| |
|
Aug. 31, 2007 |
|
Nov. 30, 2006 |
| |
|
(Unaudited) |
|
(See Note 1) |
| Assets |
|
|
|
|
| Current assets: |
|
|
|
|
| Cash and cash equivalents |
|
$ 24,954 |
|
$1,337,525 |
| Accounts receivable, net |
|
99,847 |
|
630,197 |
| Prepaid expenses and other current assets |
|
45,524 |
|
154,749 |
| Deferred finance costs, net |
|
- |
|
1,012,941 |
| Total current assets |
|
170,325 |
|
3,135,412 |
| |
| Property, plant and equipment, net |
|
802,822 |
|
903,281 |
| |
| Deferred finance costs, net |
|
570,983 |
|
- |
| Other assets |
|
105,032 |
|
149,525 |
| Total assets |
|
$1,649,162 |
|
$4,188,218 |
| |
| Liabilities and stockholders’ equity deficiency |
|
|
|
|
| Current liabilities: |
|
|
|
|
| Current portion of long-term debt and capital lease obligations |
|
$ 378,325 |
|
$3,347,707 |
| Notes payable |
|
322,861 |
|
- |
| Notes payable - officer |
|
81,000 |
|
- |
| Warrant liability |
|
- |
|
1,251,182 |
| Accounts payable and accrued expenses |
|
2,101,809 |
|
2,897,495 |
| Other liabilities |
|
853,584 |
|
- |
| Taxes payable |
|
8,120 |
|
559,617 |
| Deferred Revenue |
|
4,230 |
|
166,100 |
| Total current liabilities |
|
3,749,929 |
|
8,222,101 |
| |
|
|
|
|
| Warrant liability |
|
1,068,824 |
|
- |
| Long-term debt and capital lease obligations, less current maturities |
|
2,154,165 |
|
214,907 |
| Total liabilities |
|
6,972,918 |
|
8,437,008 |
| |
| Stockholders’ equity deficiency: |
|
|
|
|
| Preferred stock $.10 par value, 1,000,000 shares authorized, |
|
- |
|
|
| none issued and outstanding |
|
|
|
- |
| Common stock $.10 par value, 50,000,000 shares authorized, |
|
|
|
|
| 23,748,234 and 22,434,282 shares issued and outstanding in 2007 |
|
|
|
|
| and 2006 |
|
2,374,823 |
|
2,243,428 |
| Capital in excess of par value |
|
27,627,033 |
|
27,071,584 |
| Deficit |
|
(35,313,325) |
|
(33,554,700) |
| Accumulated other comprehensive loss, unrealized loss on securities |
|
(12,287) |
|
(9,102) |
| Total stockholders’ equity deficiency |
|
(5,323,756) |
|
(4,248,790) |
| Total liabilities and stockholders’ equity deficiency |
|
$1,649,162 |
|
$4,188,218 |
| |
| See notes to the condensed consolidated financial statements. |
|
|
|
|
| |
| |
| 2 |
| |
|
For the Nine Months Ended |
|
For the Three Months Ended |
| |
|
Aug. 31, 2007 |
|
Aug. 31, 2006 |
|
Aug. 31, 2007 |
|
Aug. 31, 2006 |
| |
| |
| Revenues |
|
$ 676,995 |
|
$ 105,681 |
|
$ 268,490 |
|
$ 44,289 |
| |
| Costs and expenses: |
|
|
|
|
|
|
|
|
| Costs of services |
|
846,288 |
|
346,233 |
|
310,753 |
|
126,808 |
| Selling, general and administrative |
|
1,938,448 |
|
1,729,203 |
|
597,709 |
|
582,224 |
| Depreciation and amortization |
|
425,176 |
|
215,106 |
|
189,824 |
|
106,952 |
| Total costs and expenses |
|
3,209,912 |
|
2,290,542 |
|
1,098,796 |
|
815,984 |
| |
| Loss from operations |
|
(2,532,917) |
|
(2,184,861) |
|
(829,796) |
|
(771,695) |
| |
| Other income (expense): |
|
|
|
|
|
|
|
|
| Interest expense |
|
(590,183) |
|
(392,382) |
|
(234,280) |
|
(150,445) |
| Interest and other income |
|
30,881 |
|
19,244 |
|
9,518 |
|
5,506 |
| Change in warrant valuation |
|
494,920 |
|
630,343 |
|
1,005,068 |
|
405,732 |
| Total other income (expense) |
|
(64,382) |
|
257,205 |
|
780,306 |
|
260,793 |
| |
| Loss from continuing operations before |
|
|
|
|
|
|
|
|
| discontinued operations |
|
(2,597,299) |
|
(1,927,656) |
|
(49,490) |
|
(510,902) |
| |
| Discontinued operations |
|
|
|
|
|
|
|
|
| Gain (loss) from discontinued operations |
|
(330,363) |
|
178,823 |
|
(148,247) |
|
73,389 |
| Gain on disposal of discontinued operations |
|
1,169,037 |
|
- |
|
1,169,037 |
|
- |
| Gain from discontinued operations |
|
838,674 |
|
178,723 |
|
1,020,790 |
|
73,389 |
| |
| Net income (loss) |
|
(1,758,625) |
|
(1,748,933) |
|
971,300 |
|
(437,513) |
| |
| Other comprehensive loss |
|
|
|
|
|
|
|
|
| unrealized loss on marketable securities |
|
(3,185) |
|
(1,319) |
|
(1,365) |
|
(1,159) |
| Comprehensive income (loss) |
|
($1,761,810) |
|
($1,750,252) |
|
$969,935 |
|
($438,672) |
| |
| Basic income (loss) per share: |
|
|
|
|
|
|
|
|
| Loss from continuing operations before |
|
|
|
|
|
|
|
|
| Discontinued operations |
|
($0.12) |
|
($0.11) |
|
$0.00 |
|
($0.03) |
| Income from discontinued operations |
|
.04 |
|
.01 |
|
.04 |
|
.00 |
| Net income (loss) |
|
($0.08) |
|
($0.10) |
|
$0.04 |
|
($0.03) |
| |
| Weighted average number of common shares |
|
|
|
|
|
|
|
|
| outstanding |
|
|
|
|
|
|
|
|
| Basic |
|
22,750,279 |
|
16,940,742 |
|
23,348,774 |
|
17,131,456 |
| |
| |
| See notes to the condensed consolidated |
|
|
|
|
|
|
|
|
| financial statements. |
|
|
|
|
|
|
|
|
| |
| |
| 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 in accordance with the rules and regulations of the Securities and Exchange |
| Commission for Form 10-Q. Accordingly, they do not include all of the information and |
| footnotes required by generally accepted accounting principles for complete financial statements. |
| In the opinion of management, all adjustments (consisting of normal recurring accruals) |
| considered necessary for a fair presentation have been included. Operating results for the three- |
| month or nine-month periods ended August 31, 2007 are not necessarily indicative of the results |
| that may be expected for the year ended November 30, 2007. For further information, refer to |
| the consolidated financial statements and footnotes thereto included in our Annual Report on |
| Form 10-K for the year ended November 30, 2006. |
| |
| |
| Note 2-Major Customers |
| |
| During the nine-month and three-month periods ended August 31, 2007, one customer, |
| Allegiance Communications, LLC accounted for 45% and 52%, respectively, of revenue from |
| continuing operations. During the nine-month and three-month periods ended August 31, 2006, |
| one customer accounted for 24% and 17%, respectively, of revenue from continuing operations, |
| and a second customer accounted for 17% and 23%, respectively, of revenue from continuing |
| operations. |
| |
| |
| |
| Note 3-Loss Per Common Share |
| |
| Basic loss per common share is calculated by dividing net loss by the weighted average |
| number of common shares outstanding during the period. |
| |
| Approximately 12,969,000 and 8,625,000 shares of common stock issuable upon the |
| exercise of our outstanding stock options and warrants were excluded from the calculation of |
| loss per share for the nine-month periods ended August 31, 2007 and 2006, respectively, and |
| 8,625,000 shares for the three months ended August 31, 2006, because the effect would be anti- |
| dilutive. |
| |
| |
| Note 4-Risks and Uncertainties |
| |
| We have created our own proprietary Internet Protocol (“IP”) telephony network and have |
| transitioned from a reseller of traditional wireline telephone services into a facilities-based |
