so financed by such third party financing source.
The Convertible Note is to be repaid using cash or an equity conversion option;
the details of both methods for repayment are as follows: Beginning on May 1,
2005, which is the first scheduled payment date, we are obligated to make
monthly payments to Laurus on each repayment date until the maturity date, each
in the amount of $60,606, together with any accrued and unpaid interest to date.
By the fifth business day prior to each amortization date, Laurus may deliver to
us a written notice directing that the monthly amount payable on the next
repayment date shall be paid in either shares of common stock or a combination
of cash and common stock. If a repayment notice is not delivered by Laurus on or
before the applicable notice date for any repayment date, then we are obligated
to pay the monthly amount due in cash. Any portion of the monthly amount paid in
cash shall be paid to Laurus in an amount equal to 102% of the principal portion
of the monthly amount due. If Laurus elects to receive all or a portion of the
monthly amount in shares of our common stock, the number of such shares to be
issued by us will be determined by dividing the portion of the monthly amount to
be paid in shares of common stock, by the applicable fixed conversion price,
which is presently $0.63 per share.
A registration rights agreement was executed requiring us to register the shares
of our common stock underlying the Convertible Note and warrants so as to permit
the public resale thereof.
F-5
Liquidated damages in the amount of 2% of the Convertible Note balance per month
accrue if the registration statement has not been declared effective by the
Securities and Exchange Commission by June 8, 2005. The registration statement
was filed with the Securities and Exchange Commission on March 31, 2005 but has
not yet been declared effective.
Note 3-Major Customer
---------------------
During the three-month periods ended February 28, 2005 and February 29, 2004, no
one customer accounted for more than 10% of revenue.
Note 4-Income Taxes
-------------------
At November 30, 2004, we had net operating loss carryforwards for Federal income
tax purposes of approximately $20,850,000 expiring in the years 2008 through
2024. There is an annual limitation of approximately $187,000 on the utilization
of approximately $2,450,000 of such net operating loss carryforwards under the
provisions of Internal Revenue Code Section 382.
Note 5- Earnings (Loss) Per Common Share
----------------------------------------
Basic earnings (loss) per common share are calculated by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted earnings per share is calculated by dividing net income by the
sum of the weighted average number of common shares outstanding plus all
additional common shares that would have been outstanding if potentially
dilutive securities had been issued unless such inclusion reduced the loss per
share. A reconciliation of the shares used in the computation of our basic and
diluted earnings per common share is as follows:
Three Months Ended
2/28/05 2/29/04
------- -------
Weighted average common shares outstanding 16,681,726 16,257,667
Dilutive effect of securities -- 310,898
---------- ----------
16,681,726 16,568,565
========== ==========
Approximately 8,125,000 and 1,500,000 of our stock options, warrants and shares
issuable upon the potential conversion of the Convertible Note were excluded
from the calculation of diluted earnings (loss) per share for the three months
ended February 28, 2005 and February 29, 2004 because the effect would be anti
dilutive.
Note 6-Subsidiary's Plan of Reorganization
------------------------------------------
On April 8, 2004, the United States Bankruptcy Court for the Southern District
of New York confirmed a Plan of Reorganization (the "Bankruptcy Plan") for
Telecarrier Services, Inc. ("TSI"). On July 29, 2002, TSI, a wholly-owned
subsidiary, had filed a voluntary petition for relief under Chapter 11 of the
Federal Bankruptcy Code in the United States Bankruptcy Court for the Southern
District of New York. The Bankruptcy Plan authorized us to disburse $325,000 to
creditors in full satisfaction of claims amounting to approximately $1,229,000.
For the year ended
F-6
November 30, 2004, TSI reported a gain of $904,027 as a result of being
judicially released from these claims.
For the three-month period ended February 29, 2004, TSI reported a gain of
approximately $51,000 as a result of a court-stipulated reduction in
post-petition liabilities (See Note 10) and approximately $120,000 in
professional fees. These items are included under the heading "Reorganization
items" in our Condensed Consolidated Statement of Operations and Comprehensive
Income (Loss). No such transactions occurred in the three-month period ended
February 28, 2005.
F-7
Note 7-Risks and Uncertainties
------------------------------
We buy substantially all of our telecommunication services from Regional Bell
Operating Companies ("RBOCs"), and are, therefore, highly dependent upon them.
We believe our relationship with the RBOCs from which we purchase services is
satisfactory. We also believe there are other suppliers of telecommunication
services in the geographical locations in which we conduct business. In
addition, we are at risk to regulatory changes that govern the rates we are to
be charged and the obligations of the RBOCs to interconnect with, or provide
unbundled network elements to their competitors. The FCC and state public
utility commissions have adopted extensive rules to implement the
Telecommunications Act of 1996, which sets standards for relationships between
communications providers, and they revisit such regulations on an ongoing basis
in response to the evolving marketplace and court decisions. In light of the
foregoing, it is possible that the loss of our relationship with the primary
RBOC that supplies us with wholesale telephone services or a significant
unfavorable change in the regulatory environment would have a severe near-term
impact on our ability to conduct our telecommunications business. In order to
reduce regulatory risks going forward, our main operating subsidiary has signed
a commercially negotiated wholesale services agreement with two of the RBOCs.
Future results of operations involve a number of risks and uncertainties.
Factors that could affect future operating results and cash flows and cause
actual results to vary materially from historical results include, but are not
limited to:
- Our business strategy with respect to bundled local and long
distance services may not succeed.
- Failure to manage, or difficulties in managing, our growth,
operations or restructurings including attracting and retaining
qualified personnel and opening up new territories for its service
with favorable gross margins.
- Dependence on the availability or functionality of incumbent local
telephone companies' networks, as they relate to the unbundled
network element platform or the resale of such services.
- Increased price competition in local and long distance service.
- Failure or interruption in our network and information systems.
- Changes in government policy, regulation and enforcement.
- Failure of our collection management system and credit controls
efforts for customers.
- Inability to adapt to technological change.
- Competition in the telecommunications industry.
- Inability to manage customer attrition and bad debt expense.
- Adverse change in our relationship with third party carriers.
- Failure or bankruptcy of other telecommunications companies upon
whom we rely for services and revenues.
- Lack of capital or borrowing capacity, and inability to generate
cash flow.
F-8
Note 8- Stock-Based Compensation Plans
--------------------------------------
We issue stock options to our employees and outside directors pursuant to
stockholder-approved and non-approved stock option programs. We account for our
stock-based compensation plans under the intrinsic value method of accounting,
as defined by Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. No stock-based employee
compensation cost was reflected in net income for the three months ended
February 28, 2005 and February 29, 2004, as all options granted under these
plans had an exercise price equal to the fair market value of the underlying
common stock on the date of the grant. For pro forma disclosures, the estimated
fair value of the option was amortized over the vesting periods, which range
from immediate vesting to three years. The following table illustrates the
affect on net income (loss) per share if we had accounted for our stock option
and stock purchase plans under the fair value method of accounting under
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation", as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure":
For the Three Months Ended
2/28/05 2/29/04
------- -------
Net income (loss), as reported ($401,685) $ 56,140
Deduct: Total stock-based employee
compensation expense determined
under fair value-based method
for all awards, net of related
tax effects (99,426) (58,986)
----------- -----------
Pro forma net income (loss) ($501,111) ($2,846)
----------- -----------
Earnings (loss) per share
Basic, as reported ($.02) $ .00
Basic, pro forma ($.03) $ .00
Diluted, as reported ($.02) $ .00
Diluted, pro forma ($.03) $ .00
Note 9 Related Party Transactions
---------------------------------
TSI had an agreement, effective January 2, 2002, with Telco Services, Inc.
