SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended May 31, 2003.
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from to .
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Commission file number 0-4465
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eLEC Communications Corp.
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( Name of Small Business Issuer as Specified in Its Charter)
New York 13-2511270
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(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
543 Main Street New Rochelle, New York 10801
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(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number, Including Area Code 914-633-6500
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
--- ---
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: 15,608,282 shares of
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Common Stock, par value $.10 per share, as of July 1, 2003.
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PART 1. FINANCIAL INFORMATION
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Item 1. Financial Statements
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eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Balance Sheet
May 31, 2003
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(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 333,289
Accounts receivable, net 344,912
Investment securities 36,997
Other investments 29,113
Prepaid expenses and other current assets 428,351
------------
Total current assets 1,172,662
Property, plant and equipment, net 1,758,486
Other assets 43,170
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Total assets $ 2,974,318
============
Liabilities and stockholders' equity deficiency
Current liabilities:
Short-term borrowings $ 150,000
Current maturities of long-term debt and capital lease obligations 24,138
Accounts payable and accrued expenses 4,038,389
Due to related party 59,286
Liabilities assumed in sale 7,021,713
------------
Total current liabilities 11,293,526
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Long-term debt and capital lease obligations, less current
maturities 1,127,803
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Stockholders' equity deficiency:
Preferred stock, $.10 par value, 1,000,000 shares authorized
Series B issued, 16 shares, liquidation preference $1,000 per
share 2
Common stock $.10 par value, 50,000,000 shares authorized,
15,619,282 shares issued 1,561,928
Capital in excess of par value 25,671,342
Deficit (36,682,660)
Treasury stock at cost, 11,000 shares (27,500)
Accumulated other comprehensive income, unrealized gain on
securities 29,877
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Total stockholders' equity deficiency (9,447,011)
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Total liabilities and stockholders' equity deficiency $ 2,974,318
============
See notes to the condensed consolidated financial statements
2
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
(Unaudited)
For the Six Months Ended For the Three Months Ended
May 31, 2003 May 31, 2002 May 31, 2003 May 31, 2002
------------ ------------ ------------ ------------
Revenues $ 2,500,445 $ 8,175,683 $ 1,153,416 $ 3,700,591
------------ ------------ ------------ ------------
Costs and expenses:
Costs of services 1,337,129 5,484,594 579,434 2,454,267
Selling, general and administrative 2,780,871 5,039,292 1,247,456 2,571,063
Depreciation and amortization 63,643 136,219 32,827 82,084
------------ ------------ ------------ ------------
Total costs and expenses 4,181,643 10,660,105 1,859,717 5,107,414
------------ ------------ ------------ ------------
Loss from operations (1,681,198) (2,484,422) (706,301) (1,406,823)
------------ ------------ ------------ ------------
Other income (expense):
Interest expense (69,444) (298,903) (34,357) (154,046)
Interest and other income 164,680 10,603 79,622 6,098
Gain on sale of assets 2,256,855 -- 659,966 --
Gain on sale of investment securities and
other investments 83,761 684,233 49,925 630,952
------------ ------------ ------------ ------------
2,435,852 395,933 755,156 483,004
------------ ------------ ------------ ------------
Net income (loss) 754,654 (2,088,489) 48,855 (923,819)
Other comprehensive income - unrealized
income on marketable securities 4,226 514,817 13,796 483,721
------------ ------------ ------------ ------------
Comprehensive income (loss) $ 758,880 ($ 1,573,672) $ 62,651 ($ 440,098)
============ ============ ============ ============
Basic and diluted earnings (loss) per share $ 0.05 ($ 0.13) $ 0.00 ($ 0.06)
============ ============ ============ ============
Weighted average number of common shares
outstanding
Basic 15,608,282 15,606,079 15,608,282 15,608,282
============ ============ ============ ============
Diluted 15,629,293 15,606,079 15,632,209 15,608,282
============ ============ ============ ============
See notes to the condensed consolidated
financial statements.
3
eLEC Communications Corp. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Six Months Ended
May 31, 2003 May 31, 2002
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Net cash (used in) provided by operating activities: ($ 745,399) $ 870,480
----------- -----------
Cash flows from investing activities:
Proceeds from sale of investment securities and other investments 153,227 679,162
Proceeds from the sale of property and equipment 15,650 4,000
Proceeds from note 29,102 29,108
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Net cash provided by investing activities 197,979 712,270
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Cash flows from financing activities:
Repayment of long-term debt (57,819) (1,750,486)
Proceeds from exercise of stock options -- 45,000
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Net cash used in financing activities (57,819) (1,705,486)
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Decrease in cash and cash equivalents (605,239) (122,736)
Cash and cash equivalents at beginning of period 938,528 797,616
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Cash and cash equivalents at the end of period $ 333,289 $ 674,880
=========== ===========
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $ 69,444 $ 302,433
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See notes to the condensed consolidated financial statements.
4
eLEC COMMUNICATIONS CORP.
