UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-KSB
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended November 30, 2004
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______.
Commission File No. 0-4465
eLEC COMMUNICATIONS CORP.
(Name of Small Business Issuer in Its Charter)
New York 13-2511270
(State or Other Jurisdiction (I.R.S Employer Identification No.)
of Incorporation or Organization)
75 South Broadway, Suite 302, White Plains, New York 10601
(Address of Principal Executive Offices) (Zip Code)
(914) 682-0214
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, par value $.10 per share
--------------------------------------------------------------------------------
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 |_|.
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. |_|
State issuer's revenue for its most recent fiscal year: $9,557,600
As of February 28, 2005, the aggregate market value of the voting and
non-voting common equity held by non-affiliates of the issuer was $8,793,668.
As of February 28, 2005, there were 16,759,282 shares outstanding of the
issuer's Common Stock.
Documents incorporated by reference: Definitive proxy statement of eLEC
Communications Corp. relating to the Annual Meeting of Stockholder filed with
the Commission within 120 days after the end of the fiscal year covered by this
Form 10-KSB, which is incorporated into Part II of this Form 10-KSB.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
TABLE OF CONTENTS
PART I
Item 1. Description of Business
Item 2. Description of Property
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for Common Equity, Related Stockholder Matters and Small
Business Issuer Purchases of Equity Securities
Item 6. Management's Discussion and Analysis or Plan of Operation
Item 7. Financial Statements
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Item 8A. Controls and Procedures
PART III
Item 9. Directors and Executive Officers of the Registrant
Item 10. Executive Compensation
Item 11. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Item 12. Certain Relationships and Related Transactions
Item 13. Exhibits List and Reports on Form 8-K
Item 14. Principal Accountant Fees and Services
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: (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, including laws dealing with Internet telephony; (3) the
cooperation of incumbent carriers that have signed a wholesale service agreement
with us to replace the unbundled network elements platform; (4) our ability to
maintain, attract and integrate internal management, technical information and
management information systems; (5) our ability to market our services to
current and new customers and generate customer demand for our product and
services in the geographical areas in which we operate; (6) our success in
gaining regulatory approval to access new markets; (7) our ability to negotiate
and maintain suitable interconnection agreements with the incumbent carriers;
(8) the availability and maintenance of suitable vendor relationships, in a
timely manner, at reasonable cost; (9) the intensity of competition; and (10)
general economic conditions. All written and oral forward looking statements
made in connection with this Report that are attributable to us or persons
acting on our behalf are expressly qualified in their entirety by these
cautionary statements. Given the uncertainties that surround such statements,
prospective investors are cautioned not to place undue reliance on such
forward-looking statements.
PART I
In this Annual Report on Form 10-KSB, we will refer to eLEC Communications
Corp., a New York corporation, as "eLEC," the "Company," "we," "us," and "our."
Item 1. - Description of Business
Overview
eLEC Communications Corp. is a telecommunications service holding company
with operations in three wholly-owned subsidiaries that focus on delivering
integrated telephone service by leasing landlines as a competitive local
exchange carrier ("CLEC") and by utilizing high-speed Internet connections to
provide Voice over Internet Protocol ("VoIP") services. We offer small
businesses and residential consumers an integrated set of telecommunications
products and services, including local exchange, local access, domestic and
international long distance telephone, VoIP and a full suite of features and
calling plans.
Almost all of the local telephone calls made by our customers in fiscal
2004 were routed over a circuit-switched network that we lease from Verizon
Services Corp. ("Verizon"). Although we plan to increase the number of local
access lines that we route over the Verizon network during fiscal 2005, we also
plan to use other networks by offering local exchange services on the Qwest
Corporation ("Qwest") network in some of the 14 states in which Qwest is the
incumbent local exchange carrier ("ILEC") and by offering VoIP services on an
Internet network over which our customers will make telephone calls through a
high-speed Internet connection. When we route a telephone call by our customers
over an Internet network, a carrier other than Verizon or Qwest will terminate
the call for us into the public switched telephone network ("PSTN"). We also are
able to terminate some calls ourselves that are made by our customers, in which
cases we do not incur any marginal costs for such calls.
Until December 31, 2004, both of our CLEC subsidiaries leased lines from
Verizon, using 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 can provide virtually all of the additional
voice services provided by the ILECs, such as three-way calling, call waiting,
call forwarding and caller ID. We sell our services at a fee that is at least
10% and as much as 25% less than the published rate charged by the ILEC. We also
offer a bundled package of local and regional calling minutes with popular voice
service features.
We plan to continue using the UNE-P service offering for one of our CLEC
subsidiaries, Telecarrier Services Inc. ("TSI"). UNE-P, however, has been the
subject of various court battles between the CLECs and ILECs that may bring an
end to UNE-P services. Based upon the Order on Remand in WC Docket No. 04-313
and CC Docket No. 01-338, released on February 4, 2005 (the "TRO Remand Order")
by the Federal Communications Commission ("FCC"), Verizon has sent us notice
that CLECs operating under UNE-P may not submit orders for completion on or
after March 11, 2005. In addition, Verizon has notified us that if TSI has not
made arrangements for UNE-P replacement services, TSI's embedded base of
customers shall be subject to transitional rate increases established in the TRO
Remand Order. Thereafter, TSI will have one year to transfer existing lines from
UNE-P to another platform, unless CLECs, state public service commissions or
others are successful in blocking part or all of the anticipated actions by the
ILECs. TSI currently bills approximately 10,000 lines every month, and we plan
to maintain its licensing and customer base while the regulatory battles are
waged. However, we do not plan to add any new customers to TSI unless the
regulatory environment yields results that are favorable to UNE-P-based CLECs.
We plan to rapidly grow our other CLEC, New Rochelle Telephone Corp.
("NRTC"), which will not be impacted by the regulatory rulings relating to
UNE-P. In February 2005, NRTC signed a wholesale advantage services agreement
with Verizon, effective on January 1, 2005, that provides NRTC with all the
features and functionalities of Verizon's UNE-P service offering, plus certain
additional services. While our costs under the wholesale advantage services
agreement are somewhat higher than our costs were under UNE-P, the agreement
locks in this cost structure for five years and gives us a significant benefit
by eliminating any regulatory uncertainty about the future of our CLEC business.
NRTC will no longer be impacted by rulings of regulatory bodies relating to
UNE-P that might potentially change pricing or availability of network elements
to NRTC. The agreement allows us to plan for steady high-margin growth in a
business that has been our core business since 1999. At March 1, 2005, NRTC had
approximately 17,000 local access lines that it billed under the wholesale
advantage services agreement. Pursuant to the agreement, NRTC is required to
keep confidential all additional terms and conditions of the agreement.
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We also provide local and long distance telephone service on a VoIP
platform through our wholly-owned subsidiary, VoX Communications Corp. ("VoX").
Unlike many other CLECs, during the past few years we avoided buying any
circuit-switched equipment and instead leased circuit-switched lines from ILECs.
We believe packet telephony services represent a significant step in the
advancement of telecommunications. Consequently, we have focused our network
building efforts on building packet telephony technology and, unlike some other
VoIP providers, we have written and own the code to our own software.
Ultimately, our goal is to have a wholly-owned telecommunications network that
generates revenues and high margins and does not require us to lease facilities
from an ILEC. By not being dependent upon an ILEC, we will be able to offer
features and services we develop that can be turned on and off almost instantly
without requiring an ILEC employee to intervene. We will also lower our cost of
services when we route a telephone call over our packet-based network, as we
will not be required to pay an ILEC for line rentals or for call origination,
transport and termination.
For the foreseeable future, we will continue to lease lines from the
ILECs, as we have wholesale agreements with Verizon and Qwest that allow us to
lease lines and provide Plain Old Telephone Service ("POTS"). We anticipate that
these agreements will allow us to continue to obtain an acceptable gross margin
on the POTS services we provide. We plan to attract VoIP-only customers on our
packet-switched network and to eventually offer VoIP services to our POTS
customers in NRTC and TSI. Although we believe many of our future customers will
want VoIP-only services, we are finding that several accounts want VoIP services
for the bulk of their telephony needs but still desire to maintain one or two
POTS lines. We plan to be able to satisfy the needs of our customers for both
VoIP and POTS services by maintaining our CLEC status and by continuously
advancing our VoIP product offerings.
Development of Business
We were incorporated in the State of New York under the name Sirco
Products Co. Inc. in 1964 and developed a line of high quality handbags, totes,
luggage and sport bags. Between 1995 and 1999, we divested our handbag and
luggage operations, which had experienced several years of operating losses.
We commenced operations in the telecommunications industry in fiscal 1998
by acquiring Essex Communications, Inc. ("Essex"), a newly-formed CLEC formed to
attract and retain a geographically concentrated customer base in the
metropolitan New York region, primarily through the resale of products and
services of incumbent and alternative facilities-based local providers.
In January 2000, we acquired TSI, a CLEC that operated in the states of
Massachusetts, New Jersey, New York and Rhode Island and provided long distance
service in 13 states. Most of TSI's operations were merged into Essex after the
acquisition was completed, and we maintained TSI's licenses even though it was
an inactive subsidiary. On July 29, 2002, TSI commenced a case under chapter 11
of the Bankruptcy Code. In February 2004, TSI filed a plan of reorganization
pursuant to which the capital stock of a reorganized TSI would be sold by
competitive bid and the proceeds from the sale of such stock would be used to
make distributions to creditors of TSI. In April 2004, the court accepted our
plan to purchase all the stock of a reorganized TSI for a price of $325,000.