| broadband service provider to take advantage of the network cost savings that are inherent in an |
| IP network. Although we continue to grow our IP telephony business, we face strong |
| |
| |
| 5 |
| competition. We continue to build our IP telephony business with significantly less financial |
| resources than many of our competitors. At this point in time, the survival of our business is |
| dependent upon the success of our IP operations. Future results of operations involve a number |
| of risks and uncertainties. Factors that could affect future operating results and cash flows and |
| cause actual results to vary materially from historical results include, but are not limited to: |
| |
| |
| · |
|
The acceptance of IP telephony by mainstream consumers; |
| · |
|
Our ability to market our services to current and new customers and to generate customer |
| |
|
demand for our products and services in the geographical areas in which we operate; |
| · |
|
Our ability to comply with provisions of our financing agreements; |
| · |
|
The impact of changes the Federal Communications Commission or State Public Service |
| |
|
Commissions may make to existing telecommunication laws and regulations, including |
| |
|
laws dealing with Internet telephony; |
| · |
|
The highly competitive nature of our industry; |
| · |
|
Our ability to retain key personnel; |
| · |
|
Our ability to maintain adequate customer care and manage our churn rate; |
| · |
|
The cooperation of industry service partners that have signed agreements with us; |
| · |
|
Our ability to maintain, attract and integrate internal management, technical information |
| |
|
and management information systems; |
| · |
|
The availability and maintenance of suitable vendor relationships in a timely manner and |
| |
|
at reasonable cost; |
| · |
|
Our ability to manage rapid growth while maintaining adequate controls and procedures; |
| · |
|
Failure or interruption in our network and information systems; |
| · |
|
Our inability to adapt to technological change; |
| · |
|
The possibility of our perceived infringement of our technology on another entity’s |
| |
|
patents; |
| · |
|
Our inability to manage customer attrition and bad debt expense; |
| · |
|
The failure or bankruptcy of other telecommunications companies upon which we rely |
| |
|
for services and revenues; |
| · |
|
Our lack of capital or borrowing capacity, and our inability to generate cash flow; |
| · |
|
The decrease in telecommunications prices to consumers; and |
| · |
|
General economic conditions. |
| |
| |
| Note 5-Stock-Based Compensation Plans |
| |
| We issue stock options to our employees and outside directors pursuant to stockholder- |
| approved and non-approved stock option programs. In December 2004, the Financial |
| Accounting Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment”. SFAS |
| 123R is a revision of SFAS 123, and supersedes APB 25. Among other items, SFAS 123R |
| eliminates the use of APB 25 and the intrinsic value method of accounting, and requires |
| companies to recognize in their financial statements the cost of employee services received in |
| exchange for awards of equity instruments, based on the grant date fair value of those awards. |
| SFAS 123R permits companies to adopt its requirements using either a “modified prospective” |
| method, or a “modified retrospective” method. Under the “modified prospective” method, |
| compensation cost is recognized in the financial statements beginning with the effective date, |
| based on the requirements of SFAS 123R for all share-based payments granted after that date, |
| |
| |
| 6 |
| and based on the requirements of SFAS 123 for all unvested awards granted prior to the effective |
| date of SFAS 123R. Under the “modified retrospective” method, the requirements are the same |
| as under the “modified prospective” method, but this method also permits entities to restate |
| financial statements of previous periods based on proforma disclosures made in accordance with |
| SFAS 123. Since the beginning in fiscal 2006, we have accounted for stock-based compensation |
| in accordance with the provisions of SFAS 123R and have elected the “modified prospective” |
| method. For the nine-month periods ended August 31, 2007 and 2006, we recorded |
| approximately $133,000 and $147,000, respectively, in employee stock-based compensation |
| expense, which is included in our selling, general and administrative expenses. For the three- |
| month periods ended August 31, 2007 and 2006, we recorded approximately $44,000 and |
| $47,000, respectively, in employee stock-based compensation expense. As of August 31, 2007, |
| there was approximately $107,000 of unrecognized stock-compensation expense for previously- |
| granted unvested options that will be recognized over a three-year period. |
| |
| Note 6-Impairment of Long-Lived Assets |
| |
| We review long-lived assets for impairment whenever events or changes in |
| circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability |
| of assets to be held and used is measured by a comparison of the carrying amount of an asset to |
| future forecasted net undiscounted cash flows expected to be generated by the asset. If such |
| assets are considered to be impaired, the impairment to be recognized is measured by the amount |
| by which the carrying amount of the assets exceeds the fair values. We founded our IP telephony |
| business in 2004, and since its inception it has incurred significant operating and cash flow |
| losses. It can be considered a late-stage start-up business, and we have evaluated the assets of |
| this business and future operations to determine if we need to recognize an impairment expense. |
| We have received a written offer for this business during the past 6 months that was far in excess |
| of the carrying value of the assets. We have also borrowed an additional $4 million effective |
| September 28, 2007 using these assets as collateral. Accordingly, we have determined that such |
| assets are not impaired. |
| |
| Note 7 – Other Liabilities |
| |
| We have recorded other liabilities of approximately $854,000 for items with which we |
| are negotiating settlements in conjunction with transactions related to the sale of former |
| subsidiaries (see Note 11). We believe we have valid disputes for many of these liabilities and |
| we are continuing to submit claims and present other evidence to reduce such liabilities. There |
| can be no assurance that we will be successful in our negotiations with various entities, and |
| ultimately, we may have to pay such amounts. |
| |
| Note 8-Defined Benefit Plan |
| |
| We sponsor a defined benefit plan covering one active employee and a number of former |
| employees. Our funding policy with respect to the defined benefit plan is to contribute annually |
| not less than the minimum required by applicable law and regulation to cover the normal cost |