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Notes To Condensed Consolidated Financial Statements (Unaudited)
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Note 1-Basis of Presentation
----------------------------
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB of Regulation
S-B. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the six-month period ended May 31, 2003 are not
necessarily indicative of the results that may be expected for the year ended
November 30, 2003. For further information, refer to the consolidated financial
statements and footnotes thereto included in our Annual Report on Form 10-KSB
for the year ended November 30, 2002.
Note 2-Principal Financing Arrangements
---------------------------------------
Our financing arrangements consist of a mortgage loan of $1.1 million due in
December 2005, with monthly payments of interest only at the rate of 11% per
annum, and no prepayment penalty, and a $150,000 working capital loan to our
wholly-owned subsidiary, Telecarrier Services, Inc. ("Telecarrier"), which filed
for relief under Chapter 11 of the United States Bankruptcy Code. See Note 7.
Note 3-Investment Securities
----------------------------
Details as to investment securities at May 31, 2003 are as follows:
Fair Unrealized
Cost Value Holding Gain
---- ----- ------------
Equity securities $7,120 $36,997 $29,877
Our investment securities consisted of 4,143 common shares of Talk America
Holdings Inc. ("Talk") valued at $8.93 per share at May 31, 2003.
Note 4-Major Customer
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During the three and six months ended May 31, 2003 and 2002, no one customer
accounted for more than 10% of revenue.
Note 5-Income Taxes
-------------------
At November 30, 2002, we had net operating loss carryforwards for Federal income
tax purposes of approximately $24,000,000 expiring in the years 2003 through
2022. There is an annual limitation of approximately $187,000 on the utilization
of approximately $1,500,000 of such net operating loss carryforwards under the
provisions of Internal Revenue Code Section 382.
5
Note 6- Earnings (Loss) Per Common Share
----------------------------------------
Basic earnings (loss) per common share is calculated by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted earnings (loss) per share is calculated by dividing net income
(loss) by the sum of the weighted average number of common shares outstanding
plus all additional common shares that would have been outstanding if
potentially dilutive securities had been issued unless such inclusion reduced
the loss per share. A reconciliation of the shares used in the computation of
our basic and diluted earnings (loss) per common share for the six and three
months ended May 31, 2003 and 2002 is as follows:
Six Months Ended
May 31,
2003 2002
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Weighted average common shares outstanding 15,608,282 15,609,079
Dilutive effect of securities 21,011 -
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15,629,293 15,606,079
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Three Months Ended
May 31,
2003 2002
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Weighted average common shares outstanding 15,608,282 15,608,282
Dilutive effect of securities 23,927 -
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15,632,209 15,608,282
============ ===========
For the six months ended May 31, 2003 and May 31, 2002, the computation of
diluted earnings (loss) per share excludes the effect of the assumed exercise of
approximately 1,750,000 and 3,000,000 stock options, warrants and convertible
preferred stock that were outstanding because the effect would be anti-dilutive.
Note 7-Petition for Relief Under Chapter 11
-------------------------------------------
On July 29, 2002 (the "Petition Date"), Telecarrier, our wholly-owned
subsidiary, which has licenses to resell local and long distance service in four
states, filed a voluntary petition for relief under Chapter 11 of the federal
bankruptcy laws in the United States Bankruptcy Court for the Southern District
of New York and was assigned Case No. 02-20379 (ASH). Under Chapter 11, certain
claims (liabilities subject to compromise) against Telecarrier in existence
prior to the Petition Date are stayed while Telecarrier continues business
operations as a debtor-in-possession. Additional claims (liabilities subject to
compromise) may arise subsequent to the filing date resulting from rejection of
executory contracts, including equipment leases, and from the determination by
the court (or agreed to by parties in interest) of allowed claims for
contingencies and other disputed amounts. A claim for $150,000, which a lender
maintains is secured by Telecarrier's assets (See Note 2), is also stayed,
although the claimant has the right to move the Court for relief from the stay.
As of May 31, 2003, Telecarrier had total assets of approximately $494,000 and
total liabilities of approximately $1,196,000, of which approximately $871,000
represented pre-petition
6
liabilities and approximately $325,000 represented post-petition liabilities.
Pre-petition liabilities subject to compromise are reflected below:
Line of credit $150,000
Trade payables 618,000
Other accrued expenses 103,000
Note 8-Legal Proceedings
------------------------
Our wholly-owned subsidiary, Essex Communications Inc. ("Essex"), is a party to
several legal actions over amounts owed to creditors. While legal counsel is
unable to predict the outcome of these actions, we believe such actions will not
result in a liability that will have a material adverse effect on our
consolidated financial condition. Any judgment against Essex, however, could
result in the liquidation of Essex, as it no longer has any significant liquid
assets that can be utilized to settle any judgments. The legal actions are
seeking aggregate damages of approximately $1,600,000 from Essex. Essex has
counterclaims for the actions and it has accrued payables of approximately
$250,000, which the management of Essex believes is a amount sufficient to
settle such claims. See Note 10 below regarding the sale of assets by Essex on
December 31, 2002.