("Telco"), a corporation owned by a former shareholder, under which Telco
provided TSI with collection, sales and other services. As a result of a
court-stipulated agreement between TSI and Telco, entered into on February 6,
2004, the amount owed Telco for such services was reduced by approximately
$51,000. Such reduction was reported as a gain for the three-month period ended
February 29, 2004 (See Note 6).
During the three-month periods ended February 28, 2005 and February 29, 2004, we
billed Cordia Corporation ("Cordia"), a related party, $23,403 and $135,322,
respectively, for telecommunications services, commissions and other costs, and
Cordia billed us $137,807 and $51,099, respectively, for telecommunications
services and other costs. As of February 28, 2005, we owed Cordia $36,363.
F-9
Note 10-Reclassification
------------------------
Certain 2004 amounts related to the bankruptcy of TSI have been reclassified to
conform to the 2005 presentation.
Note 11-Defined Benefit Plan
----------------------------
We sponsor a defined benefit plan covering two active employees and a number of
former employees. Our funding policy with respect to the defined benefit plan is
to contribute annually not less than the minimum required by applicable law and
regulation to cover the normal cost and to fund supplemental costs, if any, from
the date each supplemental cost was incurred. Contributions are intended to
provide not only for benefits attributable to service to date, but also for
those expected in the future.
For the three-month periods ended February 28, 2005 and February 29, 2004, we
recorded pension expense of $24,000 for each fiscal period. We did not make any
pension contributions in the first fiscal period of 2005 but we expect to
contribute $100,000 to our defined benefit plan in fiscal 2005. In the first
fiscal period of 2004, we contributed $26,000 to our defined benefit plan. The
current investment strategy for the defined benefit plan is to invest in
conservative debt and equity securities. The expected long-term rate of return
on plan assets is 8%. -
F-10
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-------------------------------------------------------
The Board of Directors
eLEC Communications Corp.
White Plains, New York
We have audited the consolidated balance sheet of eLEC Communications Corp. and
subsidiaries as of November 30, 2004, and the consolidated statements of
operations, stockholders' equity deficiency, and cash flows for the years ended
November 30, 2004 and 2003. 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 the Standards of the Public Company
Accounting Oversight Board (United States). 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 subsidiaries as of November 30, 2004, and the
consolidated results of their operations and cash flows for the years ended
November 30, 2004 and 2003, in conformity with U.S. generally accepted
accounting principles.
NUSSBAUM YATES & WOLPOW, P.C.
Melville, New York
March 4, 2005
F-11
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
NOVEMBER 30, 2004
ASSETS
2004
------------
Current assets
Cash and cash equivalents $ 371,852
Accounts receivable, net of allowance of
$547,768 1,247,063
Prepaid expenses and other current assets 42,179
------------
Total current assets 1,661,094
Property and equipment, net 192,413
Other assets 50,295
------------
Total assets $ 1,903,802
------------
LIABILITIES AND STOCKHOLDERS' EQUITY DEFICIENCY
2004
------------
Current liabilities:
Current portion of capital
lease obligations $ 32,100
Accounts payable and accrued expenses 2,445,947
Taxes payable 721,108
Due to related parties 59,384
Deferred revenues 341,702
------------
Total current liabilities 3,600,241
------------
Stockholders' equity deficiency:
Common stock, $.10 par value; 50,000,000 shares
authorized; 16,254,282 shares issued 1,625,428
Capital in excess of par value 25,624,234
Deficit (28,943,850)
Accumulated other comprehensive loss, unrealized
loss on securities (2,251)
------------
Total stockholders' equity deficiency (1,696,439)
------------
Total liabilities and stockholders'
equity deficiency $ 1,903,802
------------
See accompanying notes to consolidated financial statements.
F-12
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED NOVEMBER 30, 2004 AND 2003
2004 2003
------------ ------------
Revenues $ 9,557,600 $ 5,568,004
------------ ------------
Cost and expenses:
Cost of services 4,738,038 2,765,811
Selling, general and administrative 5,447,232 5,662,085
Depreciation 14,480 88,460
------------ ------------
Total costs and expenses 10,199,750 8,516,356
------------ ------------
Loss from operations (642,150) (2,948,352)
------------ ------------
Other income (expense):
Interest expense (3,126) (174,800)
Other income, net 45,795 163,528
Gain on sale of investment securities and other investments 770 121,687
Gain on disposition of subsidiary -- 10,825,332
Gain on sale and disposal of property, plant and equipment -- 480,574
------------ ------------
Total other income 43,439 11,416,321
------------ ------------
Income (loss) before bankruptcy reorganization
items and income tax (benefit) expense (598,711) 8,467,969
------------ ------------
Reorganization items:
Gain on settlement with creditors 904,027 --
Professional fees (161,000) (69,758)
------------ ------------
743,027 (69,758)
------------ ------------
Income before income tax (benefit) expense 144,316 8,398,211
Income tax (benefit) expense (25,937) 75,000
------------ ------------
Net income $ 170,253 $ 8,323,211
------------ ------------
Basic income per share $ .01 $ .53
------------ ------------
Diluted income per share $ .01 $ .53
------------ ------------
Weighted average number of common shares outstanding:
Basic 16,254,282 15,771,219
------------ ------------
Diluted 16,715,808 15,841,941
------------ ------------
See accompanying notes to consolidated financial statements.
F-13
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY DEFICIENCY
YEARS ENDED NOVEMBER 30, 2004 AND 2003
Preferred Stock Common Stock Capital
---------------------------- ---------------------------- in Excess of
Shares Amount Shares Amount Par Value
------------ ------------ ------------ ------------ ------------
Balance, December 1, 2002 16 $ 2 15,619,282 $ 1,561,928 $ 25,671,342
Net income
Less reclassification
adjustment for gains realized
in net income
Comprehensive income
Stock issued for interest
expense 630,000 63,000 (19,110)
Conversion of Series B
preferred stock to common
stock (16) (2) 16,000 1,600 (1,598)
------------ ------------ ------------ ------------ ------------
Balance, November 30, 2003 -- -- 16,265,282 1,626,528 25,650,634
Net income
Unrealized holding loss
Comprehensive income
Retirement of treasury stock (11,000) (1,100) (26,400)
------------ ------------ ------------ ------------ ------------
Balance, November 30, 2004 -- -- 16,254,282 $ 1,625,428 $ 25,624,234
============ ============ ============ ============ ============
Accumulated Total
Other Stockholders'
Treasury Comprehensive Equity
Deficit Stock income (Loss) Deficiency
------------ ------------ ------------- -------------
Balance, December 1, 2002 $(37,437,314) $ (27,500) $ 69,922 $(10,161,620)
------------
Net income 8,323,211 8,323,211
Less reclassification
adjustment for gains realized
in net income (69,922) (69,922)
------------
Comprehensive income 8,253,289
Stock issued for interest
expense 43,890
Conversion of Series B
preferred stock to common
stock --
------------ ------------ ------------ ------------
Balance, November 30, 2003 (29,114,103) (27,500) -- (1,864,441)
------------
Net income 170,253 170,253
Unrealized holding loss (2,251) (2,251)
------------
Comprehensive income 168,002
Retirement of treasury stock 27,500 --
------------ ------------ ------------ ------------
Balance, November 30, 2004 $(28,943,850) $ -- $ (2,251) $ (1,696,439)
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
F-14
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED NOVEMBER 30, 2004 AND 2003
2004 2003
------------ ------------
Operating activities:
Net income $ 170,253 $ 8,323,211
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation 14,480 88,460
Gain on sale of investment securities -- (87,965)
Gain on sale of other investments -- (33,722)
Loss on write-down of other investments -- 71,430
Gain loss on sale and disposal of property,
plant and equipment -- (480,574)
Gain on settlement with creditors (904,027) --
Stock issued for interest expense -- 43,890
Gain on disposition of subsidiary -- (10,825,332)
Provision for losses on accounts receivable 1,048,559 981,920
Changes in assets and liabilities:
Accounts receivable (1,590,973) (1,517,838)
Prepaid expenses and other current assets 140,251 97,399
Distribution to bankruptcy creditors (301,170) --
Other assets -- 189,855
Accounts payable and accrued expenses 1,050,704 915,065
Taxes payable 315,011 406,097
Deferred revenues 220,564 121,138
Related party, net (243,684) 71,363
------------ ------------
Net cash used in operating activities (80,032) (1,635,603)
------------ ------------
Investing activities, net of effects of acquisitions:
Purchase of property and equipment (181,502) --
Proceeds from sale of investment securities -- 98,274
Proceeds from sale of other investments -- 100,000
Purchase of investment securities (4,546) --
Proceeds from sale of property, plant and equipment -- 2,121,746
Proceeds from collection of other assets -- 209,102
------------ ------------
Net cash provided by (used in) investing activities (186,048) 2,529,122
------------ ------------
(Continued)
See accompanying notes to consolidated financial statements.