| and to fund supplemental costs, if any, from the date each supplemental cost was incurred. |
| Contributions are intended to provide not only for benefits attributable to service to date, but also |
| for those expected in the future. Effective June 30, 1995, the plan was frozen, ceasing all benefit |
| accruals and resulting in a plan curtailment. |
| |
| |
| 7 |
| For the nine- and three-month periods ended August 31, 2007 and 2006, we recorded |
| pension expense of $72,000 and $24,000, respectively. In the nine-month period ended August |
| 31, 2007, we made contributions valued at approximately $10,000 to our defined benefit plan. |
| No contributions were made during the three-months ended August 31, 2007. In the nine- and |
| three-month periods ended August 31, 2006, we contributed $101,500 and $49,000, respectively, |
| to the pension plan. We expect to make annual contributions of approximately $70,000 to our |
| defined benefit plan. The current investment strategy for the defined benefit plan is to primarily |
| invest in conservative debt and equity securities. The expected long-term rate of return on plan |
| assets is 8%. |
| |
| We also sponsor a 401(k) profit sharing plan for the benefit of all eligible employees, as |
| defined. The plan provides for the employees to make voluntary contributions not to exceed the |
| statutory limitation provided by the Internal Revenue Code. We may make discretionary |
| contributions. There were no discretionary contributions made for the nine-month and three- |
| month periods ended August 31, 2007 or 2006. |
| |
| Note 9 – Principal Financing Arrangements |
| |
| Effective September 28, 2007, we consummated a private placement pursuant to which |
| we issued to two institutional investors (the “Investors”), secured term notes in the aggregate |
| principal amount of $4,000,000 (the “Notes”). In connection with the private placement, we also |
| amended and restated two existing secured term notes issued to Laurus Master Fund, Ltd. |
| (“Laurus”) issued on November 30, 2005 (“Amended Note 1”) and May 31, 2006 (“Amended |
| Note 2”). |
| |
| Absent earlier redemption, the Notes mature on September 30, 2010 (the “Maturity |
| Date”). Interest will accrue on the unpaid principal and interest on the Notes at a rate per annum |
| equal to the “prime rate” published in The Wall Street Journal from time to time, plus two |
| percent (2%), subject to a minimum per annum rate of nine and three-quarters percent (9.75%). |
| Interest on the Notes is payable monthly on the first day of each month during the term of the |
| Notes, commencing November 1, 2007. We have deposited a total of $732,996 into an escrow |
| account and a restricted cash account to be used for the first 12 months of interest payments on |
| the Notes. We are required to make principal payments on the Notes in the aggregate amount of |
| $100,000 per month commencing on October 1, 2009 and on the first business day of each |
| succeeding month thereafter through and including the Maturity Date. Any principal amount that |
| remains outstanding on September 30, 2010 will be due and payable at that time. |
| |
| Amended Note 1 amends and restates in its entirety (and is given in substitution for and |
| not in satisfaction of) that certain $2,000,000 Secured Term Note made by us in favor of Laurus |
| on November 30, 2005. The principal changes effected in Amended Note 1 were the elimination |
| of monthly principal payments prior to maturity and the change in the maturity date from |
| November 30, 2008 to September 30, 2010. Interest payments must still be paid monthly at a |
| rate per annum equal to the “prime rate” published in The Wall Street Journal from time to time, |
| plus two percent (2%). The face amount of Amended Note 1 as of October 4, 2007 is $1,966,667 |
| and the carrying amount is $1,205,000 |
| |
| Amended Note 2 amends and restates in its entirety (and is given in substitution for and |
| not in satisfaction of) that certain $1,700,000 Secured Term Note made by us in favor of Laurus |
| on May 31, 2006. The principal changes effected in Amended Note 2 were the elimination of |
| monthly principal payments prior to maturity and the change in the maturity date from May 31, |
| |
| |
| 8 |
| 2009 to September 30, 2010. Interest payments must still be paid monthly at a rate per annum |
| equal to the “prime rate” published in The Wall Street Journal from time to time, plus two |
| percent (2%). The face amount of Amended Note 2 as of October 4, 2007 is $1,428,000 and the |
| carrying amount is $1,068,000. |
| |
| The Notes, Amended Note 1 and Amended Note 2 are secured by a blanket lien on |
| substantially all of our assets pursuant to the terms of security agreements executed by the |
| Company and its subsidiaries in favor of Laurus and a collateral agent for the Investors. In |
| addition, we have pledged our ownership interests in our subsidiaries pursuant to stock pledge |
| agreements executed by us in favor of Laurus and a collateral agent for the Investors securing |
| their obligations under the Notes. If an event of default occurs under the security agreement, the |
| stock pledge agreement or the promissory notes issued to Laurus or the Investors, the secured |
| parties have the right to accelerate payments under such promissory notes and, in addition to any |
| other remedies available to them, to foreclose upon the assets securing such promissory notes. |
| |
| As a result of the issuance of the Notes and Amended Note 1 and 2, we have no principal |
| payments due until October 1, 2009, and consequently, these debt obligations have been |
| classified as long-term liabilities as of August 31, 2007. |
| |
| In addition to the Notes, three sets of warrants that contain no registration requirements |
| were issued to the Investors (the “A Warrants,” “B Warrants” and “C Warrants”). The A |
| Warrants grant to the Investors the right to purchase for cash up to 94,722,072 shares of |
| Common Stock at an exercise price of $0.10 per share. The B Warrants grant the Investors the |
| right to purchase for cash up to 7,893,506 shares of Common Stock at an exercise price of $0.10 |
| per share. The C Warrants grant the Investors the right to purchase for cash up to 23,680,518 |
| shares of Common Stock at an exercise price of $0.10 per share. All of such warrants expire on |
| September 30, 2017. If we repay the Notes, Amended Note 1 and Amended Note 2 in full prior |
| to September 30, 2009, then the C Warrants shall be cancelled and terminated. If our operating |
| cash flow for any two consecutive months during the thirteen (13) month period ending October |
| 31, 2008 is greater than $0, then the B Warrants shall be cancelled and terminated. The Warrants |