Included in the legal proceedings against Essex is an action taken by a former
lessor against both Essex and us for failure to pay rent under a sublease
agreement. In April 2003, we received a summons filed in the Supreme Court of
the State of New York, County of Suffolk seeking unpaid rent of approximately
$134,000 plus interest, legal fees and other fees.
Note 9-Risks and Uncertainties
------------------------------
We buy substantially all of our telecommunication services from Regional Bell
Operating Companies ("RBOCs"), and are, therefore, highly dependent upon them.
We believe our relationship with the RBOCs from which we purchase services is
satisfactory. We also believe there are less desirable suppliers of
telecommunication services in the geographical locations in which we conduct
business. In addition, we are at risk to price increases in the rates RBOCs
charge us, which are determined by individual state public service commissions.
In light of the foregoing, it is possible that the loss of one or more of our
relationships with the RBOCs or a significant unfavorable change in the state
pricing regulations would have a severe near-term impact on our ability to
conduct our telecommunications business.
Future results of operations involve a number of risks and uncertainties.
Factors that could affect future operating results and cash flows and cause
actual results to vary materially from historical results, include, but are not
limited to: - Our business strategy with respect to bundled local and long
distance services may not succeed.
- Failure to manage, or difficulties in managing, our growth, operations or
restructurings, including attracting and retaining qualified personnel and
opening up new territories for its service with favorable gross margins.
- Dependence on the availability or functionality of incumbent local
telephone companies' networks, as they relate to the unbundled network
element platform or the resale of such services.
7
- Increased price competition in local or long distance service.
- Failure or inteHrruption in our network or information systems. - - Changes
in government policy, regulation or enforcement. - - Failure of our
collection management system and credit controls efforts for customers.
- Inability to adapt to technological change.
- Competition in the telecommunications industry.
- Inability to manage customer attrition or bad debt expense. - - Adverse
change in our relationship with third party carriers.
- Failure or bankruptcy of other telecommunications companies upon which we
rely for services and revenues.
- Our operations are currently using cash, and our cash position is
deteriorating. We may run out of cash and be unable to conduct business.
Note 10-Asset Sale
------------------
On September 3, 2002, we entered into an agreement with Essex Acquisition Corp.
("EAC"), a wholly-owned subsidiary of BiznessOnline.com, Inc. ("Biz"), to sell
substantially all the assets of Essex (amounting to $1,273,945 at December 31,
2002), for five dollars plus the assumption of certain liabilities of Essex
amounting to $10,552,512 at December 31, 2002, including all obligations due and
payable to Essex's largest vendor, Verizon Services Corp. ("Verizon"). EAC also
paid us $270,000 to reimburse us for amounts paid by us to Essex's former
lender, Textron Financial Corporation. The sale, which closed on December 31,
2002, is expected to result in a potential gain of approximately $9,300,000. In
connection with the acquisition, EAC entered into an agreement with Verizon that
provides a payment schedule for the Verizon liabilities assumed by EAC from
Essex. Verizon granted EAC a discount on the assumed liabilities provided EAC
adheres to the payout schedule.
The agreement with Verizon provides that Essex will remain liable for
substantially all the obligations assumed in the sale until such time as they
are paid by EAC. The last publicly available unaudited financial statements of
Biz as of June 30, 2002 indicate that Biz had a stockholders' equity deficiency
of approximately $20,500,000 and had negative working capital of approximately
$3,500,000. The most recent independent auditor's report of Biz for the calendar
year 2001 expressed significant doubt about Biz's ability to continue as a going
concern. These factors indicate there is significant uncertainty as to the
ability of Biz and its subsidiaries to repay the obligations described above.
Accordingly, we will only record gains when Verizon reports to us that EAC has
made payments to them to reduce the Essex obligations that were assumed by EAC.
In the six months ended May 31, 2003, EAC made payments to Verizon and other of
Essex's creditors of $3,530,800, which reduced the liabilities of Essex and
resulted in gains to us of approximately $2,257,000. We have been unable to
obtain other information with respect to the repayment of liabilities by EAC to
substantially all other vendors
8
and creditors other than Verizon, and accordingly, we have not recorded any gain
or other settlements, which may have been consummated during the period.
Essex has been billed for certain amounts from its service providers in certain
states, which are disputed by Essex. Essex contends that the related invoicing
of taxes, subscriber line charges and other fees and features are not in
accordance with the agreements between Essex and the service providers. At May
31, 2003 and 2002, Essex has not paid for or accrued approximately $3,200,000
and $4,000,000, respectively, of such disputed amounts. Substantially all of the
disputed liabilities are with Verizon, and have been transferred pursuant to the
asset sale. We believe Essex will prevail in these disputes if Verizon deems us
liable.