F-15
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
2004 2003
----------- -----------
Financing activities:
Proceeds from short-term borrowings $ -- $ 380,000
Repayment of short-term borrowings -- (380,000)
Repayment of long-term debt (7,260) (1,163,025)
Principal payments on pre-petition bank debt in
bankruptcy proceedings (23,830) --
----------- -----------
Net cash used in financing activities (31,090) (1,163,025)
----------- -----------
Decrease in cash and cash equivalents (297,170) (269,506)
Cash and cash equivalents at beginning of year 669,022 938,528
----------- -----------
Cash and cash equivalents at end of year $ 371,852 $ 669,022
=========== ===========
Cash paid during the year for:
Interest $ 3,126 $ 121,532
=========== ===========
Taxes $ 27,593 $ --
=========== ===========
Supplemental disclosure of non-cash investing and financing activities:
See Notes 5 and 12
See accompanying notes to consolidated financial statements.
F-16
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles
------------------------------------------------------------
Description of Business and Concentrations
eLEC Communications Corp. ("eLEC" or the "Company") is a full-service
telecommunications company that focuses on developing integrated telephone
service in the competitive local exchange carrier ("CLEC") industry and by
utilizing high-speed internet connections to provide voice over internet
protocol services which is intended to be available to customers in fiscal
2005. The Company offers small businesses and residential customers 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 CLEC, is to resell and provide low cost
alternative telecommunication services and other bundled services,
focusing on small business users and residential customers.
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 less than 20% owned
companies that do not have readily determinable fair values were carried
at cost prior to their disposition.
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 at November 30, 2004 consisted
of equity securities classified as available-for-sale and are carried at
fair value with unrealized gains or losses reported in a separate
component of shareholders' equity.
F-17
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1 Description of Business and Summary of Accounting Principles (Continued)
------------------------------------------------------------------------
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
three to five years for computer equipment and software, five to ten years
for machinery and equipment, and the lesser of the estimated useful life
or the life of the lease for leasehold improvements.
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 for carrier interconnection and access are recognized in the
period in which the service is provided.
F-18
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles (Continued)
------------------------------------------------------------------------
Collectibility of Accounts Receivable
Trade receivables potentially subject the Company to credit risk. The
Company extends credit to its customers and generally does not require
collateral. During fiscal years ended November 30, 2004 and 2003, the
Company accepted most new customers and extended initial credit without an
evaluation of the credit history or financial condition of the customer.
In the fourth quarter of the year ended November 30, 2004, the Company
made an effort to improve the acceptance of new customers by requiring
certain minimum credit scores by new applicants. Once a customer is billed
for services, the Company actively manages the accounts receivable to
minimize credit risk. Approximately $96,000 as of November 30, 2004
represented net amounts due (after allowance for doubtful collection) from
entities in the telecommunications industry related to carrier
interconnection and access.
In order to record the Company's accounts receivable at their net
realizable value, the Company must assess their collectibility. 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. Generally, when a
customer account reaches a certain level of delinquency, the Company
disconnects the customer's service and provides an allowance for the
related amount receivable from the customer. The Company has recorded
allowances for receivables that 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 was to
become impaired, increases in these allowances may be required. The
Company actively manages its accounts receivable to minimize credit risk.
As of November 30, 2004, the Company had no individual customer that
constituted more than 10% of its accounts receivable.
During the years ended November 30, 2004 and 2003, the Company recorded
bad debt expense of approximately $1,049,000 and $982,000.
Earnings Per Share
Basic earnings per share is computed by dividing net income by the
weighted-average number of shares outstanding. Diluted earnings per share
included the dilutive effect of stock options, warrants, and in 2003,
convertible preferred stock. Approximately 1,130,000 and 1,500,000 of the
Company's stock options and warrants were excluded from the 2004 and 2003
calculation of diluted earnings per share because the exercise price of
the stock options and warrants were greater than the average price of the
common shares, and therefore their inclusion would have been
anti-dilutive.
F-19
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles (Continued)
------------------------------------------------------------------------
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with
original maturities of three months or less to be cash equivalents.
Impairment of Long-Lived Assets
The Company reviews long-lived assets 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 fair values.
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. Significant estimates relate to the allowance
for doubtful accounts receivable, income tax valuation allowance, and
conclusions regarding the impairment of long-lived assets and gain
recognition on the sale of the subsidiaries. Actual results could differ
from those estimates, and any difference between the amounts recorded and
amounts ultimately realized or paid will be adjusted prospectively as new
facts become known.
F-20
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles (Continued)
------------------------------------------------------------------------
Advertising
Advertising costs are expensed as incurred. Advertising expense amounted
to approximately $1,000 in 2004 and $27,000 in 2003.
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.
o Investment Securities
The fair value of the Company's investment in marketable equity
securities is based upon the quoted market price.
o Capital Lessee Obligations
The fair value of the Company's capital lessee obligations 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.
F-21
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles (Continued)
------------------------------------------------------------------------
Stock Compensation Plan
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
Financial Accounting Standards Board ("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 1995 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, incentive stock 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, 2004, approximately
450,000 option shares remain available for future issuance.
The Company's non-employee Director Stock Option Plan provides for the
grant of options to purchase 10,000 shares of the Company's common stock
to each non-employee director on the first business day following each
annual meeting of the shareholders of the Company. Under the plan, options
may be granted at no less than the fair market value of the Company's
common stock on the date of grant.
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 in 2004 and 2003, respectively: annual dividends of $ -0-
for both years, expected volatility of 158% and 159%, risk-free interest
rate of 1.25% and 1.15%, and expected life of five years for all grants.
The weighted-average fair value of stock options granted in 2004 and 2003
was $.21 and $.09, respectively.