In October 2000, we acquired Line One, Inc. ("Line One"), a telemarketing
firm with approximately 70 seats. We believe telemarketing is a particularly
effective marketing strategy to utilize because of the ubiquitous reach that the
UNE-P service offering gives us. Due to our limited financial resources, we
decreased the operations of Line One at the beginning of 2003 to 15 seats. At
this level of operations, our line acquisition cost became higher than the cost
we would pay if we outsourced our telemarketing operation. We consequently
discontinued internal telemarketing in June 2003. Line One
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is now an inactive subsidiary and we outsource all of our telemarketing
activities on a successful efforts basis.
On September 3, 2002, we entered into a definitive purchase agreement to
sell certain of the assets of Essex to Essex Acquisition Corp. ("EAC"), a
wholly-owned subsidiary of BiznessOnline.com, Inc. ("Biz"). The sale to EAC was
completed on December 31, 2002. EAC purchased selected assets and assumed
certain liabilities in conjunction with this transaction. The remaining shell of
Essex was sold to Glad Holdings, LLC on September 11, 2003. As a result of such
sale, we recorded a gain of approximately $7,314,000 in the fourth quarter of
the fiscal 2003.
In November 2002, we began the operations of NRTC, as a start-up CLEC.
Since the intellectual know-how and internal systems we had developed in
creating Essex were still owned by us, we were able to rebuild our customer base
to a total of approximately 27,000 lines in NRTC and TSI combined, as of
February 28, 2005.
On August 4, 2004, we incorporated VoX as our wholly-owned VoIP
subsidiary. VoX owns technology that enables voice communications over the
Internet through the compression of voice into data packets that are transmitted
over data networks and then converted back into voice signals at the other end
of a telephone conversation.
On February 8, 2005, we sold a $2,000,000 convertible note and we plan to
use a substantial portion of the cash proceeds of approximately $1,744,000 from
such sale for line growth in NRTC and VoX.
eLEC's Telecommunications Services
We tailor our service offerings to meet the specific needs of small
business and residential customers in our target markets. We primarily market
our services through two different distribution channels. We use third-party
telemarketers to attract small business and residential accounts (typically less
than five telephone lines for each account), and we use agents and direct
marketing to attract small business and residential accounts (typically one to
20 lines in size for each account). Based upon feedback received from our
customers and analysis of the types of services the entities in each of these
groups typically utilize, we tailor a basic telecommunications service package,
which can be promptly adjusted to the specific needs of individual customers. To
further help our customers manage their accounts, our customers can view our
invoices, including unbilled telephone calls in the current month, and make
payments to us of their invoices, on a secure customer web site. Customers can
also input requests for repair orders, moves, adds and changes via the web site,
and check their voice mail. We creatively package our services to provide
"one-stop shopping" solutions for our customers, so they can purchase directly
from us all of their communications requirements. Listed below are the basic
categories of services that we offer:
o Local Exchange Services. We offer local exchange services,
starting with local dial tone, plus numerous features, the most common of
which are call waiting, call forwarding, caller ID and dial back features.
By offering local dial tone, when we utilize the UNE-P service offering,
we also receive originating and terminating access charges for
interexchange calls placed or received by our subscribers.
o Long Distance. In addition to our local telephone service, we
offer long distance services as part of a bundled product to customers
through agreements we have with a
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national long distance carrier. The long distance services include
domestic service, such as interLATA, which are calls that pass from one
"Local Access and Transport Area" or "LATA" to another LATA, and
intraLATA, which are calls that stay within the LATA in which they
originated, but are beyond the distance limits of the local calling plan.
Our services also include toll-free services (800, 888, 877, 866), calling
card and other enhanced services.
o International Calling. While we offer international calling, our
typical customer does not place a significant number of international
calls. Most telephone companies experience a higher bad debt percentage on
international calling than on local services. We believe there are
marketing opportunities in those cases in which we can offer low
international calling rates to particular countries and simultaneously
attract more local telephone customers. To reduce the risk of bad debt
exposure, however, we do offer a prepaid international product for
customers that want to dial overseas and receive a discounted rate. No pin
or account numbers are required as the system recognizes the telephone
number from which the call is initiated, including any cell phone number
that the customer programs into the system. Calls must originate in the
United States and can be made to any destination in the world.
o VoIP Calling. Through our wholly-owned subsidiary, VoX, we offer
VoIP services to the small business and residential marketplace. In
addition to low prices, our VoIP calling plans offer a variety of
features, such as Call Hold, Call Waiting, Caller ID, Call Transfer, Hunt
Groups, Do Not Disturb, Call Forward, International Call Blocking, Call
Return, Repeat Dialing/Redial, Extension Dialing, Anonymous Call Rejection
and email notification of voicemail, all at no additional charge. Add-on
features include: Multibox Voicemail, Music on Hold, Corporate Conference
calling, Reassign Phone, Find me/Follow me, and Auto Attendant, among
others.
Business Strategy
Our objective is to build a profitable telephone company with minimal
network costs and a stable and scalable platform. Our strategies to accomplish
this objective encompass the proper management of our core CLEC
telecommunications services on leased networks and the development and marketing
of our own technology for VoIP-based telephony applications.
VoIP is a new technology that is threatening the established
circuit-switched businesses of the ILECs. We are looking to be a rapidly-growing
second-mover in the VoIP marketplace. We believe the first-movers have helped to
validate the technology and create the market, and that some of the initial VoIP
providers have exited the market as quickly as they have entered it. Other
first-movers have demonstrated rapid market entry and unique product variants as
they rush to capture market share.
We believe a normal speed second-mover into a market is often an imitator,
and in lieu of innovation, tends to offer lower pricing. We do not intend to be
a normal speed or slow speed second-mover into the VoIP market. We plan to be
fast, owning and mastering our own technology, adjusting product designs and
marketing efforts and doing many things that a first-mover does, all while
continuing to run our CLEC business, which is currently our core business. We
believe we have the resources and know-how, and the contractual commitments with
two ILECs, to continue operating a CLEC business that can generate acceptable
gross margins and cash flow for further growth. We plan to continue in this
fashion while we develop our VoIP business.
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In establishing our VoIP business, we do not plan to compete on price, as
we believe we have a stable product, and that there is enough demand for the
feature-rich service we can provide so as to allow us to distinguish ourselves
from lower-priced VoIP alternatives. Furthermore, a VoIP line offers substantial
savings to any customer who is switching from a circuit-switched line. In
addition to enjoying a retail price for an unlimited local and national calling
plan of approximately $20 less per month than the cost of a POTS line, the VoIP
consumer also can save approximately $10 a month in telecom taxes, as VoIP
generally is considered data communications and is subject to substantially
fewer taxes than a POTS line. If we need to lower our prices in the future to
capture market share, we believe that option will be available to us.
We are taking the following actions to grow our CLEC and our VoIP
businesses:
o Target Small-Business and Residential Customers for CLEC Services.
We focus our CLEC sales efforts for local and long distance services on
small business and residential consumers having one to five local access
lines in any one location. We have elected to focus on this segment
because of our ability to obtain an ample gross margin on the services
provided to these customers, and because we can rapidly sell, provision
and bill these accounts with electronic feeds from third-party
verification companies. We also believe that the ILECs and
facilities-based CLECs may be less likely to apply significant resources
to obtaining or retaining these smaller customers. We expect to attract
and retain these customers through telemarketers and agents, by offering
bundled local and long distance services, as well as enhanced
telecommunication services, at competitive long distance rates, by
responsive customer service and support and by offering new and innovative
products.
o Achieve Market Share with Competitive Pricing. We always price our
CLEC services at a discount to the same services provided by an ILEC. We
can ascertain the prices the ILECs charge by accessing the rates they have
filed with the various state public service commissions. Our two largest
CLEC competitors have announced they are in the process of being purchased
by an ILEC. We anticipate that these purchases may help to eliminate some
of our competition as a CLEC.
o Market VoIP Services to ILEC Customers. We believe we are very
good at selling POTS lines one at a time. Since February 15, 2005, we have
sold on average approximately 300 POTS lines a day, and we generally can
provision and bill these lines within approximately three days of the
sale. Similarly, we plan to sell VoIP lines one at a time to residential
consumers, as there are many advantages in both speed and simplicity when
we only have to provision one line per location.
o Offer VoIP on a Wholesale Basis. We believe our VoIP platform is
scalable and stable. We designed and built our platform with the intention
of carrying more than one million customers. We plan to allow other
entities that want to offer VoIP to an existing customer base to use our
platform on a wholesale basis. An independent cable company, for example,
may not have the technological expertise to build its own VoIP platform,
or may realize that any efforts to do so would take more than a year to
accomplish. We plan to attract several wholesale accounts by offering our
platform on a private label basis.
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o Offer VoIP to Businesses. We also have an Internet-based PBX
solution that we are offering to business customers. Businesses that have
multiple locations that call each other continuously should achieve
substantial savings from accessing a VoIP platform. One obvious savings
from implementing a VoIP platform is that calls from one office to another
that are transported entirely on a VoIP platform will have no marginal
cost. As a result, we do not charge customers using our VoIP platform for
these calls. Typically, a new business customer will need to buy
additional telephone equipment to access our VoIP platform. However, the
monthly savings on line charges and usage should quickly pay for the
equipment investment.
o Utilize our Technological Expertise in VoIP to Add New Products.