| do not contain registration rights and require the Investors to limit the selling of any Common |
| Stock of the Company issued upon the exercise of the Warrants to a maximum of twenty-five |
| percent (25%) of the aggregate number of shares of the Common Stock traded on such trading |
| day. |
| |
| On June 26, 2007, the company that purchased our two former subsidiaries (see Note 11) |
| paid in full our term note due to Laurus, with a maturity date of February 8, 2008, and a carrying |
| amount of $1,006,800. This note was paid for in conjunction with the transfer of ownership of |
| our former subsidiaries and the issuance to the purchaser of 808,000 shares of our common |
| stock. |
| |
| Note 10-Income Taxes |
| |
| At November 30, 2006, we had net operating loss carryforwards for Federal income tax |
| purposes of approximately $25,600,000 expiring in the years 2008 through 2026. As a result of |
| the sale of two of our wholly owned subsidiaries in June 2007 (see Note 11), the amount of our |
| net operating loss that we can carry forward to future years will be reduced by the amount of the |
| net operating losses that are attributable to the divested subsidiaries. Furthermore, as a result of |
| the issuance of new warrants in conjunction with the sale of secured term notes effective |
| |
| |
| 9 |
| September 28, 2007 (see Note 8), under the provisions of Internal Revenue Code Section 382, we |
| have triggered a change in control that places an annual limitation of approximately $250,000 on |
| the utilization of our remaining net operating loss carryforwards until the year 2028. Because of |
| this limitation, we estimate that the total net operating loss carryforwards available to us is |
| approximately $5,000,000. We did not provide for a tax benefit, as it is more likely than not that |
| any such benefit will not be realized. |
| |
| |
| Note 11 - Sale of Subsidiaries |
| |
| On December 14, 2006, we entered into two separate definitive purchase agreements to |
| sell to Cyber Digital, Inc. (“Purchaser”), a publicly-traded shell company, our two former |
| wholly-owned subsidiaries that operate as competitive local exchange carriers (“CLECs”). The |
| CLECs were sold in June 2007. The operations of the CLECs are presented in our income |
| statement as discontinued operations for the nine-month and three-month periods ended August |
| 31, 2007 and 2006. The gain on the sale of the CLECs of approximately $1,169,000 was |
| recorded in the third quarter of fiscal 2007, as the sale transaction was completed in June 2007. |
| |
| CLEC revenues amounted to approximately $3,013,000 and $6,496,000 for the nine-months |
| periods ended August 31, 2007 and 2006, respectively and approximately $1,905,000 for the |
| three-month period ended August 31, 2006. The CLEC operations were sold on June 1, 2007, and |
| consequently we had no CLEC revenue in the three-month period ended August 31, 2007. |
| |
| |
| Note 12 – Accounts Payable and Accrued Expenses |
| |
| Included in accounts payable and accrued expenses are accrued interest payable of |
| approximately $563,000 and accrued pension expense payable of approximately $317,000 as of |
| August 31, 2007, as compared to accrued interest payable of approximately $77,000 and accrued |
| pension expense payable of approximately $297,000 as of November 30, 2007. |
| |
| |
| 10 |
| Item 2. Management’s Analysis and Discussion of Financial Condition and Results of |
| Operations |
| |
| The statements contained in this Report that are not historical facts are “forward- |
| looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 |
| with respect to our financial condition, results of operations and business, which can be |
| identified by the use of forward-looking terminology, such as “estimates,” “projects,” “plans,” |
| “believes,” “expects,” “anticipates,” “intends,” or the negative thereof or other variations |
| thereon, or by discussions of strategy that involve risks and uncertainties. Management wishes |
| to caution the reader of the forward-looking statements that such statements, which are |
| contained in this Report, reflect our current beliefs with respect to future events and involve |
| known and unknown risks, uncertainties and other factors, including, but not limited to, |
| economic, competitive, regulatory, technological, key employee, and general business factors |
| affecting our operations, markets, growth, services, products, licenses and other factors |
| discussed in our other filings with the Securities and Exchange Commission, and that these |
| statements are only estimates or predictions. No assurances can be given regarding the |
| achievement of future results, as actual results may differ materially as a result of risks facing |
| us, and actual events may differ from the assumptions underlying the statements that have been |
| made regarding anticipated events. Factors that may cause our actual results, performance or |
| achievements, or industry results, to differ materially from those contemplated by such forward- |
| looking statements include, without limitation those factors set forth under Note 4 – Risks and |
| Uncertainties. |
| |
| These forward-looking statements are subject to numerous assumptions, risks and |
| uncertainties that may cause our actual results to be materially different from any future results |
| expressed or implied by us in those statements. These risk factors should be considered in |
| connection with any subsequent written or oral forward-looking statements that we or persons |
| acting on our behalf may issue. All written and oral forward looking statements made in |
| connection with this Report that are attributable to us or persons acting on our behalf are |
| expressly qualified in their entirety by these cautionary statements. Given these uncertainties, |
| we caution investors not to unduly rely on our forward-looking statements. We do not undertake |
| any obligation to review or confirm analysts’ expectations or estimates or to release publicly any |
| revisions to any forward-looking statements to reflect events or circumstances after the date of |
| this Report or to reflect the occurrence of unanticipated events. Further, the information about |
| our intentions contained in this Report is a statement of our intention as of the date of this |
| Report and is based upon, among other things, the existing regulatory environment, industry |
| conditions, market conditions and prices, the economy in general and our assumptions as of such |
| date. We may change our intentions, at any time and without notice, based upon any changes in |
| such factors, in our assumptions or otherwise. |
| |
| Overview |
| |
| We are a provider of wholesale Internet Protocol (“IP”) telephone services. We route |
| telephone calls over broadband services using our own IP telephony product. IP telephony is the |