F-22
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles (Continued)
------------------------------------------------------------------------
Stock Compensation Plan (Continued)
Under the above model, the total value of stock options granted in 2004
and 2003 was $466,273 and $68,574, respectively, which would be amortized
ratably on a pro forma basis over the related vesting periods, which range
from immediate vesting to five years. Had compensation cost been
determined based upon the fair value of the stock options at grant date
for all awards, the Company's net income (loss) and earnings (loss) per
share would have been changed to the pro forma amounts indicated below:
2004 2003
---------- ----------
Net income:
As reported $ 170,253 $8,323,211
Stock-based compensation cost, net of
related tax effects, that would have been
included in the determination of net income
if the fair value based method had been
applied to all awards 279,145 294,338
---------- ----------
Proforma net income (loss) ($ 108,892) $8,028,873
Basic earnings (loss) per share:
As reported $ .01 $ .53
Proforma ($ .01) $ .51
Diluted earnings (loss) per share:
As reported $ .01 $ .53
Proforma ($ .01) $ .51
Stock-based employee compensation
cost, net of related tax effects, included
in the determination of net income as
reported $ -0- $ -0-
---------- ----------
F-23
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles
------------------------------------------------------------
Recent Accounting Pronouncements (Continued)
On December 16, 2004, the Financial Accounting Standards Board (FASB)
issued Statement No. 123 (revised 2004) that will require compensation
costs related to share-based payment transactions to be recognized in the
financial statements. With limited exceptions, the amount of compensation
cost will be measured based on the grant-date fair value of the equity or
liability instruments issued. In addition, liability awards will be
measured each reporting period. Statement 123(R) replaces FASB Statement
No. 123, Accounting for Stock-Based Compensation, and supercedes APB
Opinion No. 25, accounting for Stock Issued to Employees. SFAS 123(R) is
effective as of the first interim or annual reporting period that begins
after December 15, 2005. The Company is currently assessing the impact of
adopting SFAS 123(R).
In December 2003, the FASB issued a revision to SFAS No. 132, "Employers
Disclosures about Pensions and Other Postretirement Benefits", which
revision is effective for fiscal years ending after December 15, 2003. The
adoption of this revision does not have any impact on the Company's
results of operations or financial position, but requires additional
disclosures related to the Company's defined benefit plan (See Note 9).
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure", which is effective
for fiscal years ending after December 15, 2002. The provisions of this
statement provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for
stock-based employee compensation, and requires disclosure about the
effects on reported net income of an entity's accounting policy decisions
with respect to stock-based compensation. The Company did not change its
accounting method for stock-based employee compensation and, accordingly,
the provisions of this new standard did not have a material impact on its
consolidated results of operations and financial position.
Reclassification
Certain 2003 amounts related to the bankruptcy of TSI and certain other
items have been reclassified to conform to the 2004 presentation.
F-24
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
2. Investment Securities
---------------------
At November 30, 2004:
Fair Unrealized
Cost Value Holding Loss
------- ------- ------------
Equity securities included
in other assets $ 4,546 $ 2,295 ($2,251)
------- ------- -------
The Company holds a non-marketable warrant to purchase 95,238 of shares of
Talk America Holding, Inc. ("Talk") at $6.30 per share, expiring in 2005.
As of November 30, 2004, the Talk shares closed at $6.32 per share.
3. Other Investments
-----------------
The Company held shares in Cordia Corporation (Cordia), a publicly-held
company whose shares were quoted in the over-the-counter market. Cordia is
controlled by entities owned by a shareholder and former employee of the
Company and members of his family. Due to the thinly-traded nature of the
Cordia shares, such shares had not been accounted for as marketable equity
securities in accordance with Statement of Financial Accounting Standards
No. 115, but instead were carried at cost.
During the years ended November 30, 2004 and 2003, the Company sold 2,000
and 70,000 shares of Cordia stock, resulting in gains of $770 and $33,722.
The shares were sold at a significant discount to published market prices.
At November 30, 2003, the Company wrote off its remaining investment in
Cordia amounting to $71,430, because the value of the Cordia investment
was deemed to be worthless. At November 30, 2004, the Company held 81,180
shares of Cordia.
4. Property, Plant and Equipment
-----------------------------
2004
--------
Machinery and equipment $ 82,605
Computer equipment and software 448,780
Furniture and fixtures 90,452
--------
621,837
Less accumulated depreciation and amortization 429,424
--------
$192,413
--------
F-25
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
4. Property, Plant and Equipment (Continued)
-----------------------------------------
On October 8, 2003, the Company sold its New Rochelle, New York corporate
headquarters. The Company received proceeds of $2,200,000 and used
$1,100,000 of such proceeds to retire in full the mortgage note on this
property (Note 6). As a result of the sale, the Company recorded a gain of
approximately $546,000 in the fourth quarter of 2003.
The Company placed approximately $100,000 in escrow to be used to remedy
potential environmental costs. As of November 30, 2003, approximately
$91,000 remained in escrow. In 2004, all but approximately $46,000 was
returned to the Company and the balance was used to cover environmental
costs. The $45,000 expense is included in other income, net.
5. Short-Term Borrowings
---------------------
Short-term borrowings as of November 30, 2003 consisted of an unsecured
line of credit agreement with a finance company, up to $150,000, due on
demand with interest payable monthly at the prime lending rate plus 2%.
This liability was settled on April 8, 2004 as part of a Plan of
Reorganization (see Note 8).
During the year ended November 30, 2003, the Company borrowed $380,000
from certain individuals that was repaid upon the sale of the corporate
headquarters described in Note 4. Interest expense related to such
borrowings amounted to approximately $45,000, including the issuance by
the Company of 630,000 shares of common stock valued at approximately
$44,000.
6. Long-Term Debt and Capital Lease Obligations
--------------------------------------------
On December 7, 2000, the Company acquired a building in New Rochelle, New
York, which served as the Company's headquarters. The purchase price of
the building was $1,500,000, of which $1,100,000 was paid with the
proceeds of a mortgage loan from the seller, and the remainder of the
purchase price was paid in cash at closing. The mortgage loan required
interest payments only on a monthly basis through December 2005, when the
entire loan principal balance became due. The interest rate was 10%
through December 2001, and 11% for the remaining period. See Note 4
regarding sale of the building and repayment of the mortgage loan.
F-26
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
6. Long-Term Debt and Capital Lease Obligations (Continued)
--------------------------------------------------------
Long-term debt consists of the following:
2004
-------
Capital lease obligations (Note 10) $32,100
Less current maturities 32,100
-------
$ --
=======
7. Income Taxes
------------
At November 30, 2004, the Company had net operating loss carryforwards for
Federal income tax purposes of approximately $20,850,000 expiring in the
years 2008 through 2024. There is an annual limitation of approximately
$187,000 on the utilization of approximately $2,450,000 of such net
operating loss carryforwards under the provisions of Internal Revenue Code
Section 382.
At November 30, 2004, the Company's Federal net operating loss carry
forwards are scheduled to expire as follows:
Year ended November 30
2008 $ 1,110,000
2009 1,050,000
2010 1,000,000
2012 3,100,000
2018 2,710,000
2019 2,510,000
2020 2,350,000
2021 5,850,000
2022 770,000
2024 400,000
-----------
$20,850,000
===========
F-27
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
7. Income Taxes (Continued)
------------------------
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, 2004 are as follows:
2004
-----------
Deferred tax assets:
Net operating loss carryforwards $ 7,090,000
Allowance for doubtful accounts and accruals 190,000
-----------
7,280,000
Valuation allowance (7,280,000)
-----------
Net deferred tax assets $ --
===========
The following is a reconciliation of the tax provisions for the two years
ended November 30, 2004 with the statutory Federal income tax rates:
Percentage of
Pre-Tax Income
------------------
2004 2003
------ ------
Statutory Federal income tax rate 34.0% 35.0%
Utilization of net operating loss carryovers -- (34.1)
Operating losses generating no tax benefit (34.0) --
State taxes, net of Federal effect 15.3 --
Reversal of accrual for prior year items (33.3) --
====== ======
(18.0)% .9%
====== ======
For the year ended November 30, 2004, the Company recorded a tax benefit
of approximately $48,000 which resulted from the reduction of an estimated
accrual of tax expense for the year ended November 30, 2003, offset by tax
expense of $22,000 for the year ended November 30, 2004.