Assets and liabilities transferred to EAC, as adjusted, consisted of the
following at December 31, 2002:
Assets:
Cash $ 44,024
Accounts receivable, net 1,070,013
Property and equipment, net 35,851
Security deposits 124,057
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$ 1,273,945
=============
Liabilities:
Accounts payable and accrued expenses $ 9,671,563
Taxes payable 782,572
Capital lease obligations 98,377
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$ 10,552,512
=============
For the six months ended May 31, 2003, we recorded a gain on the transaction of
approximately $2,257,000. This gain was calculated by taking all liabilities
assumed by EAC that were paid by EAC before June 1, 2003 and subtracting the
book value of the assets transferred.
Assumed liabilities paid by EAC $3,530,800
Assets transferred to EAC 1,273,945
---------
Gain $2,256,855
==========
For the three months ended May 31, 2003, we recorded a gain on the transaction
of approximately $660,000. This gain was calculated by taking all liabilities
assumed by EAC that were paid by EAC before June 1, 2003 and subtracting the
book value of the assets transferred.
Assumed liabilities paid by EAC $739,310
Assets transferred to EAC 79,344
------
Gain $659,966
========
We will continue to recognize additional amounts of gain on the asset sale in
subsequent quarters, if and when EAC pays the liabilities it assumed from Essex.
The following unaudited pro forma summary presents consolidated financial
information of our operations for the six-month periods ended May 31, 2003 and
2002, as if the sale of Essex's
9
assets had occurred at the beginning of each period presented. The pro forma
amounts include certain adjustments that eliminate all the operations of Essex
for the periods presented. The pro forma information does not necessarily
reflect the actual results that would have occurred had the sale taken place for
the periods presented, nor is it necessarily indicative of the future results of
operations of the remaining company:
Unaudited
Six months ended May 31,
----------------------------------
2003 2002
---- ----
Revenues $1,607,249 $141,410
---------- --------
Net loss ($1,222,220) ($2,296,398)
------------ ----------
Basic and diluted loss per share ($0.08) ($0.15)
----- -----
The following unaudited pro forma summary presents consolidated financial
information of our operations for the three-month periods ended May 31, 2003 and
2002, as if the sale of Essex's assets had occurred at the beginning of each
period presented. The pro forma amounts include certain adjustments that
eliminate all the operations of Essex for the periods presented. The pro forma
information does not necessarily reflect the actual results that would have
occurred had the sale taken place for the periods presented, nor is it
necessarily indicative of the future results of operations of the remaining
company:
Unaudited
Three months ended May 31,
--------------------------
2003 2002
---- ------
Revenues $1,153,416 $78,251
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Net income (loss) ($624,928) ($1,262,191)
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Basic and diluted Income (loss) per share ($0.04) ($0.08)
----- -----
Note 11-Reclassifications
-------------------------
Certain amounts in the May 31, 2002 Condensed Consolidated Statements of
Operations and Comprehensive Income (Loss), have been reclassified to conform to
the May 31, 2003 presentation.
10
Item 2. Management's Analysis and Discussion of Financial Condition and Results
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of Operations
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The statements contained in this Report that are not historical facts are
"forward-looking statements" which can be identified by the use of
forward-looking terminology, such as "estimates," "projects," "plans,"
"believes," "expects," "anticipates," "intends," or the negative thereof or
other variations thereon, or by discussions of strategy that involve risks and
uncertainties. Management wishes to caution the reader of the forward-looking
statements, that such statements, which are contained in this Report, reflect
our current beliefs with respect to future events and involve known and unknown
risks, uncertainties and other factors, including, but not limited to, economic,
competitive, regulatory, technological, key employee, and general business
factors affecting our operations, markets, growth, services, products, licenses
and other factors discussed in our other filings with the Securities and
Exchange Commission, and that these statements are only estimates or
predictions. No assurances can be given regarding the achievement of future
results, as actual results may differ materially as a result of risks facing us,
and actual events may differ from the assumptions underlying the statements that
have been made regarding anticipated events. Factors that may cause our actual
results, performance or achievements, or industry results, to differ materially
from those contemplated by such forward-looking statements include, without
limitation: (1) the availability of additional funds to successfully pursue our
business plan; (2) the impact of changes the Federal Communications Commission
or State Public Service Commissions may make to existing telecommunication laws
and regulations; (3) the cooperation of incumbent carriers in implementing the
unbundled network elements platform required by the Federal Communications
Commission; (4) our ability to maintain, attract and integrate internal
management, technical information and management information systems; (5) our
ability to market its services to current and new customers and generate
customer demand for its product and services in the geographical areas in which
we operate; (6) our success in gaining regulatory approval to access new
markets; (7) our ability to negotiate and maintain suitable interconnection
agreements with the incumbent carriers; (8) the availability and maintenance of
suitable vendor relationships, in a timely manner, at reasonable cost; (9) the
intensity of competition; and (10) general economic conditions. All written and
oral forward looking statements made in connection with this Report that are
attributable to us or persons acting on our behalf are expressly qualified in
their entirety by these cautionary statements. Given the uncertainties that
surround such statements, prospective investors are cautioned not to place undue
reliance on such forward-looking statements.