We have developed a robust VoIP platform that we intend to use to develop
further product enhancements. By adding new features and technologically
innovative products, we believe we can continue to attract new customers
and provide additional incentives for current customers to continue using
our services.
Competition in the Telecommunications Industry
The local telecommunications market is a highly competitive environment
and is dominated by ILECs. Based upon the geographical locations in which we
currently sell services, Verizon is our largest competitor. Verizon has a
"win-back" program through which it approaches former customers lost to a CLEC
or other competitor in an attempt to have the former customers switch back to
its services. Most of our actual and potential competitors have substantially
greater financial, technical, marketing and other resources (including brand
name recognition) than we do. Furthermore, our established competitors, such as
the ILECs, are able to compete effectively because they have long-term existing
relationships with their customers, strong name recognition, abundant financial
resources, and the ability to cut prices of certain services by subsidizing such
services with revenues generated from other products. Although the
Telecommunications Act of 1996 reduced barriers to entry into the local market,
future regulatory decisions could increase the rates that CLECs must pay ILECs
for use of ILEC facilities, which would result in lower margins for CLECs and
lessen the ability of CLECs to offer consumers a significant percentage savings
on their telephone bill. Our CLEC subsidiary, TSI, may face some of these
regulatory challenges. However, our CLEC subsidiary, NRTC, has commercial
agreements with two ILECs and should not be subject to future regulatory
decisions involving the prices that ILECs can charge.
In addition to competition from ILECs and other CLECs, several other
entities currently offer or are capable of offering local service, such as
wireless service providers, long distance carriers, cable television companies
and electric utilities. These entities, upon entering into appropriate
interconnection agreements or resale agreements with ILECs, can offer single
source local and long distance services like those we offer. For example, long
distance carriers, such as AT&T, MCI and Sprint Corporation, among other
carriers, have each successfully implemented local telecommunications services
in major U.S. markets using UNE-P or by reselling the ILECs' services.
The long distance market, in comparison to the local market, has
relatively insignificant barriers to entry and has been populated by numerous
entities that compete for the same customers by frequently offering promotional
incentives and lower rates. We compete with many such companies that do not
offer any service other than long distance, and we compete with established
major carriers, such as AT&T and MCI. We believe our bundled package of local
services and our attentive customer service department will help us compete in
this market. We will also have to maintain high quality and low cost
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services to compete effectively. In many instances, we must be in a position to
reduce our rates to remain competitive. Such reductions could adversely impact
our results of operations if we do not also provide other services to our long
distance customers.
We also compete with wholesale DSL carriers, including companies such as
Covad Communications Group, Inc., that offer DSL services and other data related
products. Many DSL carriers have significant strategic equity investors,
marketing alliances and product development partners, and have obtained licenses
to operate as a CLEC. Additionally, many of these competitors are offering, or
may soon offer, VoIP services that may take business away from our CLECs or from
VoX. VoIP competitors include the brands AT&T, Lingo, Net2phone, Packet8 and
Vonage, as well as several ILECs.
Government Regulation
Local and long distance telecommunications services provided by CLECs are
subject to regulation by the FCC and by state regulatory authorities. Among
other things, these regulatory authorities impose regulations governing the
rates, terms and conditions for interstate and intrastate telecommunications
services and require us to file tariffs and obtain approval for intrastate
service provided in the states in which we currently market our services. We
must obtain and maintain certificates of public convenience and necessity from
regulatory authorities in the states in which we operate. We are also required
to file and obtain prior regulatory approval for tariffs and intrastate
services. In addition, we must update or amend the tariffs and, in some cases,
the certificates of public convenience and necessity, when rates are adjusted or
new products are added to the local and long distance services we offer. Changes
in existing laws and regulations, particularly regulations resulting in
increased price competition, may have a significant impact on our business
activities and on our future operating results. We are also subject to Federal
Trade Commission regulation and other federal and state laws relating to the
promotion, advertising and direct marketing of our products and services.
Certain marketing practices, including the means to convert a customer's
local or long distance telephone service from one carrier to another, have
recently been subject to increased regulatory review of both federal and state
authorities. Even though we have implemented procedures to comply with
applicable regulations, increased regulatory scrutiny could adversely affect the
transitioning of customers and the acquisition of new customer bases. Amendments
to existing statutes and regulations, adoption of new statutes and regulations
and expansion of our operations into new geographic areas and new services could
require us to alter our methods of operation or obtain additional approvals, at
costs which could be substantial. There can be no assurance that we will be able
to comply with applicable laws, regulations and licensing requirements. Failure
to comply with applicable laws, regulations and licensing requirements could
result in civil penalties, including substantial fines, as well as possible
criminal sanctions.
The use of the Internet and VoIP networks as a way of providing voice
services is a relatively recent development. Although the provisioning of such
services is currently permitted by United States law and is largely unregulated
within the United States, several foreign governments have adopted laws and/or
regulations that could restrict or prohibit the provisioning of voice
communications services over the Internet. Various regulatory actions are
underway or are being contemplated by federal, state and local authorities,
including the FCC, state regulatory agencies and local governments. To date, the
FCC has treated Internet service providers as information service providers.
Information service providers are currently exempt from federal and state
regulations governing legacy telecommunication carriers, including the
obligation to pay access charges and contribute to the universal service fund.
More aggressive domestic or international regulation of the Internet in general,
and Internet telephony
8
providers and services specifically, may materially and adversely affect our
business plan, financial condition and future prospects, particularly if
increased numbers of governments impose regulations restricting the use and sale
of Internet telephony services.
Employees
At February 28, 2005, we employed 46 employees, of whom 40 were employed
on a full-time basis and six were employed on a part-time basis. We are not
subject to any collective bargaining agreement and we believe our relationship
with our employees is good.
Item 2. - Description of Property
The following table sets forth pertinent facts concerning our office
leases at February 15, 2005.
Location Use Approximate Square Feet Annual Rent
-------- --- ----------------------- -----------
75 South Broadway Office 4,000 $72,000
White Plains, NY 10601
118 Celebration Avenue Office 2,000 $51,600
Celebration, FL 34747
The lease for our office space in White Plains, New York is a five-year
lease that began on December 1, 2003 and our lease for our office space in
Celebration, Florida is a three-year lease that began on February 1, 2005. We
believe this space is adequate for our current operating needs. We have no other
leased or owned properties.
Item 3. - Legal Proceedings
Other than the license and regulatory proceedings that routinely occur for
telecommunication entities as described under "Government Regulation," we are
not currently a party to any legal proceeding that we believe will have a
material adverse effect on our financial condition or results of operations.
Item 4. - Submission of Matters To a Vote of Security Holders
None.
9
PART II
Item 5. - Market for Common Equity, Related Stockholder Matters and Small
Business Issuer Purchases of Equity Securities
Our common stock currently trades on The OTC Bulletin Board(R) ("OTCBB")
under the symbol ELEC. The high and low sales price for each quarterly period of
our last two fiscal years are listed below:
High Low
---- ---
Fiscal 2003
-----------
1st Quarter $0.08 $0.04
2nd Quarter 0.16 0.05
3rd Quarter 0.14 0.08
4th Quarter 0.21 0.08
Fiscal 2004
-----------
1st Quarter $0.25 $0.13
2nd Quarter 0.26 0.14
3rd Quarter 0.36 0.14
4th Quarter 0.40 0.21
The quotations set forth in the table above reflect inter-dealer prices,
without retail mark-up, mark-down or commission, and may not necessarily
represent actual transactions. As of February 28, 2005, there were 235 holders
of record of our common stock and approximately 4,000 beneficial holders.
We have never paid dividends on our common stock and do not expected to do
so in the foreseeable future. Our loan agreement with Laurus Master Funds, Ltd.
("Laurus") does not allow us to directly or indirectly declare or pay any
dividends so long as our secured convertible term note to Laurus remains
outstanding.
10
The following table provides information as of November 30, 2004 with
respect to shares of our common stock that are issuable under equity
compensation plans.
Number of securities
remaining available to
Number of securities future issuance under
to be issued upon Weighted-average equity compensation
exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
warrants and rights warrants and rights column (a))
Plan Category (a) (b) (c)
------------------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders:
Employee Stock Option Plan (1) 1,572,500 $ 0.59 453,215
1996 Restricted Stock Plan (2) -- 400,000
--------- ---------
Subtotal 1,572,500 853,215
--------- ---------
Equity compensation plans not
approved by security holders:
Employee stock options 1,900,000 0.24 --
RFC Warrants (3) 200,000 1.54 --
Kaufman Bros. Warrants (4) 350,000 1.88 --
--------- ---------
Subtotal 2,450,000
---------
Total 4,022,500 853,215
========= =========
----------
(1) Our Employee Stock Option Plan allows for the granting of share options to
Board members, officers, non-officer employees and consultants.
(2) Our Restricted Stock Plan provides for the issuance of restricted share
grants to officers and non-officer employees.
(3) A former lender, RFC Capital Corp., was issued warrants (the "RFC
Warrants") in conjunction with a revolving credit facility. The facility
has been retired; however, the RFC Warrants will remain outstanding until
exercised or until the expiration date of October 23, 2010.