F-28
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
8. Subsidiary's Plan of Reorganization
-----------------------------------
On April 8, 2004, the United States Bankruptcy Court for the Southern
District of New York confirmed a Plan of Reorganization (the "Bankruptcy
Plan") for Telecarrier Services, Inc. ("TSI"). On July 29, 2002, TSI, a
wholly owned subsidiary, had filed a voluntary petition for relief under
Chapter 11 of the Federal Bankruptcy Code in the United States Bankruptcy
Court for the Southern District of New York. The Bankruptcy Plan
authorized the Company to disburse $325,000 to creditors in full
satisfaction of claims amounting to approximately $1,229,000.
For the year ended November 30, 2004, TSI reported a gain of $904,027 as a
result of being judicially released from liabilities and claims as
follows:
Pre-petition claims:
Unsecured line of credit $ 150,000
Trade payables and due to related party 618,482
Other accrued expenses 103,250
----------
Total pre-petition claims 871,732
Post-petition payables and accrued expenses 68,124
Administrative claims and legal costs 289,171
----------
Total claims 1,229,027
Distribution to creditors 325,000
----------
Gain on debt reduction $ 904,027
==========
TSI had an agreement, effective January 2, 2002, with Telco Services, Inc.
("Telco"), a corporation owned by a former shareholder of the Company,
under which Telco provided TSI with collection, sales and other services.
As a result of a court-stipulated agreement between TSI and Telco, entered
into on February 6, 2004, the amount owed Telco for such services was
reduced by approximately $51,000. Such reduction was included in the gain
on settlement with creditors for the year ended November 30, 2004. As of
November 30, 2004, all of Telco's claims related to the TSI bankruptcy had
been paid in full, including $65,000 in administrative claims and
approximately $31,000 in unsecured claims. The President of Telco is also
the President of Glad Holdings (See Note 11).
F-29
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
9. Pension Plans
-------------
The Company sponsors a defined benefit plan covering two active employees
and a number of former employees. The Company's funding policy with
respect to the defined benefit plan is to contribute annually not less
than the minimum required by applicable law and regulation to cover the
normal cost and to fund supplemental costs, if any, from the date each
supplemental cost was incurred. Contributions are intended to provide not
only for benefits attributed to service to date, but also for those
expected to be paid in the future. Plan assets consist primarily of
investments in conservative equity and debt securities. The Company uses a
November 30 measurement date for its pension plan.
Effective June 30, 1995, the plan was frozen, ceasing all benefit accruals
and resulting in a plan curtailment.
Obligations and Funded Status at November 30:
Pension Benefits 2004 2003
--------- ---------
Change in benefit obligation:
Benefit obligation at beginning of year ($820,709) ($736,717)
Interest cost (52,125) (54,086)
Actuarial loss (32,373) (41,981)
Benefits paid 38,181 12,075
--------- ---------
Benefit obligation at end of year ($867,026) ($820,709)
========= =========
Change in plan assets:
Fair value of plan assets at beginning of year $498,149 $417,601
Actual return on plan assets 31,105 7,357
Employer contribution 89,000 85,266
Benefits paid (38,181) (12,075)
--------- ---------
Fair value of plan assets at end of year $580,073 $498,149
--------- ---------
F-30
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
9. Pension Plans (Continued)
-------------------------
2004 2003
--------- ---------
Funded status ($286,953) ($322,560)
--------- ---------
Net amount recognized ($286,953) ($322,560)
========= =========
Amounts recognized in the statement of financial position consist of:
2004 2003
--------- ---------
Accrued benefit cost ($286,953) ($322,560)
--------- ---------
Net amount recognized ($286,953) ($322,560)
========= =========
The accumulated benefit obligation for the Company's defined benefit
pension plan was $867,026 and $820,709 at November 30, 2004 and 2003,
respectively.
Information required for pension plan with an accumulated benefit
obligation in excess of plan assets:
November 30
-----------------------
2004 2003
--------- ---------
Projected benefit obligation ($867,026) ($820,709)
Accumulated benefit obligation ($867,026) ($820,709)
Fair value of plan assets $580,073 $498,149
Components of Net Periodic Benefit Cost:
2004 2003
--------- ---------
Interest cost $ 52,125 $ 54,086
Expected return on plan assets (41,390) (35,411)
Amortization of net loss 37,356 34,057
--------- ---------
Net periodic benefit cost $ 48,091 $ 52,732
========= =========
F-31
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
9. Pension Plans (Continued)
-------------------------
Assumptions
Weighted-average assumptions used to
determine net periodic benefit cost
November 30:
2004 2003
------- -------
Discount rate 6.25% 7.00%
Expected long-term return on plan assets 8.00% 8.00%
Rate of compensation increase -- --
The expected return on Plan assets should remain constant from year to
year since the long-term expectation should not change significantly based
on a single year's experience. A rate of 8% was adopted for this purpose.
Plan Assets
The Company's pension plan weighted-average asset allocations at November
30, 2004 and 2003, by asset category are as follows:
November 30
-----------------
2004 2003
----- -----
Asset Category
Equity securities 51.8% 57.1%
Debt securities 22.0% 27.8%
Other 26.2% 15.1%
----- -----
Total 100.0% 100.0%
===== =====
The current investment policy for pension plan assets is to reduce
exposure to equity market risks. The current strategy for Plan assets is
to invest in conservative equity and debt securities. The Plan also
maintains a significant cash balance.
Equity securities include the Company's common stock in the amounts of
approximately $5,400 and $3,900 at November 30, 2004 and 2003.
F-32
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
9. Pension Plans (Continued)
-------------------------
Cash Flows - Contributions
The Company expects to contribute approximately $100,000 to its defined
benefit plan in fiscal 2005.
Estimated Future Benefit Payments
The following pension benefit payments are expected to be paid:
2005 $ 17,672
2006 19,852
2007 42,137
2008 46,176
2009 55,992
2010 - 2014 306,881
Defined Contribution Plan
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.
There were no contributions made for the years ended November 30, 2004 and
2003.
F-33
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
10. Commitments
-----------
Operating Leases
The Company leases its offices under noncancelable operating lease
agreements which expire through 2009.
Rent expense was approximately $82,000 and $67,000 in 2004 and 2003,
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 commitments under all operating leases that have
remaining non-cancelable terms in excess of one year are approximately as
follows:
Year ended November 30,
-----------------------
2005 $160,000
2006 162,000
2007 139,000
2008 96,000
2009 6,000
--------
$563,000
========
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 12.4% to 20.2%.
The capitalized cost and accumulated depreciation included in property and
equipment was as follows:
2004
-------
Cost $69,567
Accumulated depreciation 69,567
-------
$ --
=======
F-34
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
10. Commitments (Continued)
-----------------------
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,
-----------------------
2005 $40,689
Less amount representing interest 8,589
-------
Present value of future minimum
lease payments (Note 6) $32,100
=======
Other Commitments
In January 2005, the Company entered into a minimum purchase agreement
with a wholesale VOIP (Voice Over Internet Protocol) provider. The
agreement requires minimum fees aggregating approximately $108,000 through
January 2006.
11. Related Party Transactions
--------------------------
TSI has an agreement, effective January 2, 2002, with Telco Services, Inc.
("Telco"), a corporation owned by a former 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 $21,127 for the year ended November 30, 2003. The President of
Telco is also the President of Glad Holdings LLC ("Glad Holdings") (see
Note 12).
During the years ended November 30, 2004 and 2003, the Company billed
Cordia, a related party (see Note 3), $338,087 and $197,224 for rent,
telemarketing services, commissions, and other costs. Cordia billed the
Company $585,397 and $ 395,232 for the years ended November 30, 2004 and
2003 for telecommunications services and other costs. As of November 30,
2004, the Company owed Cordia $59,384.