Overview
eLEC Communications Corp. is a full-service telecommunications company that
focuses on developing integrated telephone service in the emerging competitive
local exchange carrier ("CLEC") industry. We offer small businesses and
residential consumers an integrated set of telecommunications products and
services, including local exchange, local access, domestic and international
long distance telephone, data and a full suite of local features and calling
plans. We have built a scalable operating platform that can provision a local
telephone line, provide dial-tone to our customers, read usage records, rate
telephone calls for billing purposes, prepare monthly invoices to customers,
provide real-time on-line customer support services at our inbound call centers,
capture credit and collection data, calculate gross margins for each line and
perform any moves, adds, changes and repairs that a customer requests. We
utilize universal
11
client technology that enables our employees and agents to access our system
from any PC using any Internet browser.
We believe that the Telecommunications Act of 1996 (the "Telecommunications
Act"), which opened the local exchange market to competition, has created an
attractive opportunity for CLECs. Like most CLECs, our entry in this industry
was dependent upon the provisions of the Telecommunications Act that allow CLECs
to lease various elements of the networks of the incumbent local exchange
carriers ("ILECs") that are necessary to provide local telephone service in a
cost-effective manner. This aspect of the Telecommunications Act is referred to
as "unbundling" the ILEC networks, and allows us to lease unbundled network
elements on an as-needed basis and provide such elements to our customers at a
lower cost than that which the ILEC is charging.
Although we believe the opportunity for CLECs is attractive, it is also
challenging. We must contend with federal and state government regulators,
rapidly changing technologies, incumbent carriers that are better staffed and
capitalized than us and real-time business partners that also carry our
customer's telephone call, whether it is local, long distance or international.
At the same time that we are managing these challenges, we also must provide
connectivity, superior customer service and a culture of continuous improvement.
Because of the complexity of the business, we have focused our energies on
simplifying our working environment and improving performance through
automation.
Other CLECs have invested a substantial amount of capital to buy
circuit-switched equipment and rollout fiber, only to find that their equipment
is severely underutilized and that there is a significant shortfall in their
revenue stream when compared to their capital investment. We refer to this
strategy as a "facilities-first" strategy, because the CLEC has invested in its
equipment and placed the equipment in service before the CLEC has developed a
customer base. Our strategy is a "customer-first," or a "deferred-build"
strategy. We invested our capital in our Operations Support System ("OSS") to
support our customers and we lease facilities on an as-needed basis from ILECs
while we build our customer base. After we have obtained a substantial
geographical concentration of customers, we will make decisions regarding the
purchase and installation of our own network equipment. This strategy allows us
to be more flexible with our customer base as we grow our business. We can move
our customer base to alternative access, if appropriate, and we do not become a
captive of our own underutilized equipment, as can happen with a
"facilities-first" CLEC. The technological advances in equipment and the
lowering of equipment prices have substantiated our deferred-build strategy and
have enabled us to better utilize our limited capital.
When we lease lines from an ILEC, we use the unbundled network elements platform
("UNE-P") service offering. UNE-P allows us to lease the network elements we
need, such as the local line and the port on a local switch, so that we can
provide local dial tone service to our customers. We are capable of providing
virtually all of the same additional voice services provided by any ILEC, such
as three-way calling, call waiting, call forwarding and caller ID. We sell our
services at a fee that is at least 10% and as much as 25% less than the rate
charged by the ILEC. We also offer a bundled package of local and regional
calling minutes with popular voice service features.
We believe UNE-P is the preferable platform for any CLEC to operate under while
it is growing and building a customer base. We have designed our OSS to be
flexible and scalable so that any company that wants to begin providing local
exchange services utilizing UNE-P can rely on our OSS. UNE-P has substantial
value because it allows a CLEC to provide service with
12
significantly lower capital requirements than either fiber-based or wireless
systems, and to offer services to a broader customer base more quickly and at a
lower price. The ability to rapidly provision accounts and to deliver reliable
service at a lower price than offered by the ILECs should provide us with
certain competitive advantages as we market our services to small business and
residential customers. Recently, several ILECs have petitioned the Federal
Communications Commission ("FCC") to make changes to regulatory requirements for
the UNE-P service offering. These ILECs have attempted to lobby the FCC and
state public utility commissions to impose restrictions on certain individual
network elements that would destroy the competitive value of the UNE-P
structure. If the ILECs succeed in their lobbying efforts, it is likely the
resulting amendments to the existing UNE-P structure will significantly harm our
operations and gross margins.
In March 2002, UNE-P became more valuable to us when the costs charged to us for
providing local voice services on the UNE-P service offering in New York State
were lowered. We believe current rates are also very attractive in New Jersey
and Pennsylvania. Our original CLEC business, built in our wholly-owned
subsidiary, Essex, began as a reseller with approximately 10% gross margins.