(4) The Kaufman Bros. Warrants represent two warrant grants for investment
banking services.
11
Item 6. - Management's Discussion and Analysis or Plan of Operation
Certain statements set forth below under this caption constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Please refer to page 2 of this Report for
additional factors relating to such statements.
Plan of Operation
Our financial condition was significantly improved in February 2005, when
we sold to Laurus our fixed rate convertible term note in the principal amount
of $2,000,000 and entered into a wholesale services agreement with Verizon. The
promissory note issued to Laurus has a three-year term, is payable in
thirty-three equal monthly principal installments of $60,606, plus monthly
interest at the rate of prime plus 3% per annum, beginning on May 1, 2005, and
is convertible into shares of our common stock at a conversion price of $0.63
per share, subject to adjustment. The result of these two transactions is that
we now have cash balances that we can use for new customer acquisitions, and a
five-year agreement that will allow us to continue our core business regardless
of whether the FCC or state public service commissions rule in favor of or
against UNE-P.
Our primary methods of obtaining new customer accounts will continue to be
through telemarketing and outside sales agents. We believe these are effective
low-cost methods of building new accounts, and our past history with these
customer acquisition methods is helpful in planning and budgeting our operations
on a going-forward basis. While we believe our cash balances are adequate for
continued growth, our cash balances may not be sufficient to generate the growth
we desire for our VoIP subsidiary. We plan to reassess our cash requirements for
VoIP on a regular basis as we begin adding customers to our platform.
We expect to have controlled capital expenditures for our VoIP product
during the next 12 months. The amount expended will depend on demand for our
product. If we experience higher demand and strong sales growth, we will require
additional equipment expenditures. We believe we will be able to make such
expenditures as we grow our business so that the utilization percentages of our
network equipment will remain high. We do not see a need to purchase network
assets that may remain idle or underutilized.
Fiscal Year 2004 Compared to Fiscal Year 2003
Our revenues for fiscal 2004 increased by approximately $3,990,000, or
approximately 72%, to approximately $9,558,000 as compared to approximately
$5,568,000 reported for fiscal 2003. The growth in revenues is directly related
to the growth in our customer base or number of local access lines that we
served. We ended fiscal 2004 with 24,034 billed lines, as compared to 10,835
billed lines at November 30, 2003. Although the line count increased by 13,199
lines, or 122%, in fiscal 2004, due to insufficient cash flow to support our
telemarketing costs in the first half of fiscal 2004, most of the increase came
in the second half of our fiscal year. Therefore, annual revenues did not
increase by the same percentage as the percentage increase in our line count. We
anticipate that, by utilizing the majority of the net proceeds we received from
the Laurus financing we completed in February 2005 for marketing purposes to
attract new customers, we will be able to continue to grow our line count by
more than 100% in fiscal 2005. Several large CLECs that sell in New Jersey, New
York and Pennsylvania have indicated to the public that they are decreasing or
discontinuing their selling efforts to new customers because of the TRO Remand
Order. We anticipate that the reduced competition in these states will be a
factor that will help us to retain our current selling prices in those states,
which currently
12
average monthly revenues of approximately $50 per line. We also believe the
decrease in the number of competitors may make our selling efforts somewhat
easier than we have experienced in the past.
Our gross profit for fiscal 2004 increased by approximately $2,018,000 to
approximately $4,820,000 from approximately $2,802,000 reported in fiscal 2003,
while our gross profit percentage of 50.4% in fiscal 2004 as compared to 50.3%
in fiscal 2003 essentially remained the same from fiscal period to fiscal
period. The increase in our dollars of gross profit resulted from the increase
in our customer base in fiscal 2004 over fiscal 2003. Our gross profit
percentage of approximately 50.4% reflects our sales strategy to sell only in
those states in which we believe we will be able to achieve a gross margin of
over 40%. Our selling strategy in fiscal 2005 is to continue to sell in states
that offer the opportunity to achieve higher margins. However, we do not
anticipate achieving a 50% gross margin in fiscal 2005 because our cost of
services are higher under our wholesale services agreement with Verizon than we
previously experienced while operating under UNE-P. We have passed on this
increase in cost to new customers beginning on October 1, 2004, but we have not
raised our prices to our existing customers and do not intend to do so in the
near future. During fiscal 2005, we also plan to begin selling in localities
serviced by Qwest. Although we will begin selling in areas in which we believe
we can achieve a gross margin greater than 40%, we do not believe we will
achieve gross margins of 50%. In addition, we plan to sell VoIP services
nationwide in fiscal 2005. The margins for such services will be dependent on
the cost structures we negotiate with carriers for wholesale services or to
terminate calls made by our VoIP customers to a traditional landline telephone.
Gross margins may also be impacted by product mix in 2005. If we have success in
selling our VoIP to wholesale VoIP customers, our gross margins will be lower
than if we only sell directly to individual end-users.
Selling, general and administrative expenses ("SG&A") decreased by
approximately $215,000, or approximately 3.8%, to approximately $5,447,000 for
fiscal 2004 from approximately $5,662,000 reported in the prior year fiscal
period. Although we grew our revenues significantly in fiscal 2004, we were able
to limit our SG&A. Our occupancy costs were substantially lower in fiscal 2004,
as we incurred rental expense of approximately $6,000 per month under our
existing headquarters lease as compared to the occupancy costs of approximately
$22,000 per month we incurred in operating our former headquarters building,
which we sold in the fourth quarter of fiscal 2003. We believe there are no
additional areas in which we can materially reduce our SG&A going forward, and
we anticipate our SG&A will increase significantly in fiscal 2005 as we add new
customers. We pay outside sales agencies approximately $45 a line for each new
local access line they bring to us, and we pay independent verification
companies approximately $3 a line for a recorded letter of agency from each new
customer. We anticipate new line acquisition costs will increase from
approximately $385,000 a quarter in fiscal 2004 to up to one million dollars a
quarter in fiscal 2005 as we attempt to rapidly increase our customer base.
Depreciation expense decreased by approximately $74,000, to approximately
$14,000 for fiscal 2004 as compared to approximately $88,000 for fiscal 2003.
The decline in depreciation expense was primarily attributable to the sale of
our headquarters building in the fourth quarter of fiscal 2003 and to the sale
of certain assets to EAC in the first quarter of fiscal 2003.
Interest expense decreased by approximately $172,000, to approximately
$3,000 for fiscal 2004 as compared to approximately $175,000 for fiscal 2003.
The decrease in interest expense was primarily attributable to the repayment of
a mortgage note in conjunction with the sale of our headquarters building in the
fourth quarter of fiscal 2003. We anticipate interest expense for fiscal 2005
will increase due to the interest that we project we will pay on the debt that
we have incurred in 2005.
13
Other income, net for fiscal 2004 was approximately $46,000 as compared to
approximately $164,000 for fiscal 2003. The income for fiscal 2004 resulted
primarily from commission income of approximately $88,000, which was partially
offset by charges for environmental costs of approximately $45,000 directly
related to the sale of our headquarters building in the fourth quarter of fiscal
2003. The income for fiscal 2003 resulted primarily from rental and commission
income of approximately $210,000, which was partially offset by the write-down
of our investment in Cordia Corporation of approximately $71,000.
In fiscal 2004, we reported income of approximately $904,000 from debt
reduction related to the TSI bankruptcy. No such income was reported in fiscal
2003. Bankruptcy reorganization costs for fiscal years 2004 and 2003 of
approximately $161,000 and $70,000, respectively, represented legal cost
associated with the TSI bankruptcy.
In fiscal 2003, we sold Essex assets, Essex stock and our headquarters
building. The sales netted a gain of approximately $11,306,000. We had no such
asset sales in fiscal 2004.
In fiscal 2004, gain on the sale of investment securities and other
investments of approximately $1,000, resulted from the sale of Cordia
Corporation ("Cordia") shares as compared to the gain of approximately $122,000
in fiscal 2003, which resulted from the sale of shares of Cordia and Talk
America Holdings Inc. ("Talk").
In fiscal 2004, we recorded a net tax benefit of approximately $48,000
offset by a current year provision of $22,000, which resulted from the reduction
of an estimated accrual of corporate tax expense for fiscal 2003. In fiscal,
2003, we recorded estimated corporate tax expense of approximately $75,000.
Liquidity and Capital Resources
At November 30, 2004, we had cash and cash equivalents of approximately
$372,000 and negative working capital of approximately $1,939,000 as compared to
cash and cash equivalents of approximately $669,000 and negative working capital
of approximately $1,938,000 at November 30, 2003. On February 8, 2005, we
received net proceeds of $1,744,500 from the sale of a $2 million secured
convertible term note.
Net cash used in operating activities aggregated approximately $80,000 and
$1,636,000 in fiscal 2004 and 2003, respectively. The principal use of cash from
operating activities in fiscal 2004 was the increase in accounts receivable of
approximately $1,590,000, which was offset by a non-cash item, an increase in
the provision for doubtful accounts of approximately $1,049,000. The principal
use of cash from operating activities in fiscal 2003 was net income of
approximately $8,323,000, which was offset by non-cash gains on the sale of the
Essex assets and subsidiary of approximately $10,825,000.