F-35
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
12. 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 Communications
Inc., ("Essex") a former wholly-owned subsidiary, (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 entered into an agreement with
Verizon that provided a payment schedule for the liabilities assumed from
Essex and Verizon granted EAC a discount on the assumed liabilities
provided EAC adhered to the payout schedule. EAC also paid the Company
$270,000 to reimburse the Company for amounts paid by the Company to
Essex's lender. The sale closed on December 31, 2002. As the creditors of
Essex did not consent to the assignment of their claims, Essex had
remained liable for substantially all the obligations assumed in the sale
until such time as they were paid. The June 30, 2002 unaudited financial
statements of Biz indicated that Biz had a stockholders' equity deficiency
of approximately $20,500,000 and had negative working capital of
approximately $3,500,000. The most recent independent auditor's report of
Biz expressed significant doubt about Biz's ability to continue as a going
concern. These factors indicated that there was significant uncertainty as
to Biz and its subsidiaries' ability to repay the obligations described
above. Accordingly, the Company did not record any gain until Essex was
released from the assumed obligations. During the period December 1, 2002
through September 11, 2003, EAC had settled liabilities of approximately
$3,511,000 and accordingly, gain was recorded for such amount.
On September 11, 2003, the Company sold all the outstanding capital stock
of Essex to Glad Holdings (see Note 11), a New Jersey limited liability
company, for an aggregate purchase price of $100 and a general release
from Glad Holdings with respect to any and all matters arising prior to
September 11, 2003. The Company, based on all available information and
consultation with counsel, concluded that it was unlikely that any
creditor of Essex would be able to hold the Company responsible for any
debts or liabilities of Essex. As a result thereof, the Company believed
it had been released of all the liabilities related to Essex, which
amounted to approximately $7,314,000 on such date, and accordingly,
recorded such amount as gain in the fourth quarter fiscal of 2003.
F-36
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
12. Asset Sale (Continued)
----------------------
The following unaudited pro forma summary presents information as if the
sale of Essex's assets had occurred at the beginning of the year ended
November 30, 2003. 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:
2003
-----------
(Unaudited)
-----------
Revenues $4,674,808
-----------
Net loss ($2,106,605)
-----------
Basic and diluted loss per share ($ .13)
===========
13. Accounts payable and accrued expenses
-------------------------------------
As of November 30, 2004 approximately $198,000 of liabilities related to
the discontinued luggage business remain on the Company's balance sheet
under the capiton accounts payable and accrued expenses. There has not
been any demand for payment of liabilities. The Company intends to reverse
these liabilities in 2006 when the statute of limitations expires if
payment is not demanded.
F-37
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
14. Stockholders' Equity
--------------------
The Company was authorized to issue up to 1,300 shares of Series B
Preferred stock $.10 par value, and such stock was entitled to receive
dividends when as, and if dividends were declared by the Company on its
common stock. Each holder of Series B preferred stock had the right, at
the option of the holder, to convert each share of such stock into 1,000
shares of common stock. The holders of shares of Series B preferred stock
were 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.
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. During 2003, the remaining Series B shareholder converted
its shares to common shares, resulting in the issuance of 16,000 shares of
common stock.
The following is a summary of outstanding options:
Weighted-
Average
Number Exercise Price Exercise
of Shares Per Share Price
--------- -------------- ---------
Outstanding December 1, 2002 1,618,453 $.05 - $4.88 $1.60
Granted during year ended
November 30, 2003 740,000 $.10 $ .10
Canceled during year ended
November 30, 2003 (635,119) $.58 - $4.88 $1.91
----------
Outstanding November 30, 2003 1,723,334 $.05 - $2.50 $ .84
Granted during year ended
November 30, 2004 2,185,000 $.16 - $.28 $ .23
Canceled during year ended
November 30, 2004 (435,834) $.10 - $2.25 $1.35
----------
Outstanding November 30, 2004 3,472,500 $.05 - $2.50 $ .40
----------
Options exercisable,
November 30, 2004 937,500 $.05 - $2.50 $ .40
----------
Options exercisable,
November 30, 2003 621,334 $.72 - $2.50 $1.43
----------
F-38
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
14. Stockholders' Equity (Continued)
--------------------------------
The following table summarizes information about the options outstanding
at November 30, 2004:
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 2,976,500 4.44 $ .22 791,500 $ .17
$1.41 - $1.44 470,000 1.00 $ 1.41 120,000 $ 1.43
$1.41 - $2.50 26,000 .48 $ 2.50 26,000 $ 2.50
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 have 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 2004 and 2003.
As of November 30, 2004 and 2003, 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.
15. Net Income Per Common Share
---------------------------
Net income per common share data was computed as follows:
2004 2003
----------- -----------
Net income $ 170,253 $ 8,323,211
=========== ===========
Weighted average common shares outstanding 16,254,282 15,771,219
Effect of dilutive securities, stock options and preferred stock 461,526 70,722
----------- -----------
Weighted average dilutive common shares outstanding 16,715,808 15,841,941
=========== ===========
Net income per common share - basic $ .01 $ .53
=========== ===========
Net income per common share - diluted $ .01 $ .53
=========== ===========
F-39
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
16. Subsequent Events
-----------------
On December 17, 2004, the Company sold a promissory note ("Note") in the
principal amount of $328,767 and 160,000 shares of restricted common stock
of the Company to an unaffiliated party for $300,000. The Note is payable
on December 17, 2005 and is unsecured. The Note requires the Company to
expend the proceeds of the Note on sales and marketing efforts.
On February 8, 2005, the Company consummated a private placement pursuant
to which the Company issued a secured convertible term note in the
principal amount of $2,000,000 (the "Convertible Note"), and the Company
issued a common stock purchase warrant (the "Warrant") to the holder of
the Convertible Note, exercisable at any time through February 8, 2012, to
purchase up to 793,650 shares of the Company's common stock, par value
$.10 per share (the "Common Stock"). The exercise price is $.72 for the
first 264,550 shares, $.79 for the next 264,550 shares, and $.95 for any
additional shares. The proceeds received by the Company, net of related
fees and expenses was approximately $1,744,000. The Company agreed to use
the proceeds only for marketing, general working capital and general
business purposes. Interest on the Convertible Note is payable monthly on
the first day of each month during the term of the Convertible Note, at 3%
above the prime rate commencing March 1, 2005. Commencing May 1, 2005, the
Company is required to make monthly principal payments of $60,606 per
together, with any accrued and unpaid interest payable on such date, the
"Monthly Payment Amount". All or a portion of the outstanding principal
and interest due under the Convertible Note shall be paid in shares of
Common Stock upon satisfaction of certain conditions. The Convertible Note
is initially convertible into shares of Common Stock at a price of $0.63
per share (together with any adjustments, the "Fixed Conversion Price").
The Fixed Conversion Price is subject to anti-dilution protection
adjustments, on a weighted average basis, upon the Company's issuance of
additional shares of Common Stock at a price that is less than the
then-current Fixed Conversion Price. This agreement prohibits the payment
of any dividends as long as the Convertible Note remains outstanding. The
Convertible Note is secured by a blanket lien on substantially all of the
Company's assets and the common stock of all subsidiaries, and contains
prepayment penalty provisions.
F-40
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
16. Subsequent Events (Continued)
-----------------------------
Absent earlier redemption by the Company or earlier conversion by the
investor, the Convertible Note originally matured on February 8, 2006.
Since the Company entered into a service provider agreement with a
wholesale telephone service provider, the maturity date of the Convertible
Note has been extended to February 8, 2008.