This subsidiary was unable to operate profitably and we sold the Essex customer
base and related assets on December 31, 2002. Another CLEC subsidiary that we
own, Telecarrier, is operating under the protection of Chapter 11 of the Federal
Bankruptcy Code. As with Essex, Telecarrier began as a reseller and was unable
to operate profitably. Our primary operating CLEC, New Rochelle Telephone Corp.
("NRTC"), is selling services in New York State and Pennsylvania, and is
currently achieving gross margins over 45%. As a start-up CLEC, NRTC is not yet
profitable. If we are able to obtain an appropriate working capital facility, or
a sufficient amount of cash from the sale of our building, we project NRTC will
be able to reach a breakeven level this year. However, there can be no assurance
that this will occur, nor can there be any assurance we will be able to obtain
the financing we are seeking. Failure to reach a breakeven level in our
operations could cause us to seek to reorganize under applicable bankruptcy
laws.
Six Months Ended May 31, 2003 vs. Six Months Ended May 31, 2002
---------------------------------------------------------------
Our net revenues for the six months ended May 31, 2003 decreased by
approximately $5,675,000, or approximately 69%, to approximately $2,500,000 as
compared to approximately $8,176,000 reported for the six months ended May 31,
2002. The decrease in sales is directly attributable to the sale of Essex's
customer base on December 31, 2002, discussed above. For the six months ended
May 31, 2003, Essex's sales were approximately $893,000, which represented the
sales of this subsidiary from the period December 1, 2002 to December 31, 2002,
the date on which certain of its assets were sold to EAC (See Note 10). After
the sale of the customer base on December 31, 2002, Essex did not have any
additional sales, and we believe Essex will eventually be dissolved or sold.
Sales of $893,000 represent a decrease in Essex's sales for the six months ended
May 31, 2003 of approximately $7,140,000, or 89%, as compared to approximately
$8,033,000 reported for the six months ended May 31, 2002. The decrease in
Essex's sales was offset, in part, by aggregate sales of approximately
$1,496,000 reported by NRTC and Telecarrier, each of which had no comparable
sales for the six months ended May 31, 2002. We anticipate sales for NRTC and
Telecarrier to continue to increase in the second half of fiscal 2003, as we
work to add new customers. In June 2003, we invoiced NRTC and Telecarrier
customers a total of approximately $480,000 for approximately 9,300 lines. Our
line count and customer base has continued to grow in July 2003, but additional
growth will be directly related to the cash we have available for new line
acquisition costs. See the discussion on liquidity below.
13
Our gross profit for the six-months ended May 31, 2003 decreased by
approximately $1,528,000 to approximately $1,163,000 from approximately
$2,691,000 reported in for the six-months ended May 31, 2002, and the gross
profit percentage increased to 46.5% from 32.9% reported in the prior fiscal
period. The decrease in gross profit is directly related to the sale of Essex's
customer base as discussed above. The increase in gross profit percentage
reflects our sales strategy to sell in only those states in which we believe we
will be able to achieve a margin of at least 40%. In the first half of fiscal
2003, NRTC and Telecarrier sold telephone service in New York State and in New
Jersey. During June 2003, we started to expand NRTC's service offerings into
Pennsylvania and we are currently negotiating for an interconnection agreement
to provide NRTC's service offerings to business and residential consumers in
Michigan.
Selling, general and administrative expenses ("SG&A") decreased by approximately
$2,258,000, or approximately 45%, to approximately $2,781,000 for the six-months
ended May 31, 2003 from approximately $5,039,000 reported in the prior fiscal
period. This decrease in expense is directly related to the curtailment of our
Essex operations and our on going efforts to implement various cost-cutting
measures, which included, among other things, a reduction in staffing. SG&A
expenses incurred by Essex represented approximately $646,000 of the $2,739,000
in SG&A costs for the period ended May 31, 2003. Currently, our SG&A costs have
averaged approximately $350,000 per month, approximately $60,000 of which
represents new line acquisition expenses. In June 2003, we curtailed our
in-house telemarketing efforts and reduced staff and associated overhead costs,
such as telephone expense. We will focus on third party telemarketing firms to
generate new sales, as we believe this is a more efficient means of generating
new sales as we only pay for lines that we accept. We continue to evaluate our
operations for efficiencies, and we are looking for ways to implement further
SG&A reductions in the remainder of fiscal 2003.
Depreciation and amortization expense decreased by approximately $72,000, to
approximately $64,000 for the six months ended May 31, 2003 as compared to
approximately $136,000 for the six months ended May 31, 2002. The decline in
depreciation expense was partially attributable to the sale of certain assets to
EAC on December 31, 2002.
Interest expense decreased by approximately $230,000, to approximately $69,000
for the six months ended May 31, 2003 as compared to approximately $299,000 for
the six months ended May 31, 2002. The decrease in interest expense resulted
from the termination of our credit facility that was in place in the prior
period.
Interest and other income for the six months ended May 31, 2003 increased by
approximately $154,000 from amounts reported in the prior fiscal period
resulting primarily from commission and rental income.