Net cash (used in) provided by investing activities aggregated
approximately ($186,000) and $2,529,000 in fiscal 2004 and 2003, respectively.
The principal use of cash from financing activities in fiscal 2004 was the
purchase of property and equipment of approximately $182,000. The principal
source of cash from investing activities was the net proceeds of $2,100,000
received from the sale of our corporate headquarters building.
Net cash used in financing activities aggregated approximately $31,000 and
$1,163,000 in fiscal 2004 and 2003, respectively. In fiscal 2004, net cash used
in financing activities resulted from the repayment of debt. In fiscal 2003, net
cash used in financing activities resulted principally from the repayment of the
mortgage note payable in respect of our former headquarters building of
$1,100,000.
14
In fiscal 2004, we spent approximately $180,000 on capital expenditures,
primarily for software related to our VoIP initiative. We intend to spend a
similar amount for software enhancements in fiscal 2005. We believe we will also
make capital expenditures for our VoIP platform and that capital additions will
be flexible depending upon the number of customers that we are able to attract
to our network.
We have stock purchase warrants that entitle us to purchase approximately
95,000 shares of Talk. The warrant exercise price is $6.30 per share and, at
February 28, 2005, our warrants were not in-the-money, as Talk common stock was
trading at approximately $6.15 per share at such date.
We have reported profits in the last two fiscal years, but we have also
sustained net losses from operations during this time period, as we have worked
to build our customer base since the sale of almost all of our customers on
December 31, 2002. Our operating losses have been funded through the sale of
non-operating assets, the issuance of equity securities and borrowings. We
believe that current cash and cash equivalents will be sufficient to finance our
operations through at least the next twelve months. However, we continually
evaluate our cash needs and growth opportunities and we anticipate seeking
additional equity or debt financing in order to achieve our overall business
objectives. There can be no assurance that such financing will be available, or,
if available, at a price that would be acceptable to us. Failure to generate
sufficient revenues, raise additional capital or reduce certain discretionary
spending could have an adverse impact on our ability to achieve our longer-term
business objectives.
New Accounting Standards
The new accounting pronouncements in Note 1 to our consolidated financial
statements, which are included in this Report, are incorporated herein by
reference.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles ("GAAP") in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities and disclosures of contingent assets and liabilities at the
date of the financial statements and reported amounts of revenues and expenses
during the reporting period. The most significant estimates include:
* revenue recognition and estimating allowance for doubtful
accounts;
* valuation of long-lived assets; and
* income tax valuation allowance.
We continually evaluate our accounting policies and the estimates we use
to prepare our consolidated financial statements. In general, the estimates are
based on historical experience, on information from third party professionals
and on various other sources and assumptions that are believed to be reasonable
under the facts and circumstances at the time such estimates are made.
Management considers an accounting estimate to be critical if:
* it requires assumptions to be made that were uncertain at the
time the estimate was made; and
15
* changes in the estimate, or the use of different estimating
methods, could have a material impact on our consolidated
results of operations or financial condition.
Actual results could differ from those estimates. Significant accounting
policies are described in Note 1 to our consolidated financial statements, which
are included in this Report. In many cases, the accounting treatment of a
particular transaction is specifically dictated by GAAP. There are also areas in
which management's judgment in selecting any available alternative would not
produce a materially different result.
Certain of our accounting policies are deemed "critical", as they require
management's highest degree of judgment, estimates and assumptions. The
following critical accounting policies are not intended to be a comprehensive
list of all of our accounting policies or estimates:
Revenue Recognition
We apply the provisions of Staff Accounting Bulletin 101 "Revenue
Recognition". We recognize revenue from telecommunication services in the period
that the service is provided. We estimate amounts earned for carrier
interconnection and access fees based on usage.
Accounts Receivable
In an effort to increase the number of customer lines, we attempt to
purchase lists of potential customers that have credit scores that are deemed to
be credit worthy. Other than having an acceptable credit score, we do not
perform significant initial credit evaluations of our customers. Once a customer
is billed for services, we actively manage the accounts receivable to minimize
credit risk.
We maintain an allowance for doubtful accounts, which is estimated based
upon historical experience as well as specific customer collection issues that
have been identified. We cannot guarantee that we will continue to experience
the same credit loss rates that we have in the past.
Impairment of Long-Lived Assets
We follow the provisions of SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." This statement requires that certain assets
be reviewed for impairment and, if impaired, remeasured at fair value whenever
events or changes in circumstances indicate that the carrying amount of the
asset may not be recoverable. Impairment loss estimates are primarily based upon
management's analysis and review of the carrying value of long-lived assets at
each balance sheet date, utilizing an undiscounted future cash flow calculation.
During fiscal years 2004 and 2003, there were no impairment losses.
Income Taxes
We estimate the degree to which tax assets and loss carryforwards will
result in a benefit based on expected profitability by tax jurisdiction. A
valuation allowance for such tax assets and loss carryforwards is provided when
it is determined that such assets will more likely than not go unused. If it
becomes more likely than not that a tax asset or loss carryforward will be used,
the related valuation allowance on such assets is reversed. If actual future
taxable income by tax jurisdiction varies from estimates, additional allowances
or reversals of reserves may be necessary.
16
Item 7. - Financial Statements
The following consolidated financial statements, notes thereto, and the
related independent auditors' report contained on page F-2 to our consolidated
financial statements are herein incorporated:
Consolidated balance sheet - November 30, 2004
Consolidated statements of operations - Years ended November 30, 2004 and
2003
Consolidated statements of stockholders' equity deficiency - Years ended
November 30, 2004 and 2003
Consolidated statements of cash flows - Years ended November 30, 2004 and
2003
Notes to consolidated financial statements - Years ended November 30, 2004
and 2003
17
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
YEARS ENDED NOVEMBER 30, 2004 AND 2003
CONSOLIDATED FINANCIAL STATEMENTS AND
REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors
eLEC Communications Corp.
White Plains, New York
We have audited the consolidated balance sheet of eLEC Communications Corp. and
subsidiaries as of November 30, 2004, and the consolidated statements of
operations, stockholders' equity deficiency, and cash flows for the years ended
November 30, 2004 and 2003. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the Standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of eLEC
Communications Corp. and subsidiaries as of November 30, 2004, and the
consolidated results of their operations and cash flows for the years ended
November 30, 2004 and 2003, in conformity with U.S. generally accepted
accounting principles.
NUSSBAUM YATES & WOLPOW, P.C.
Melville, New York
March 4, 2005
F-1
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
NOVEMBER 30, 2004
ASSETS
2004
------------
Current assets
Cash and cash equivalents $ 371,852
Accounts receivable, net of allowance of
$547,768 1,247,063
Prepaid expenses and other current assets 42,179
------------
Total current assets 1,661,094
Property and equipment, net 192,413
Other assets 50,295
------------
Total assets $ 1,903,802
------------
LIABILITIES AND STOCKHOLDERS' EQUITY DEFICIENCY
2004
------------
Current liabilities:
Current portion of capital
lease obligations $ 32,100
Accounts payable and accrued expenses 2,445,947
Taxes payable 721,108
Due to related parties 59,384
Deferred revenues 341,702
------------
Total current liabilities 3,600,241
------------
Stockholders' equity deficiency:
Common stock, $.10 par value; 50,000,000 shares
authorized; 16,254,282 shares issued 1,625,428
Capital in excess of par value 25,624,234
Deficit (28,943,850)
Accumulated other comprehensive loss, unrealized
loss on securities (2,251)
------------
Total stockholders' equity deficiency (1,696,439)
------------
Total liabilities and stockholders'
equity deficiency $ 1,903,802
------------
See accompanying notes to consolidated financial statements.
F-2
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED NOVEMBER 30, 2004 AND 2003
2004 2003
------------ ------------
Revenues $ 9,557,600 $ 5,568,004
------------ ------------
Cost and expenses:
Cost of services 4,738,038 2,765,811
Selling, general and administrative 5,447,232 5,662,085
Depreciation 14,480 88,460
------------ ------------
Total costs and expenses 10,199,750 8,516,356
------------ ------------
Loss from operations (642,150) (2,948,352)
------------ ------------
Other income (expense):
Interest expense (3,126) (174,800)
Other income, net 45,795 163,528
Gain on sale of investment securities and other investments 770 121,687
Gain on disposition of subsidiary -- 10,825,332
Gain on sale and disposal of property, plant and equipment -- 480,574
------------ ------------
Total other income 43,439 11,416,321
------------ ------------
Income (loss) before bankruptcy reorganization
items and income tax (benefit) expense (598,711) 8,467,969
------------ ------------
Reorganization items:
Gain on settlement with creditors 904,027 --
Professional fees (161,000) (69,758)
------------ ------------
743,027 (69,758)
------------ ------------
Income before income tax (benefit) expense 144,316 8,398,211
Income tax (benefit) expense (25,937) 75,000
------------ ------------
Net income $ 170,253 $ 8,323,211
------------ ------------
Basic income per share $ .01 $ .53
------------ ------------
Diluted income per share $ .01 $ .53
------------ ------------
Weighted average number of common shares outstanding:
Basic 16,254,282 15,771,219
------------ ------------
Diluted 16,715,808 15,841,941
------------ ------------
See accompanying notes to consolidated financial statements.