On February 24, 2005, New Rochelle Telephone Company ("NRTC"), a
wholly-owned subsidiary of the Company, completed its negotiations with
Verizon Services Corp. ("Verizon") and signed a Wholesale Advantage
Services Agreement (the "Agreement"). The Agreement is a long-term
commercial alternative to the unbundled network elements platform
("UNE-P") and allows NRTC to purchase from Verizon wholesale dial tone
services on terms that preserve, in all material respects, the features,
functionality and ordering processes previously available to NRTC under
Verizon's UNE-P service offering. The rates and charges for such services
are fixed at agreed upon price levels that should allow NRTC to continue
to offer its existing telephone services at competitive prices. Pursuant
to the Agreement, NRTC and the Company are required to keep confidential
all additional terms and provisions of the Agreement. The Company has
minimum line commitments in connection with the agreement.
17. Risks and Uncertainties
-----------------------
The Company buys substantially all of the telecommunication services that
it resells from Regional Bell Operating Companies ("RBOC's"), and long
distance carriers and is, therefore, highly dependent upon them. The
Company believes that its relationships with them are satisfactory. The
Company believes 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 such vendors 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.
F-41
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
17. Risks and Uncertainties (Continued)
-----------------------------------
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.
- 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 upon
whom the Company relies for services and revenues.
- Lack of capital or borrowing capacity, and inability to generate
cash flow.
F-42
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
18. Fourth Quarter Adjustments (Unaudited)
--------------------------------------
During the fourth quarter of the year ended November 30, 2004, the Company
made a year-end adjustment that was material to the results of the fourth
quarter. The net effect of the year-end adjustment was to increase net
income in the fourth quarter by approximately $115,000, to record as
recoverable certain telecommunication excise taxes previously expensed as
part of cost of sales.
F-43
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 24. Indemnification of Directors and Officers
Reference is made to Sections 721 through 725 of the Business Corporation
Law of the State of New York (the "BCL"), which provides for indemnification of
directors and officers of New York corporations under certain circumstances.
Section 722 of the BCL provides that a corporation may indemnify directors
and officers as well as other employees and individuals against judgments,
fines, amounts paid in settlement and reasonable expenses, including attorneys'
fees, in connection with actions or proceedings, whether civil or criminal
(other than an action by or in the right of the corporation, a "derivation
action"), if they acted in good faith and in a manner they reasonably believed
to be in or not opposed to the best interests of the corporation, and, with
respect to any criminal action or proceeding, had no reasonable cause to believe
their conduct was unlawful. A similar standard is applicable in the case of
derivative actions, except that indemnification only extends to amounts paid in
settlement and reasonable expenses (including attorneys' fees) incurred in
connection with the defense or settlement of such actions, and the statute does
not apply in respect of a threatened action, or a pending action that is settled
or otherwise disposed of, and requires court approval before there can be any
indemnification where the person seeking indemnification has been found liable
to the corporation. Section 721 of the BCL provides that Article 7 of the BCL is
not exclusive of other indemnification that may be granted by a corporation's
certificate of incorporation, disinterested director vote, shareholders vote,
agreement or otherwise.
Article XII of the Registrant's by-laws requires the Registrant to
indemnify its officers and directors to the fullest extent permitted under the
BCL. Article XII of the Registrant's by-laws further provides that no director
of the Registrant shall be personally liable to the Registrant or its
shareholders for monetary damages for breach of fiduciary duty as a director,
except that no indemnification shall be made in respect of (1) a threatened
action, or a pending action which is settled or otherwise disposed of, or (2)
any claim, issue or matter as to which such person shall have been adjudged to
be liable to the Registrant unless and only to the extent that the court in
which such action or suit was brought or, if no action was brought, any court of
competent jurisdiction determines upon application that, in view of all the
circumstances of the case, such person is fairly and reasonably entitled to
indemnity for such portion of the settlement and expenses as the court deems
proper.
Section 402(b) of the BCL provides that a corporation's certificate of
incorporation may include a provision that eliminates or limits the personal
liability of the corporation's directors to the corporation or its shareholders
for damages for any breach of a director's duty, provided that such provision
does not eliminate or limit (1) the liability of any director if a judgment or
other final adjudication adverse to the director establishes that the director's
acts or omissions were in bad faith or involved intentional misconduct or a
knowing violation of law or that the director personally gained a financial
profit or other advantage to which the director was not legally entitled or that
the director's acts violated Section 719 of the BCL; or (2) the liability of any
director for any act or omission prior to the adoption of a provision authorized
by Section 402(b) of the BCL. Article Sixth of the Registrant's Certificate of
Incorporation, as amended, provides that no director of the Registrant shall be
liable to the Registrant or its shareholders for any breach of duty in such
capacity except as provided in Section 402(b) of the BCL.
Any amendment to or repeal of the Registrant's Certificate of
Incorporation or by-laws shall not adversely affect any right or protection of a
director or officer of the Registrant for or with respect to any acts or
omissions of such director or officer occurring prior to such amendment or
repeal.
43
The Registrant maintains directors and officers insurance which, subject
to certain exclusions, insures the directors and officers of the Registrant
against certain losses which arise out of any neglect or breach of duty
(including, but not limited to, any error, misstatement, act, or omission) by
the directors or officers in the discharge of their duties, and insures the
Registrant against amounts which it has paid or may become obligated to pay as
indemnification to its directors and/or officers to cover such losses.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers or persons controlling the
Registrant pursuant to the foregoing, the Registrant has been informed that in
the opinion of the SEC such indemnification is against public policy as
expressed in the Securities Act and is therefore unenforceable.
Item 25. Other Expenses of Issuance and Distribution
The following table sets forth the expenses expected to be incurred by us
in connection with the issuance and distribution of the common stock registered
hereby, all of which expenses, except for the Securities and Exchange Commission
registration fee, are estimates:
Description Amount
------
Securities and Exchange Commission registration fee $ 276
Accounting fees and expenses 5,000*
Legal fees and expenses 35,000*
Miscellaneous fees and expenses 1,724*
-------
Total $42,000
=======
-------------
* Estimated
Item 26. Recent Sales of Unregistered Securities
In February 2005, we issued a secured convertible term note (the
"Convertible Term Note") in the principal amount of $2,000,000 to Laurus Master
Fund, Ltd. ("Laurus"). The Convertible Term Note is convertible into shares of
our common stock at a fixed conversion price of $0.63 per share of common stock.
We also issued Laurus a warrant (the "Laurus Warrants") to purchase up to
793,650 shares of our common stock, at an exercise price of (i) $0.72 per share
for the first 264,550 shares acquired; (ii) $0.79 per share for the next 264,550
shares acquired and (iii) $0.95 per share for the remaining shares acquired. The
Laurus Warrants expire on February 8, 2012. The Convertible Term Note and the
warrant were issued in reliance on the exemption from registration provided by
Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"),
on the basis that their issuance did not involve a public offering, no
underwriting fees or commissions were paid by us in connection with such sale
and Laurus represented to us that it was an "accredited investor," as defined in
the Securities Act.
In February 2005, we paid to Source Capital Group, Inc. ("Source
Capital"), in consideration of the introduction made by Source Capital of Laurus
to the Company, a finder's fee in the amount of $160,000 and issued to or at the
direction of Source Capital common stock purchase warrants (the "Source
Warrants") to purchase up to an aggregate of 253,968 shares of common stock at
an exercise price of $0.63 per share. The Source Warrants expire on February 8,
2009. The Source Warrants were issued in reliance on the exemption from
registration provided by Section 4(2) of the Securities Act, on the basis that
their issuance did not involve a public offering and satisfied the conditions of
Rule 506 of
44
the Securities Act, and Source Capital represented to us that it is an
"accredited investor," as defined in the Securities Act.