| real time transmission of voice communications in the form of digitized “packets” of information |
| over the Internet or a private network, which is analogous to the way in which e-mail and other |
| data is transmitted. We use proprietary softswitch technology that runs on Cisco and Dell |
| hardware to provide broadband telephone services to other service providers, such as cable |
| operators, Internet service providers, WiFi and fixed wireless broadband providers, data |
| integrators, value-added resellers and satellite broadband providers. Our technology enables |
| |
| |
| 11 |
| these carriers to quickly and inexpensively offer premier broadband telephone services, complete |
| with order flow management for efficient provisioning, billing and support services and user |
| interfaces that are easily customized to reflect the carrier’s unique brand. |
| |
| The worldwide rollout of broadband voice services has allowed consumers and |
| businesses to communicate at dramatically-reduced costs in comparison to traditional telephony |
| networks. Traditionally, telephone service companies have built networks based on circuit |
| switching technology, which creates and maintains a dedicated path for individual telephone |
| calls until the call is terminated. While circuit-switched networks have provided reliable voice |
| communications services for more than 100 years, transmission capacity is not efficiently utilized |
| in a circuit-switched system. Under circuit-switching technology, when a person makes a |
| telephone call, a circuit is created and remains dedicated for the entire duration of that call, |
| rendering the circuit unavailable for the transmission of any other calls. |
| |
| Data networks, such as IP networks, utilize packet switching technology that divides |
| signals into packets and simultaneously routes them over different channels to a final destination |
| where they are reassembled into the original order in which they were transmitted. No dedicated |
| circuits are required and a fixed amount of bandwidth is not needed for the duration of each call. |
| The more efficient use of network capacity results in the ability to transmit significantly greater |
| amounts of traffic over a packet-switched network than a circuit-switched network. Packet- |
| switching technology enables service providers to converge traditional voice and data networks |
| in an efficient manner by carrying voice, fax, video and data traffic over the same network. IP |
| networks are therefore less expensive for carriers to operate, and these cost savings can be passed |
| on to the consumer in the form of lower costs for local, long distance and international long |
| distance telephone services. |
| |
| We have created our own Linux-based IP platform and have transitioned into a |
| facilities-based broadband service provider to take advantage of the network cost savings that are |
| inherent in an IP network. Our proprietary softswitch provides more than 20 of the Class 5 call |
| features, voice mail and enhanced call handling on our own Session Initiation Protocol (“SIP”) |
| server suite. We control all of the features we offer to broadband voice customers because we |
| write the software code for any new features that we desire to offer our customers rather than |
| relying on a third-party software vendor. We have no software licensing fees and our other |
| variable network costs are expected to drop as we increase our network traffic and as we attract |
| more pure-IP telephony users with traffic that does not incur the cost of originating or |
| terminating on a circuit-switched network. |
| |
| Our SIP servers are part of a cluster of servers, which we refer to as a server farm, in |
| which each server performs different network tasks, including back-up and redundant services. |
| We believe the server farm structure can be easily and cost-effectively scaled as our broadband |
| voice business grows. In addition, servers within our server farm can be assigned different tasks |
| as demand on the network dictates. If an individual server ceases to function, our server farm is |
| designed in a manner that subscribers should not have their calls interrupted. |
| |
| We began our telecom operations in 1998 as a reseller of local telephone service. Our |
| reseller subsidiaries were sold to a third-party purchaser in June 2007 and have been presented in |
| our financial statements as discontinued operations. |
| |
| |
| 12 |
| Plan of Operations |
| |
| Our objective is to build a profitable Internet-based telephone company on a stable and |
| scalable platform with minimal network costs. We want to be known for our high quality of |
| service, robust features and ability to deliver any new product to a wholesale customer or a web |
| store without delay. We believe that to achieve our objective we need to have “cradle to grave” |
| automation of our back-office web and billing systems. We have written our software for |
| maximum automation, flexibility and changeability. |
| |
| We know from experience in provisioning complex telecom orders that back-office |
| automation is a key factor in keeping overhead costs low. Technology continues to work for 24 |
| hours a day and we believe that the fewer people a company has in the back office, the more |
| efficiently it can run, which should drive down the cost per order. |
| |
| Our strategy is to grow rapidly by leveraging the capital, customer bases and marketing |
| strength of our wholesale customers. Many of our targeted wholesale customers and some of our |
| existing wholesale customers have ample capital to market a private-labeled broadband voice |
| product to their existing customer bases or to new customers. We believe our strength is our |
| technology-based platform. By providing our technology to cable companies, CLECs, ISPs, |
| WiFi and fixed-wireless broadband providers, data integrators, value-added resellers, satellite |
| broadband providers and any other entity that desires to offer a broadband telephony product, we |
| believe we will require significantly less cash resources than other providers will require to |
| attract a similar number of subscribers. |
| |
| By taking a wholesale approach, our goal is to obtain and manage 500 customers that |
| have an average customer base of 1,000 end-users. We believe we will be more successful and |
| more profitable by taking this approach to reaching 500,000 end-users than we would be if we |
| tried to attract and manage 500,000 individual end-users by ourselves. |
| |
| |
| Nine Months August 31, 2007 vs. Nine Months Ended August 31, 2006 |
| |
| Our revenue from continuing operations for the nine-month period ended August 31, |
| 2007 increased by approximately $571,000, or approximately 539%, to approximately $677,000 |