F-3
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY DEFICIENCY
YEARS ENDED NOVEMBER 30, 2004 AND 2003
Preferred Stock Common Stock Capital
---------------------------- ---------------------------- in Excess of
Shares Amount Shares Amount Par Value
------------ ------------ ------------ ------------ ------------
Balance, December 1, 2002 16 $ 2 15,619,282 $ 1,561,928 $ 25,671,342
Net income
Less reclassification
adjustment for gains realized
in net income
Comprehensive income
Stock issued for interest
expense 630,000 63,000 (19,110)
Conversion of Series B
preferred stock to common
stock (16) (2) 16,000 1,600 (1,598)
------------ ------------ ------------ ------------ ------------
Balance, November 30, 2003 -- -- 16,265,282 1,626,528 25,650,634
Net income
Unrealized holding loss
Comprehensive income
Retirement of treasury stock (11,000) (1,100) (26,400)
------------ ------------ ------------ ------------ ------------
Balance, November 30, 2004 -- -- 16,254,282 $ 1,625,428 $ 25,624,234
============ ============ ============ ============ ============
Accumulated Total
Other Stockholders'
Treasury Comprehensive Equity
Deficit Stock income (Loss) Deficiency
------------ ------------ ------------- -------------
Balance, December 1, 2002 $(37,437,314) $ (27,500) $ 69,922 $(10,161,620)
------------
Net income 8,323,211 8,323,211
Less reclassification
adjustment for gains realized
in net income (69,922) (69,922)
------------
Comprehensive income 8,253,289
Stock issued for interest
expense 43,890
Conversion of Series B
preferred stock to common
stock --
------------ ------------ ------------ ------------
Balance, November 30, 2003 (29,114,103) (27,500) -- (1,864,441)
------------
Net income 170,253 170,253
Unrealized holding loss (2,251) (2,251)
------------
Comprehensive income 168,002
Retirement of treasury stock 27,500 --
------------ ------------ ------------ ------------
Balance, November 30, 2004 $(28,943,850) $ -- $ (2,251) $ (1,696,439)
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
F-4
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED NOVEMBER 30, 2004 AND 2003
2004 2003
------------ ------------
Operating activities:
Net income $ 170,253 $ 8,323,211
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation 14,480 88,460
Gain on sale of investment securities -- (87,965)
Gain on sale of other investments -- (33,722)
Loss on write-down of other investments -- 71,430
Gain loss on sale and disposal of property,
plant and equipment -- (480,574)
Gain on settlement with creditors (904,027) --
Stock issued for interest expense -- 43,890
Gain on disposition of subsidiary -- (10,825,332)
Provision for losses on accounts receivable 1,048,559 981,920
Changes in assets and liabilities:
Accounts receivable (1,590,973) (1,517,838)
Prepaid expenses and other current assets 140,251 97,399
Distribution to bankruptcy creditors (301,170) --
Other assets -- 189,855
Accounts payable and accrued expenses 1,050,704 915,065
Taxes payable 315,011 406,097
Deferred revenues 220,564 121,138
Related party, net (243,684) 71,363
------------ ------------
Net cash used in operating activities (80,032) (1,635,603)
------------ ------------
Investing activities, net of effects of acquisitions:
Purchase of property and equipment (181,502) --
Proceeds from sale of investment securities -- 98,274
Proceeds from sale of other investments -- 100,000
Purchase of investment securities (4,546) --
Proceeds from sale of property, plant and equipment -- 2,121,746
Proceeds from collection of other assets -- 209,102
------------ ------------
Net cash provided by (used in) investing activities (186,048) 2,529,122
------------ ------------
(Continued)
See accompanying notes to consolidated financial statements.
F-5
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
2004 2003
----------- -----------
Financing activities:
Proceeds from short-term borrowings $ -- $ 380,000
Repayment of short-term borrowings -- (380,000)
Repayment of long-term debt (7,260) (1,163,025)
Principal payments on pre-petition bank debt in
bankruptcy proceedings (23,830) --
----------- -----------
Net cash used in financing activities (31,090) (1,163,025)
----------- -----------
Decrease in cash and cash equivalents (297,170) (269,506)
Cash and cash equivalents at beginning of year 669,022 938,528
----------- -----------
Cash and cash equivalents at end of year $ 371,852 $ 669,022
=========== ===========
Cash paid during the year for:
Interest $ 3,126 $ 121,532
=========== ===========
Taxes $ 27,593 $ --
=========== ===========
Supplemental disclosure of non-cash investing and financing activities:
See Notes 5 and 12
See accompanying notes to consolidated financial statements.
F-6
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles
------------------------------------------------------------
Description of Business and Concentrations
eLEC Communications Corp. ("eLEC" or the "Company") is a full-service
telecommunications company that focuses on developing integrated telephone
service in the competitive local exchange carrier ("CLEC") industry and by
utilizing high-speed internet connections to provide voice over internet
protocol services which is intended to be available to customers in fiscal
2005. The Company offers small businesses and residential customers an
integrated set of telecommunications products and services, including
local exchange, local access, and domestic and international long distance
telephone.
The Company presently operates in one business segment. The principal
focus of the Company, as a CLEC, is to resell and provide low cost
alternative telecommunication services and other bundled services,
focusing on small business users and residential customers.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries after elimination of significant
intercompany balances and transactions. Investments in less than 20% owned
companies that do not have readily determinable fair values were carried
at cost prior to their disposition.
Investment Securities
In accordance with generally accepted accounting principles, the Company
follows Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities", which requires
that investment securities be classified as trading, held-to-maturity or
available-for-sale. Investment securities at November 30, 2004 consisted
of equity securities classified as available-for-sale and are carried at
fair value with unrealized gains or losses reported in a separate
component of shareholders' equity.
F-7
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1 Description of Business and Summary of Accounting Principles (Continued)
------------------------------------------------------------------------
Property, Plant and Equipment and Depreciation
Property, plant and equipment are recorded at cost. Depreciation is
computed primarily by use of accelerated and straight-line methods over
the estimated useful lives of the assets. The estimated useful lives are
three to five years for computer equipment and software, five to ten years
for machinery and equipment, and the lesser of the estimated useful life
or the life of the lease for leasehold improvements.
Income Taxes
The Company accounts for income taxes according to the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting
for Income Taxes." Under the liability method specified by SFAS 109,
deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities as
measured by the enacted tax rates which will be in effect when these
differences reverse and the effect of net operating loss carryforwards.
Deferred tax expense is the result of changes in deferred tax assets and
liabilities. A valuation allowance has been established to eliminate the
deferred tax assets as it is more likely than not that such deferred tax
assets will not be realized.
Revenue Recognition
Revenues from voice, data and other telecommunication-related services are
recognized in the period in which subscribers use the related services.
Revenues for carrier interconnection and access are recognized in the
period in which the service is provided.
F-8
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles (Continued)
------------------------------------------------------------------------
Collectibility of Accounts Receivable
Trade receivables potentially subject the Company to credit risk. The
Company extends credit to its customers and generally does not require
collateral. During fiscal years ended November 30, 2004 and 2003, the
Company accepted most new customers and extended initial credit without an
evaluation of the credit history or financial condition of the customer.
In the fourth quarter of the year ended November 30, 2004, the Company
made an effort to improve the acceptance of new customers by requiring
certain minimum credit scores by new applicants. Once a customer is billed
for services, the Company actively manages the accounts receivable to
minimize credit risk. Approximately $96,000 as of November 30, 2004
represented net amounts due (after allowance for doubtful collection) from
entities in the telecommunications industry related to carrier
interconnection and access.
In order to record the Company's accounts receivable at their net
realizable value, the Company must assess their collectibility. A
considerable amount of judgment is required in order to make this
assessment, including an analysis of historical bad debts and other
adjustments, a review of the aging of the Company's receivables, and the
current creditworthiness of the Company's customers. Generally, when a
customer account reaches a certain level of delinquency, the Company
disconnects the customer's service and provides an allowance for the
related amount receivable from the customer. The Company has recorded
allowances for receivables that it considered uncollectible, including
amounts for the resolution of potential credit and other collection issues
such as disputed invoices, customer satisfaction claims and pricing
discrepancies. However, depending on how such potential issues are
resolved, or if the financial condition of any of the Company's customers
was to deteriorate and their ability to make required payments was to
become impaired, increases in these allowances may be required. The
Company actively manages its accounts receivable to minimize credit risk.
As of November 30, 2004, the Company had no individual customer that
constituted more than 10% of its accounts receivable.
During the years ended November 30, 2004 and 2003, the Company recorded
bad debt expense of approximately $1,049,000 and $982,000.
Earnings Per Share
Basic earnings per share is computed by dividing net income by the
weighted-average number of shares outstanding. Diluted earnings per share
included the dilutive effect of stock options, warrants, and in 2003,
convertible preferred stock. Approximately 1,130,000 and 1,500,000 of the
Company's stock options and warrants were excluded from the 2004 and 2003
calculation of diluted earnings per share because the exercise price of
the stock options and warrants were greater than the average price of the
common shares, and therefore their inclusion would have been
anti-dilutive.
F-9
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles (Continued)
------------------------------------------------------------------------
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with
original maturities of three months or less to be cash equivalents.
Impairment of Long-Lived Assets
The Company reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to future
forecasted net undiscounted cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the
assets exceeds the fair values.