In December 2004, we sold 160,000 shares of our stock in conjunction with
the sale of a promissory note in the principal amount of $328,767.12 to an
unaffiliated third party for an aggregate purchase price of $300,000. Such
shares were issued in reliance upon the exemption from registration provided by
Section 4(2) of the Securities Act, 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 unaffiliated third party represented to
us that he was an "accredited investor" as defined in Regulation D under the
Securities Act.
In August 2003 and October 2003, we issued an aggregate of 450,000 and
180,000 shares of our common stock, respectively, to three investors in
conjunction with certain financing agreements as interest expense. Such shares
were issued in reliance upon the exemption from registration provided by Section
4(2) of the Securities Act, 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 recipients were "accredited investors" as defined in
Regulation D under the Securities Act of 1933, as amended.
Item 27. Exhibits
(3) Articles of Incorporation and By-laws
(a) Certificate of Incorporation, as amended, incorporated by reference
to our 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 our definitive proxy statement filed
with the Securities and Exchange Commission in connection with our
Annual Meeting of Shareholders held in May 1984.
(c) Certificate of Amendment to the Certificate of Incorporation,
incorporated by reference to Exhibit 3(b) to our 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 our 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 our Quarterly Report on
Form 10-Q for the quarter ended August 30, 1995.
(f) Certificate of Amendment of the Certificate of Incorporation,
incorporated by reference to Exhibit 3(f) to our Annual Report on
Form 10-K for the year ended November 30, 1998.
(g) Certificate of Amendment of the Certificate of Incorporation,
incorporated by reference to Exhibit 3.2 to our 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 our 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 our Annual Report on Form 10-K for the
year ended November 30, 1996.
(5) Opinion re: Legality
(a) Opinion of Pryor Cashman Sherman & Flynn LLP.*
--------------------
* Previously filed.
45
(10) Material Contracts
(a) 1995 Stock Option Plan, incorporated by reference to Exhibit 10(I)
to our 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 our Proxy Statement dated October 24, 1996.
(c) Non-Employee Director Stock Option Plan, dated March 30, 2001,
incorporated by reference to Exhibit 10(c) to our Annual Report on
Form 10-KSB for the year ended November 30, 2003.
(d) Lease Agreement between South Broadway WP, LLC, Landlord, and New
Rochelle Telephone Corp., Tenant, dated August 2003, incorporated by
reference to Exhibit 10(d) to our Annual Report on Form 10-KSB for
the year ended November 30, 2003.
(e) Office Lease between Lexin Celebration, LLC, as Landlord, and VoX
Communications Corp., as Tenant, dated January 25, 2005,
incorporated by reference to Exhibit 10(e) to our Annual Report on
Form 10-KSB for the year ended November 30, 2004.
(f) Securities Purchase Agreement, dated as of February 8, 2005, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.1 to our Current Report on Form 8-K dated
February 8, 2005.
(g) Secured Convertible Term Note, dated as of February 8, 2005, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.2 to our Current Report on Form 8-K dated
February 8, 2005.
(h) Master Security Agreement, dated as of February 8, 2005, among us,
New Rochelle Telephone Corp., Telecarrier Services, Inc., VoX
Communications Corp., Line One, Inc., AVI Holding Corp. and
TelcoSoftware.com Corp. in favor of Laurus Master Fund, Ltd.,
incorporated by reference to Exhibit 10.3 to our Current Report on
Form 8-K dated February 8, 2005.
(i) Stock Pledge Agreement, dated as of February 8, 2005, executed by
eLEC Communications Corp. in favor of Laurus Master Fund, Ltd.,
incorporated by reference to Exhibit 10.4 to our Current Report on
Form 8-K dated February 8, 2005.
(j) Subsidiary Guaranty, dated as of February 8, 2005, executed by New
Rochelle Telephone Corp., Telecarrier Services, Inc., VoX
Communications Corp., Line One, Inc., AVI Holding Corp. and
TelcoSoftware.com Corp., incorporated by reference to Exhibit 10.5
to our Current Report on Form 8-K dated February 8, 2005.
(k) Registration Rights Agreement, dated as of February 8, 2005, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.6 to our Current Report on Form 8-K dated
February 8, 2005.
(l) Common Stock Purchase Warrant, dated as of February 8, 2005, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.7 to our Current Report on Form 8-K dated
February 8, 2005.
(m) Form of Common Stock Purchase Warrant, dated as of February 8, 2005,
issued by eLEC Communications Corp. to or on the order of Source
Capital Group, Inc., incorporated by reference to Exhibit 10.8 to
our Current Report on Form 8-K dated February 8, 2005.
(22) Subsidiaries - The significant wholly-owned subsidiaries are as follows:
Name Jurisdiction of Organization
---- ----------------------------
New Rochelle Telephone Corp. New York
Telecarrier Services, Inc. Delaware
VoX Communications Corp Delaware
(23) Consent of Experts and Counsel
46
(a) Consent of Nussbaum, Yates & Wolpow, P.C.1
(b) Consent of Pryor Cashman Sherman & Flynn LLP (included in their
opinion filed as Exhibit 5(a))
(24) Powers of Attorney
(a) Powers of Attorney of certain officers and directors of the Company
(included on the signature page of this Registration Statement as
originally filed on March 30, 2005).
Item 28. Undertakings
Insofar as indemnification for liabilities arising under the Securities Act of
1933, as amended (the "Securities Act") may be permitted to directors, officers
and controlling persons of the Company, we have been advised that in the opinion
of the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by the Company in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, we will, unless in the opinion
of our counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Securities Act and will be
governed by the final adjudication of such issue.
The undersigned Company hereby undertakes that:
(1) To file, during any period in which it offers or sells securities, a
post-effective amendment to this Registration Statement to:
(i) Include any prospectus required by Section 10(a)(3) of the Securities
Act;
(ii) Reflect in the prospectus any facts or events which, individually or
together, represent a fundamental change in the information set forth in
the Registration Statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than a 20% change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in
the effective Registration Statement;
(iii) Include any additional or changed information on the plan of
distribution.
(2) For determining liability under the Securities Act, the Company will
treat each such post-effective amendment as a new Registration Statement of the
securities offered, and the offering of such securities at that time to be the
initial bona fide offering.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
(4) For determining any liability under the Securities Act, treat each
post-effective amendment
--------------------
47
that contains a form of prospectus as a new Registration Statement for the
securities offered in the Registration Statement, and that offering of the
securities at that time as the initial bona fide offering of those securities.
48
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it met all
the requirements of filing on Form SB-2 and authorized this Amendment No. 2 to
Registration Statement to be signed on its behalf by the undersigned, in White
Plains, New York on June 7, 2005.
eLEC COMMUNICATIONS CORP.
By: /s/Paul H. Riss
-----------------------
Paul H. Riss
Chief Executive Officer
In accordance with the requirements of the Securities Act of 1933, this
Amendment No. 2 to Registration Statement was signed by the following persons in
the capacities and on the dates stated.
Signature Title Date
/s/Paul H. Riss Chairman of the Board, Chief Executive June 7, 2005
---------------------------- Officer and Chief Financial Officer
Paul H. Riss (principal financial officer, principal
accounting officer and principal
executive officer)
* Director June 7, 2005
----------------------------
Michael H. Khalilian
* Director June 7, 2005
----------------------------
Greg M. Cooper
* Director June 7, 2005
----------------------------
Gayle Greer
*By: /s/Paul H. Riss
------------------------
Paul H. Riss
Attorney-in-fact
49