| as compared to approximately $106,000 reported for the nine-month period ended August 31, |
| 2006. The increase in our revenues was directly related to the increase in the number of |
| wholesale customers that began reselling our Internet telephone service. At August 31, 2007, we |
| were billing 48 wholesale customers, as compared to 17 customers at August 31, 2006. As of |
| August 31, 2007, we had signed 96 wholesale customer contracts, consisting of seven CLECs, |
| seven cable operators, five Internet service providers, eight data integrators, eight carriers, 33 |
| resellers and 28 agents. When we sign up a new customer, typically it will be several months |
| before the customer begins to resell our service to individual retail consumers. Some of our |
| wholesale customers will abandon their efforts to sell Internet telephony services and we will |
| never be able to bill them. In addition to the 96 signed wholesale customers, we have |
| approximately 40 potential customers in trial. In October 2007, we attended two industry trade |
| shows and accumulated 63 additional leads from face-to-face meetings. We anticipate continued |
| rapid growth in our monthly billings, as many of the wholesale customers that we signed early in |
| the year are beginning to turn up services. We anticipate that our revenue in the fourth quarter of |
| fiscal 2007 will continue to maintain a strong quarter-to-quarter growth and will exceed |
| $350,000. |
| |
| |
| 13 |
| We reported a negative gross profit for the nine-month period ended August 31, 2007 of |
| approximately ($169,000), which was an improvement of approximately $71,000 over the |
| negative gross profit of approximately ($240,000) reported in the nine-month period ended |
| August 31, 2006. Our IP telephony facilities have significant unused capacity and we have |
| therefore been unable to generate a positive gross profit on a quarterly basis. We anticipate that |
| due to higher revenue dollars that we are currently generating and the addition of two vendors |
| who are providing us with lower cost routing than that which we previously had received, that |
| beginning in October 2007 we will realize additional improvement in our gross margin. |
| |
| Selling, general and administrative expenses increased by approximately $209,000, or |
| approximately 12%, to approximately $1,938,000 for the nine-month period ended August 31, |
| 2007 from approximately $1,729,000 reported in the same prior-year fiscal period. Additional |
| personnel expense, including options for a consultant, accounted for the majority of the increase. |
| |
| Depreciation and amortization expense increased by approximately $210,000 for the nine |
| months ended August 31, 2007 to approximately $425,000 as compared to approximately |
| $215,000 for the same period in fiscal 2006. Approximately $153,000 of the increase was for the |
| amortization of financing costs related to our financing agreements and approximately $57,000 |
| related to depreciation of our Internet telephony platform. |
| |
| Interest expense increased by approximately $198,000 to approximately $590,000 for the |
| nine months ended August 31, 2007 as compared to approximately $392,000 for the nine months |
| ended August 31, 2006. The increase in interest expense was due to a higher level of debt in the |
| 2007 fiscal period being associated with continuing operations. Approximately $195,000 and $447,000 |
| in interest expense in the nine months ended August 31, 2007 and 2006 has been included in discontinued |
| operations, because the debt was financing those operations. |
| |
| Warrant income for the nine-month period ended August 31, 2007 amounted to |
| approximately $495,000, due to the decrease in the market value of our common stock from |
| November 30, 2006 to August 31, 2007, as compared to the warrant income of approximately |
| $630,000 for the same period in fiscal 2006, which resulted from a decrease in the price of our |
| common stock at August 31, 2006 as compared to the value at November 30, 2005. |
| |
| Discontinued operations reflected the income for the nine-month periods ended August |
| 31, 2007 and 2006 attributable to our former CLEC operations, which were sold in June 2007. |
| The gain from discontinued operations in fiscal 2007 included a gain of approximately |
| $1,169,000 on the sale of the CLEC operations. |
| |
| |
| Three Months Ended August 31, 2007 vs. Three Months Ended August 31, 2006 |
| |
| Our revenue from continuing operations for the three-month period ended August 31, |
| 2007 increased by approximately $224,000, or approximately 509%, to approximately $268,000 |
| as compared to approximately $44,000 reported for the three-month period ended August 31, |
| 2006. The increase in revenues was directly related to the increase in the number of wholesale |
| customers that began reselling our Internet telephone service. As discussed above, at August 31, |
| 2007, we were billing 45 wholesale customers as compared to 15 customers at August 31, 2006. |
| |
| |
| 14 |
| We reported a negative gross profit for the three-month period ended August 31, 2007 of |
| approximately ($42,000), which was an improvement of approximately $41,000 over the |
| negative gross profit of approximately ($83,000) reported in the three-month period ended |
| August 31, 2006. Our IP telephony facilities have significant unused capacity and we have |
| therefore been unable to generate a positive gross profit on a quarterly basis. As discussed |
| above, we anticipate that due to the higher revenue dollars that we are currently generating and |
| the addition of two vendors that are providing us with lower-cost routing than that which we |
| previously had received, that beginning in October 2007 we will realize additional improvements |
| in our gross margin. |
| |
| Selling, general and administrative expenses increased by approximately $21,000, or |
| approximately 4%, to approximately $603,000 for the three-month period ended August 31, 2007 |
| from approximately $582,000 reported in the same prior year fiscal period. |
| |
| Depreciation and amortization expense increased by approximately $83,000 for the three |
| months ended August 31, 2007 to approximately $190,000 as compared to approximately |
| $106,000 for the same period in fiscal 2006. Approximately $17,000 of the increase was |
| primarily for higher depreciation expense related to our Internet telephony platform and $66,000 |
| was for the amortization of financing costs related to our financing agreements. |
| |
| Interest expense increased by approximately $84,000 to approximately $234,000 for the |
| three months ended August 31, 2007 as compared to approximately $150,000 for the three |
| months period ended August 31, 2006. This increase is due to lower effective debt levels |