Use of Estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
the disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses
during the reporting period. Significant estimates relate to the allowance
for doubtful accounts receivable, income tax valuation allowance, and
conclusions regarding the impairment of long-lived assets and gain
recognition on the sale of the subsidiaries. Actual results could differ
from those estimates, and any difference between the amounts recorded and
amounts ultimately realized or paid will be adjusted prospectively as new
facts become known.
F-10
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles (Continued)
------------------------------------------------------------------------
Advertising
Advertising costs are expensed as incurred. Advertising expense amounted
to approximately $1,000 in 2004 and $27,000 in 2003.
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value
of each class of significant financial instruments:
o Cash and Cash Equivalents
The carrying amount approximates fair value because of the short
maturity of those instruments.
o Investment Securities
The fair value of the Company's investment in marketable equity
securities is based upon the quoted market price.
o Capital Lessee Obligations
The fair value of the Company's capital lessee obligations is
estimated based on current rates offered to the Company for debt of
the same remaining maturities and approximates the carrying amount.
The Company has no instruments with significant off-balance-sheet risk.
F-11
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles (Continued)
------------------------------------------------------------------------
Stock Compensation Plan
The Company accounts for its stock option awards under the intrinsic value
based method of accounting prescribed by APB Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations, including
Financial Accounting Standards Board ("FASB") Interpretation No. 44,
"Accounting for Certain Transactions Including Stock Compensation," an
interpretation of APB Opinion No. 25. Under the intrinsic value based
method, compensation cost is the excess, if any, of the quoted market
price of the stock at grant date or other measurement date over the amount
an employee must pay to acquire the stock. The Company makes pro forma
disclosures of net income and earning per share as if the fair value based
method of accounting had been applied as required by SFAS No. 123,
"Accounting for Stock-Based Compensation."
The Company's 1995 Stock Option Plan (the "Plan") provides for the grant
of up to 3,400,000 incentive stock options, non-qualified stock options,
tandem stock appreciation rights, and stock appreciation rights of shares
of common stock. Under the Plan, incentive stock options may be granted at
no less than the fair market value of the Company's stock on the date of
grant, and in the case of an optionee who owns directly or indirectly more
than 10% of the outstanding voting stock (an "Affiliate"), 110% of the
market price on the date of grant. As of November 30, 2004, approximately
450,000 option shares remain available for future issuance.
The Company's non-employee Director Stock Option Plan provides for the
grant of options to purchase 10,000 shares of the Company's common stock
to each non-employee director on the first business day following each
annual meeting of the shareholders of the Company. Under the plan, options
may be granted at no less than the fair market value of the Company's
common stock on the date of grant.
For disclosure purposes, the fair value of each stock option grant is
estimated on the date of grant using the Black Scholes option-pricing
model with the following weighted average assumptions used for stock
options granted in 2004 and 2003, respectively: annual dividends of $ -0-
for both years, expected volatility of 158% and 159%, risk-free interest
rate of 1.25% and 1.15%, and expected life of five years for all grants.
The weighted-average fair value of stock options granted in 2004 and 2003
was $.21 and $.09, respectively.
F-12
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles (Continued)
------------------------------------------------------------------------
Stock Compensation Plan (Continued)
Under the above model, the total value of stock options granted in 2004
and 2003 was $466,273 and $68,574, respectively, which would be amortized
ratably on a pro forma basis over the related vesting periods, which range
from immediate vesting to five years. Had compensation cost been
determined based upon the fair value of the stock options at grant date
for all awards, the Company's net income (loss) and earnings (loss) per
share would have been changed to the pro forma amounts indicated below:
2004 2003
---------- ----------
Net income:
As reported $ 170,253 $8,323,211
Stock-based compensation cost, net of
related tax effects, that would have been
included in the determination of net income
if the fair value based method had been
applied to all awards 279,145 294,338
---------- ----------
Proforma net income (loss) ($ 108,892) $8,028,873
Basic earnings (loss) per share:
As reported $ .01 $ .53
Proforma ($ .01) $ .51
Diluted earnings (loss) per share:
As reported $ .01 $ .53
Proforma ($ .01) $ .51
Stock-based employee compensation
cost, net of related tax effects, included
in the determination of net income as
reported $ -0- $ -0-
---------- ----------
F-13
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
1. Description of Business and Summary of Accounting Principles
------------------------------------------------------------
Recent Accounting Pronouncements (Continued)
On December 16, 2004, the Financial Accounting Standards Board (FASB)
issued Statement No. 123 (revised 2004) that will require compensation
costs related to share-based payment transactions to be recognized in the
financial statements. With limited exceptions, the amount of compensation
cost will be measured based on the grant-date fair value of the equity or
liability instruments issued. In addition, liability awards will be
measured each reporting period. Statement 123(R) replaces FASB Statement
No. 123, Accounting for Stock-Based Compensation, and supercedes APB
Opinion No. 25, accounting for Stock Issued to Employees. SFAS 123(R) is
effective as of the first interim or annual reporting period that begins
after December 15, 2005. The Company is currently assessing the impact of
adopting SFAS 123(R).
In December 2003, the FASB issued a revision to SFAS No. 132, "Employers
Disclosures about Pensions and Other Postretirement Benefits", which
revision is effective for fiscal years ending after December 15, 2003. The
adoption of this revision does not have any impact on the Company's
results of operations or financial position, but requires additional
disclosures related to the Company's defined benefit plan (See Note 9).
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure", which is effective
for fiscal years ending after December 15, 2002. The provisions of this
statement provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for
stock-based employee compensation, and requires disclosure about the
effects on reported net income of an entity's accounting policy decisions
with respect to stock-based compensation. The Company did not change its
accounting method for stock-based employee compensation and, accordingly,
the provisions of this new standard did not have a material impact on its
consolidated results of operations and financial position.
Reclassification
Certain 2003 amounts related to the bankruptcy of TSI and certain other
items have been reclassified to conform to the 2004 presentation.
F-14
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
2. Investment Securities
---------------------
At November 30, 2004:
Fair Unrealized
Cost Value Holding Loss
------- ------- ------------
Equity securities included
in other assets $ 4,546 $ 2,295 ($2,251)
------- ------- -------
The Company holds a non-marketable warrant to purchase 95,238 of shares of
Talk America Holding, Inc. ("Talk") at $6.30 per share, expiring in 2005.
As of November 30, 2004, the Talk shares closed at $6.32 per share.
3. Other Investments
-----------------
The Company held shares in Cordia Corporation (Cordia), a publicly-held
company whose shares were quoted in the over-the-counter market. Cordia is
controlled by entities owned by a shareholder and former employee of the
Company and members of his family. Due to the thinly-traded nature of the
Cordia shares, such shares had not been accounted for as marketable equity
securities in accordance with Statement of Financial Accounting Standards
No. 115, but instead were carried at cost.
During the years ended November 30, 2004 and 2003, the Company sold 2,000
and 70,000 shares of Cordia stock, resulting in gains of $770 and $33,722.
The shares were sold at a significant discount to published market prices.
At November 30, 2003, the Company wrote off its remaining investment in
Cordia amounting to $71,430, because the value of the Cordia investment
was deemed to be worthless. At November 30, 2004, the Company held 81,180
shares of Cordia.
4. Property, Plant and Equipment
-----------------------------
2004
--------
Machinery and equipment $ 82,605
Computer equipment and software 448,780
Furniture and fixtures 90,452
--------
621,837
Less accumulated depreciation and amortization 429,424
--------
$192,413
--------
F-15
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
4. Property, Plant and Equipment (Continued)
-----------------------------------------
On October 8, 2003, the Company sold its New Rochelle, New York corporate
headquarters. The Company received proceeds of $2,200,000 and used
$1,100,000 of such proceeds to retire in full the mortgage note on this
property (Note 6). As a result of the sale, the Company recorded a gain of
approximately $546,000 in the fourth quarter of 2003.
The Company placed approximately $100,000 in escrow to be used to remedy
potential environmental costs. As of November 30, 2003, approximately
$91,000 remained in escrow. In 2004, all but approximately $46,000 was
returned to the Company and the balance was used to cover environmental
costs. The $45,000 expense is included in other income, net.
5. Short-Term Borrowings
---------------------
Short-term borrowings as of November 30, 2003 consisted of an unsecured
line of credit agreement with a finance company, up to $150,000, due on
demand with interest payable monthly at the prime lending rate plus 2%.
This liability was settled on April 8, 2004 as part of a Plan of
Reorganization (see Note 8).
During the year ended November 30, 2003, the Company borrowed $380,000
from certain individuals that was repaid upon the sale of the corporate
headquarters described in Note 4. Interest expense related to such
borrowings amounted to approximately $45,000, including the issuance by
the Company of 630,000 shares of common stock valued at approximately
$44,000.
6. Long-Term Debt and Capital Lease Obligations
--------------------------------------------
On December 7, 2000, the Company acquired a building in New Rochelle, New
York, which served as the Company's headquarters. The purchase price of
the building was $1,500,000, of which $1,100,000 was paid with the
proceeds of a mortgage loan from the seller, and the remainder of the
purchase price was paid in cash at closing. The mortgage loan required
interest payments only on a monthly basis through December 2005, when the
entire loan principal balance became due. The interest rate was 10%
through December 2001, and 11% for the remaining period. See Note 4
regarding sale of the building and repayment of the mortgage loan.