Gain on the sale of assets for the six months ended May 31, 2003 was
approximately $2,257,000 (See Note 10).
Gain on the sale of investment securities and other investments for the six
months ended May 31, 2003 was approximately $84,000, which resulted from the
sale of Cordia Corporation ("Cordia") and Talk shares, as compared to $684,000
for the six months ended May 31, 2002, which resulted from the sale of Talk
shares.
14
Three Months Ended May 31, 2003 vs. Three Months Ended May 31, 2002
-------------------------------------------------------------------
Our net revenues for the three months ended May 31, 2003 decreased by
approximately $2,548,000, or approximately 69%, to approximately $1,153,000 as
compared to approximately $3,701,000 reported for the three months ended May 31,
2002. The decrease in sales is directly attributable to the sale of Essex's
customer base on December 31, 2002, discussed above. For the three months ended
May 31, 2003, Essex had no sales as compared to approximately $3,622,000
reported for the three months ended May 31, 2002. The decrease in Essex's sales
was offset, in part, by aggregate sales of approximately $1,084,000 reported by
NRTC and Telecarrier, each of which had no comparable sales for the three months
ended May 31, 2002. We anticipate sales for NRTC and Telecarrier to continue to
increase in the second quarter of fiscal 2003, as we work to add new customers.
See the discussion on liquidity below.
Our gross profit for the three months ended May 31, 2003 decreased by
approximately $672,000 to approximately $574,000 from approximately $1,246,000
reported in the three months ended May 31, 2002, and the gross profit percentage
increased to 49.8% from 33.7% reported in the prior fiscal period. The decrease
in gross profit is directly related to the sale of Essex's customer base as
discussed above. The increase in gross profit percentage reflects our sales
strategy to sell in only those states in which we believe we will be able to
achieve a margin of at least 40%, as discussed above.
Selling, general and administrative expenses ("SG&A") decreased by approximately
$1,324,000, or approximately 51%, to approximately $1,247,000 for the three
months ended May 31, 2003 from approximately $2,571,000 reported in prior fiscal
period. As discussed above, this decrease in expense is directly related to the
curtailment of our Essex operations and our on-going efforts to implement
various cost-cutting measures, which included, among other things, a reduction
in staffing.
Depreciation and amortization expense decreased by approximately $49,000, to
approximately $33,000 for the three months ended May 31, 2003 as compared to
approximately $82,000 for the three months ended May 31, 2002. The decline in
depreciation expense was partially attributable to the sale of certain assets to
EAC on December 31, 2002.
Interest expense decreased by approximately $120,000 to approximately $34,000
for the three-months ended May 31, 2003 as compared to approximately $154,000
for the three months ended May 31, 2002. The decrease in interest expense
resulted from the termination of our credit facility that was in place in the
prior period.
Interest and other income for the three months ended May 31, 2003 increased by
approximately $74,000 from amounts reported in the prior fiscal period resulting
primarily from commission and rental income.
Gain on the sale of assets for the three months ended May 31, 2003 was
approximately $660,000 (See Note 10).
Gain on the sale of investment securities and other investments for the
three-month periods ended May 31, 2003 and 2002 of approximately $50,000 and
$631,000, respectively, resulted from the sale of Talk shares.
15
Liquidity and Capital Resources
-------------------------------
At May 31, 2003, we had cash and cash equivalents of approximately $333,000,
including approximately $218,000 in Telecarrier, and negative working capital of
approximately $10,121,000 as compared to cash and cash equivalents available of
approximately $675,000, and negative working capital of approximately $9,573,000
at May 31, 2002. Of such working capital deficiency at May 31, 2003,
approximately $7,021,000 in liabilities were assumed by EAC on December 31,
2002, for which we remain liable.
Net cash (used in) provided by operating activities aggregated approximately
($745,000) and $870,000 in the six-month periods ended May 31, 2003 and 2002,
respectively. The principal source of cash in fiscal 2003 was the net profit for
the period of approximately $800,000, which was offset by a non-cash item, the
net effect of the gain on the transfer of assets to EAC of approximately
$2,257,000. The principal use of cash in fiscal 2002 was the loss for the period
of approximately $2,088,000, which was offset by the increase in accounts
payable, principally through the delaying of payments to vendors, and the
reduction in accounts receivable of approximately $3,080,000 and $398,000,
respectively.
Net cash provided by investing activities aggregated approximately $198,000 and
$712,000 in the six-month periods ended May 31, 2003 and 2002, respectively. The
principal source of cash in fiscal 2003 and 2002 were the proceeds from the sale
of investment securities and other investments of approximately $153,000 and
$679,000, respectively.
Net cash used in financing activities aggregated approximately $58,000 and
$1,705,000 in the six-month periods ended May 31, 2003 and 2002, respectively.
In fiscal 2003, net cash used in financing activities resulted from the
repayment of debt. In fiscal 2002, net cash used in financing activities
resulted from the repayment of short and long-term debt of approximately
$1,750,000, which was partially offset by the proceeds from the exercise of
stock options of approximately $45,000.