| charged to operations in the quarter ended August 31, 2006. Included in discontinued |
| operations in the fiscal 2006 quarter is approximately $84,000 in interest expense. |
| |
| Warrant income for the three months ended August 31, 2007 amounted to approximately |
| $1,005,000 due to the decrease in the market price of our common stock at August 31, 2007 as |
| compared to May 31, 2007. Similarly, a decrease in the market price of our common stock at |
| August 31, 2006 as compared to the market price at May 31, 2007, generated warrant income of |
| approximately $406,000 in the three month period ended August 31, 2006. |
| |
| Discontinued operations reflected the net income for the three-month periods ending |
| August 31, 2007 and 2006 attributable to our former CLEC operations, which were sold in June |
| 2007. The gain from the sale of the discontinued operations in fiscal 2007 was approximately |
| $1,169,000. |
| |
| Liquidity and Capital Resources |
| |
| At August 31, 2007, we had cash and cash equivalents of approximately $25,000 and |
| negative working capital of approximately $3,580,000. On September 28, 2007 we borrowed $4 |
| million to enhance our cash balances and provide us with the cash proceeds we project is |
| necessary for the working capital we need to become a profitable company. We have deposited |
| an aggregate of $732,996 in a restricted cash account and a cash escrow account that is |
| designated to make interest payments for the next 12 months on all of our outstanding |
| indebtedness. The notes we issued in September 2007 require no principal payments until |
| |
| |
| 15 |
| October 1, 2009. Our other term notes have been amended and no principal payments are due |
| until September 30, 2010, when the notes mature. |
| |
| Net cash used in operating activities aggregated approximately $1,670,000 and |
| $1,325,000 in the nine-month periods ended August 31, 2007 and 2006, respectively. The |
| principal use of cash in the fiscal 2007 period was the loss for the period of approximately |
| $1,759,000, which was partially offset by a non-cash mark-to-market warrant adjustment of |
| $495,000 and a net gain from discontinued operations of $839,000. The principal use of cash in |
| the fiscal 2006 period was the loss for the period of approximately $1,749,000. |
| |
| Net cash used in investing activities in the nine-month periods ended August 31, 2007 |
| and 2006 aggregated approximately $108,000 and $240,000, respectively, resulting primarily |
| from expenditures related to enhancements to our IP telephony software. |
| |
| Net cash provided by financing activities aggregated approximately $465,000 and |
| $1,695,000 in the nine-month periods ended August 31, 2007 and 2006, respectively. In fiscal |
| 2007, net cash provided in financing activities resulted from the exercise of warrants of |
| approximately $48,000 and short-term borrowings that aggregated approximately $451,000, and |
| was offset by the repayment of long-term debt of approximately $34,000. In fiscal 2006, net cash |
| provided by financing activities resulted from the proceeds of long-term notes of approximately |
| $2,329,000, which was partially offset by the repayment of debt of approximately $729,000. |
| |
| For the nine months ended August 31, 2007, we had approximately $108,000 in capital |
| expenditures primarily related to our IP telephony business. We expect to make equipment |
| purchases of approximately $50,000 to $100,000 in the next fiscal quarter of 2007, depending on |
| our growth and the availability of cash or equipment financing. We expect that other capital |
| expenditures over the next 12 months will relate primarily to a continued roll-out of our IP |
| telephony network that will be required to support a growing customer base of IP telephony |
| subscribers. |
| |
| The report of our independent registered public accounting firm on our 2006 financial |
| statements indicates there is substantial doubt about our ability to continue as a going concern. |
| Our operating losses have been funded through the sale of non-operating assets, the issuance of |
| equity securities and borrowings. We believe the notes we issued on September 28, 2007 for a |
| gross amount of $4 million provides us with adequate cash to fund our operations and service our |
| debt for the next 12 months. |
| |
| Item 3. Quantitative and Qualitative Disclosure About Market Risk |
| |
| Our outstanding debt is primarily under three borrowing arrangements with one lender |
| and its affiliates and such borrowings are at the rate of 2% over the prime rate. We currently do |
| not use interest rate derivative instruments to manage our exposure to interest rate changes. As a |
| result of conversion features, warrant issuances and lender discounts, the effective rate of interest |
| has been calculated at rates of approximately 47% on our November 2005 financing and 185% |
| on the $650,000 portion of our August 2006 financing. |
| |
| Item 4. Controls and Procedures |
| |
| (a) Disclosure Controls and Procedures. Our management, with the participation of our |
| chief executive officer/chief financial officer, has evaluated the effectiveness of our disclosure |
| |
| |
| 16 |
| controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the |
| Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period |
| covered by this Report. Based on such evaluation, our chief executive officer/chief financial |
| officer has concluded that, as of the end of such period, for the reasons set forth below, our |
| disclosure controls and procedures were not effective. We are presently taking the necessary |
| steps to improve the effectiveness of such disclosure controls and procedures. |
| |
| (b) Internal Control Over Financial Reporting. There have not been any changes in our |
| internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d- |
| 15(f) under the Exchange Act) during the third quarter of fiscal 2007 that have materially |
| affected, or are reasonably likely to materially affect, our internal control over financial |
| reporting. In connection with our year-end November 30, 2006 audit, our management became |
| aware of an inadequately designed accounting system as it pertains to our VoX subsidiary. As |
| reported in fiscal 2006 and 2005, we also have a lack of staffing within our accounting |
| department, both in terms of the small number of employees performing our financial and |
| accounting functions and their lack of experience to account for complex financial transactions. |
| Management believes the lack of qualified personnel, in the aggregate, and the inadequately |
| designed accounting system, are both a material weakness in our internal control over financial |
| reporting. We have updated and enhanced our internal reporting at VoX and we will continue to |
| evaluate the number of accounting employees we utilize, the need to engage outside consultants |
| with technical and accounting-related expertise to assist us in accounting for complex financial |
| transactions and the hiring of additional accounting staff with complex financing experience. |
| |
| We also are evaluating our internal controls systems so that when we are required to do |
| so, our management will be able to report on, and our independent auditors to attest to, our |
| internal controls, as required by Section 404 of the Sarbanes-Oxley Act of 2002. We will be |
| performing the system and process evaluation and testing (and any necessary remediation) |
| required in an effort to comply with the management certification and auditor attestation |
| requirements of Section 404 of the Sarbanes-Oxley Act. In connection with our year-end |
| November 30, 2006 and 2005 audits, we identified the control deficiencies and issues with our |
| internal controls over financial reporting that we believe amounted in the aggregate to a |
| significant deficiency in our internal controls over financial reporting. Such deficiencies no |
| longer exist as of the date of this Report due to the sale of our CLEC businesses. |
| |
| |
| 17 |
| eLEC COMMUNICATIONS CORP. |
| |
| PART II-OTHER INFORMATION |
| |
| Item 2. |
|
Unregistered Sale of equity securities and use of proceeds |
| |
| |
|
During the three months ended August 31, 2007, we issued warrants for the for |
| |
|
the purchase of 75,000 shares of our common stock at an exercise price of $0.28 |
| |
|
per share, in conjunction with a short-term lending agreement with an individual |
| |
|
accredited investor. Such warrants were issued in reliance upon the exemption |
| |
|
from registration provided by Section 4(2) of the Securities Act of 1933, as |
| |
|
amended. |
| |
| |
|
On August 31, 2007, in accordance with a consulting arrangement, we extended |
| |
|
the termination date to March 8, 2008 of an existing option grant for the |
| |
|
purchase of 900,000 shares of our common stock at a price of $0.23. |
| |
| Item 6. |
|
Exhibits |
| |
| |
|
Exhibit |
|
|
| |
|
Number |
|
Description |
| |
| |
|
31.1 |
|
Certification of our Chief Executive Officer and Chief Financial |
| |
|
|
|
Officer, Paul H. Riss, pursuant to 18 U.S.C. 1350 (Section 302 of the |
| |
|
|
|
Sarbanes-Oxley Act of 2002) |
| |
| |
|
32.1 |
|
Certification of our Chief Executive Officer and Chief Financial |
| |
|
|
|
Officer, Paul H. Riss, pursuant to 18 U.S.C. 1350 (Section 906 of the |
| |
|
|
|
Sarbanes-Oxley Act of 2002) |
| |
| |
| 18 |
| |
|
|
|
EXHIBIT 31.1 |
| |
| CERTIFICATION |
| |
| Pursuant to 18 U.S.C. 1350 |
| (Section 302 of the Sarbanes-Oxley Act of 2002) |
| |
| I, Paul H. Riss, Chief Executive Officer and Chief Financial Officer of eLEC Communications |
| Corp., certify that: |
| |
| 1. |
|
I have reviewed this quarterly report on Form 10-Q of eLEC Communications Corp.; |
| |
| 2. |
|
Based on my knowledge, this report does not contain any untrue statement of a material |
| fact or omit to state a material fact necessary to make the statements made, in light of the |
| circumstances under which such statements were made, not misleading with respect to the period |
| covered by this report; |
| |
| 3. |
|
Based on my knowledge, the financial statements, and other financial information |
| included in this report, fairly present in all material respects the financial condition, results of |
| operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| |
| 4. |
|
I am responsible for establishing and maintaining disclosure controls and procedures (as |
| defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and I have: |
| |
| |
|
(a) |
|
Designed such disclosure controls and procedures, or caused such disclosure |
| |
|
controls and procedures to be designed under my supervision, to ensure that material |
| |
|
information relating to the registrant, including its consolidated subsidiaries, is made |
| |
|
known to me by others within those entities, particularly during the period in which this |
| |
|
report is being prepared; |
| |
| |
|
(b) |
|
Evaluated the effectiveness of the registrant’s disclosure controls and procedures |
| |
|
and presented in this report our conclusions about the effectiveness of the disclosure |
| |
|
controls and procedures, as of the end of the period covered by this report based on such |
| |
|
evaluation; and |
| |
| |
|
(c) |
|
Disclosed in this report any change in the registrant’s internal control over |
| |
|
financial reporting that occurred during the registrant’s most recent fiscal quarter that has |
| |
|
materially affected, or is reasonably likely to materially affect, the registrant’s internal |
| |
|
control over financial reporting; and |
| |
| 5. |
|
I have disclosed, based on my most recent evaluation of internal control over financial |
| reporting, to the registrant’s auditors and the audit committee of the registrant’s board of |
| directors (or persons performing the equivalent functions): |
| |
| |
|
(a) |
|
All significant deficiencies and material weaknesses in the design or operation of |
| |
|
internal control over financial reporting which are reasonably likely to adversely affect |
| |
|
the registrant’s ability to record, process, summarize and report financial information; |
| |
|
and |
| |
|
|
|
EXHIBIT 32.1 |
| |
| CERTIFICATION |
| Pursuant to 18 U.S.C. 1350 |
| (Section 906 of the Sarbanes-Oxley Act of 2002) |
| |
| In connection with the Quarterly Report on Form 10-Q of eLEC Communications Corp. |
| (the "Company") for the quarter ended August 31, 2007, as filed with the Securities and |
| Exchange Commission on the date hereof (the "Report"), Paul H. Riss, as Chief Executive |
| Officer and Chief Financial Officer of the Company, hereby certifies, pursuant to 18 U.S.C. |
| §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that: |
| |
| (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of |
| the Securities Exchange Act of 1934, as amended; and |
| |
| (2) The information contained in the Report fairly presents, in all material |
| respects, the financial condition and results of operations of the Registrant. |
| |
| |
| |
| Date: October 22, 2007 |
|
By: |
|
/s/ Paul H. Riss |
| |
|
Paul H. Riss |
| |
|
Chief Executive Officer and |
| |
|
Chief Financial Officer |
| |
| |
| |
| |
| This certification accompanies each Report pursuant to § 906 of the Sarbanes-Oxley Act |
| of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be |
| deemed filed by the Company for purposes of §18 of the Securities Exchange Act of 1934, as |
| amended. |
| |
| A signed original of this written statement required by Section 906 has been provided to |
| the Company and will be retained by the Company and furnished to the Securities and Exchange |
| Commission or its staff upon request. |
| |
| |
| 23 |