For the six-month period ended May 31, 2003, we had no capital expenditures. We
do not expect to make any significant capital expenditures for the remainder of
fiscal 2003.
At May 31, 2003, we owned 4,143 shares of Talk (NASDAQ:TALK) and 83,180 shares
of Cordia (OTCBB:CORG). We have the right to purchase approximately 95,000
additional shares of Talk if we exercise a warrant. The warrant exercise price
is $6.30 per share and, at May 31, 2003, was in-the-money, as Talk common stock
was trading at approximately $8.93 per share at such date.
The report of the independent auditors on our 2002 financial statements
indicates there is substantial doubt about our ability to continue as a going
concern. We have worked during the course of the year to improve our financial
condition and, as discussed previously, the sale of most of the assets and
liabilities of our wholly-owned subsidiary, Essex, in December 2002, has helped
us to continue our business operations. However, we do not believe we currently
have enough working capital to build our business to a profitable level. We have
been seeking, for more than six months, a working capital facility that will
provide us with financing of up to 80% of our outstanding accounts receivables.
We anticipate that with such financing, we will be able to achieve our plan of
becoming profitable before the end of this fiscal year.
16
However, our current operating losses and the current reluctance of financing
sources to lend to the telecom sector have contributed to our inability to
secure such financing. In lieu of such asset-based financing, new debt or equity
financing of up to $1 million, or a sale of additional assets of such amount,
would be required to fund our operations. Given the current market price of our
common stock and the current market conditions in the telecom sector, there can
be no assurances that we will be able to obtain such funding when needed, or
that such funding, if available, will be obtainable on acceptable terms. We have
determined that an appropriate source of approximately $1 million of cash can be
obtained from the sale our corporate headquarters building. In June 2003, we
signed a contract to sell our building that has several conditions to closing.
We believe this sale will generate sufficient cash for us to satisfy our
mortgage indebtedness and to obtain a number of lines that will allow us to move
toward our goal of reaching profitability. We anticipate working with the buyer
to close the transaction as soon as possible so that the cash proceeds will be
available to us. The buyer plans to demolish our building and construct
residential units. The local zoning board and planning board have meetings
scheduled at the end of July 2003 to consider approval of the buyer's plans for
demolition and new construction. The buyer is not required to complete the
building purchase if such approvals are not obtained. The failure to close this
transaction promptly, to secure bridge financing until such transaction closes
or to raise the necessary funds to finance our operations will have an adverse
effect on our ability to carry out our business plan. The inability to carry out
this plan may result in the continuance of unprofitable operations, and the
eventual inability to pay our operating expenses, which would adversely affect
our ability to continue operating as a going concern.
17
PART II-OTHER INFORMATION
-------------------------
Item 1. Legal Proceedings
------- -----------------
See Note 8-Legal Proceedings
Item 2. Changes in Securities
------- ---------------------
None
Item 3. Controls and Procedures
------- -----------------------
(a) Within the 90 days prior to the date of this report,
we carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer
and principal accounting officer, of the effectiveness of the design
and operation of our disclosure controls and procedures pursuant to
Exchange Act Rule 13a-14. Based upon that evaluation, our Chief
Executive Officer and principal accounting officer concluded that our
disclosure controls and procedures are effective in timely alerting him
to material information relating to our company (including its
consolidated subsidiaries) required to be included in our periodic SEC
filings.
(b) There have been no significant changes in our internal
controls or in other factors that could significantly affect our
internal controls subsequent to the date we carried out this
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Item 6. Exhibits and Reports on Form 8-K
------- --------------------------------
(a) Exhibits.
99.1 Certification of Principal Executive Officer
and Principal Financial Officer
Pursuant to 18 U.S.C. 1350
(Section 906 of the Sarbanes-Oxley Act of 2002)
18
(b) Reports on Form 8-K
On April 21, 2003, we filed a Current Report on Form 8-K
providing certifications of our Principal Executive Officer and
Principal Financial Officer with respect to our Quarterly Report on
Form 10-QSB for the fiscal period ended February 28, 2003, as required
by Section 906 of the Sarbanes-Oxley Act of 2002.
19
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
eLEC Communications Corp.
July 15, 2003 By: /s/ Paul H. Riss
------------------ ---------------------------------
Date Paul H. Riss
Chief Executive Officer
(Principal Financial and
Accounting Officer)
20
Certifications
--------------
I, Paul H. Riss, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of eLEC
Communications Corp.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. I am responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for
the registrant and I have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to me by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report my conclusions about the
effectiveness of the disclosure controls and procedures based on my
evaluation as of the Evaluation Date;
5. I have disclosed, based on my most recent evaluation, to the
registrant's auditors and the audit committee of registrant's board of directors
(or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
21
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
6. I have indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date of my most recent
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: July 15, 2003
/s/ Paul H. Riss
----------------------------------------
Paul H. Riss
Chief Executive Officer and Principal
Financial and Accounting Officer
22