F-16
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
6. Long-Term Debt and Capital Lease Obligations (Continued)
--------------------------------------------------------
Long-term debt consists of the following:
2004
-------
Capital lease obligations (Note 10) $32,100
Less current maturities 32,100
-------
$ --
=======
7. Income Taxes
------------
At November 30, 2004, the Company had net operating loss carryforwards for
Federal income tax purposes of approximately $20,850,000 expiring in the
years 2008 through 2024. There is an annual limitation of approximately
$187,000 on the utilization of approximately $2,450,000 of such net
operating loss carryforwards under the provisions of Internal Revenue Code
Section 382.
At November 30, 2004, the Company's Federal net operating loss carry
forwards are scheduled to expire as follows:
Year ended November 30
2008 $ 1,110,000
2009 1,050,000
2010 1,000,000
2012 3,100,000
2018 2,710,000
2019 2,510,000
2020 2,350,000
2021 5,850,000
2022 770,000
2024 400,000
-----------
$20,850,000
===========
F-17
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
7. Income Taxes (Continued)
------------------------
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets and
liabilities as of November 30, 2004 are as follows:
2004
-----------
Deferred tax assets:
Net operating loss carryforwards $ 7,090,000
Allowance for doubtful accounts and accruals 190,000
-----------
7,280,000
Valuation allowance (7,280,000)
-----------
Net deferred tax assets $ --
===========
The following is a reconciliation of the tax provisions for the two years
ended November 30, 2004 with the statutory Federal income tax rates:
Percentage of
Pre-Tax Income
------------------
2004 2003
------ ------
Statutory Federal income tax rate 34.0% 35.0%
Utilization of net operating loss carryovers -- (34.1)
Operating losses generating no tax benefit (34.0) --
State taxes, net of Federal effect 15.3 --
Reversal of accrual for prior year items (33.3) --
====== ======
(18.0)% .9%
====== ======
For the year ended November 30, 2004, the Company recorded a tax benefit
of approximately $48,000 which resulted from the reduction of an estimated
accrual of tax expense for the year ended November 30, 2003, offset by tax
expense of $22,000 for the year ended November 30, 2004.
F-18
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
8. Subsidiary's Plan of Reorganization
-----------------------------------
On April 8, 2004, the United States Bankruptcy Court for the Southern
District of New York confirmed a Plan of Reorganization (the "Bankruptcy
Plan") for Telecarrier Services, Inc. ("TSI"). On July 29, 2002, TSI, a
wholly owned subsidiary, had filed a voluntary petition for relief under
Chapter 11 of the Federal Bankruptcy Code in the United States Bankruptcy
Court for the Southern District of New York. The Bankruptcy Plan
authorized the Company to disburse $325,000 to creditors in full
satisfaction of claims amounting to approximately $1,229,000.
For the year ended November 30, 2004, TSI reported a gain of $904,027 as a
result of being judicially released from liabilities and claims as
follows:
Pre-petition claims:
Unsecured line of credit $ 150,000
Trade payables and due to related party 618,482
Other accrued expenses 103,250
----------
Total pre-petition claims 871,732
Post-petition payables and accrued expenses 68,124
Administrative claims and legal costs 289,171
----------
Total claims 1,229,027
Distribution to creditors 325,000
----------
Gain on debt reduction $ 904,027
==========
TSI had an agreement, effective January 2, 2002, with Telco Services, Inc.
("Telco"), a corporation owned by a former shareholder of the Company,
under which Telco provided TSI with collection, sales and other services.
As a result of a court-stipulated agreement between TSI and Telco, entered
into on February 6, 2004, the amount owed Telco for such services was
reduced by approximately $51,000. Such reduction was included in the gain
on settlement with creditors for the year ended November 30, 2004. As of
November 30, 2004, all of Telco's claims related to the TSI bankruptcy had
been paid in full, including $65,000 in administrative claims and
approximately $31,000 in unsecured claims. The President of Telco is also
the President of Glad Holdings (See Note 11).
F-19
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
9. Pension Plans
-------------
The Company sponsors a defined benefit plan covering two active employees
and a number of former employees. The Company's funding policy with
respect to the defined benefit plan is to contribute annually not less
than the minimum required by applicable law and regulation to cover the
normal cost and to fund supplemental costs, if any, from the date each
supplemental cost was incurred. Contributions are intended to provide not
only for benefits attributed to service to date, but also for those
expected to be paid in the future. Plan assets consist primarily of
investments in conservative equity and debt securities. The Company uses a
November 30 measurement date for its pension plan.
Effective June 30, 1995, the plan was frozen, ceasing all benefit accruals
and resulting in a plan curtailment.
Obligations and Funded Status at November 30:
Pension Benefits 2004 2003
--------- ---------
Change in benefit obligation:
Benefit obligation at beginning of year ($820,709) ($736,717)
Interest cost (52,125) (54,086)
Actuarial loss (32,373) (41,981)
Benefits paid 38,181 12,075
--------- ---------
Benefit obligation at end of year ($867,026) ($820,709)
========= =========
Change in plan assets:
Fair value of plan assets at beginning of year $498,149 $417,601
Actual return on plan assets 31,105 7,357
Employer contribution 89,000 85,266
Benefits paid (38,181) (12,075)
--------- ---------
Fair value of plan assets at end of year $580,073 $498,149
--------- ---------
F-20
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
9. Pension Plans (Continued)
-------------------------
2004 2003
--------- ---------
Funded status ($286,953) ($322,560)
--------- ---------
Net amount recognized ($286,953) ($322,560)
========= =========
Amounts recognized in the statement of financial position consist of:
2004 2003
--------- ---------
Accrued benefit cost ($286,953) ($322,560)
--------- ---------
Net amount recognized ($286,953) ($322,560)
========= =========
The accumulated benefit obligation for the Company's defined benefit
pension plan was $867,026 and $820,709 at November 30, 2004 and 2003,
respectively.
Information required for pension plan with an accumulated benefit
obligation in excess of plan assets:
November 30
-----------------------
2004 2003
--------- ---------
Projected benefit obligation ($867,026) ($820,709)
Accumulated benefit obligation ($867,026) ($820,709)
Fair value of plan assets $580,073 $498,149
Components of Net Periodic Benefit Cost:
2004 2003
--------- ---------
Interest cost $ 52,125 $ 54,086
Expected return on plan assets (41,390) (35,411)
Amortization of net loss 37,356 34,057
--------- ---------
Net periodic benefit cost $ 48,091 $ 52,732
========= =========
F-21
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
9. Pension Plans (Continued)
-------------------------
Assumptions
Weighted-average assumptions used to
determine net periodic benefit cost
November 30:
2004 2003
------- -------
Discount rate 6.25% 7.00%
Expected long-term return on plan assets 8.00% 8.00%
Rate of compensation increase -- --
The expected return on Plan assets should remain constant from year to
year since the long-term expectation should not change significantly based
on a single year's experience. A rate of 8% was adopted for this purpose.
Plan Assets
The Company's pension plan weighted-average asset allocations at November
30, 2004 and 2003, by asset category are as follows:
November 30
-----------------
2004 2003
----- -----
Asset Category
Equity securities 51.8% 57.1%
Debt securities 22.0% 27.8%
Other 26.2% 15.1%
----- -----
Total 100.0% 100.0%
===== =====
The current investment policy for pension plan assets is to reduce
exposure to equity market risks. The current strategy for Plan assets is
to invest in conservative equity and debt securities. The Plan also
maintains a significant cash balance.
Equity securities include the Company's common stock in the amounts of
approximately $5,400 and $3,900 at November 30, 2004 and 2003.
F-22
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
9. Pension Plans (Continued)
-------------------------
Cash Flows - Contributions
The Company expects to contribute approximately $100,000 to its defined
benefit plan in fiscal 2005.
Estimated Future Benefit Payments
The following pension benefit payments are expected to be paid:
2005 $ 17,672
2006 19,852
2007 42,137
2008 46,176
2009 55,992
2010 - 2014 306,881
Defined Contribution Plan
The Company has a 401(k) profit sharing plan for the benefit of all
eligible employees, as defined. The plan provides for voluntary
contributions not to exceed the statutory limitation provided by the
Internal Revenue Code. The Company may make discretionary contributions.
There were no contributions made for the years ended November 30, 2004 and
2003.
F-23
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
10. Commitments
-----------
Operating Leases
The Company leases its offices under noncancelable operating lease
agreements which expire through 2009.
Rent expense was approximately $82,000 and $67,000 in 2004 and 2003,
respectively. In addition to the annual rent, the Company pays real estate
taxes, insurance and other occupancy costs on its leased facilities.
The minimum annual commitments under all operating leases that have
remaining non-cancelable terms in excess of one year are approximately as
follows:
Year ended November 30,
-----------------------
2005 $160,000
2006 162,000
2007 139,000
2008 96,000
2009 6,000
--------
$563,000
========
Capital Lease Obligations
The Company leases certain machinery and equipment with lease terms
through 2005. Obligations under capital leases have been recorded in the
accompanying financial statements at the present value of future minimum
lease payments, discounted at interest rates ranging from 12.4% to 20.2%.
The capitalized cost and accumulated depreciation included in property and
equipment was as follows:
2004
-------
Cost $69,567
Accumulated depreciation 69,567
-------
$ --
=======
F-24
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
10. Commitments (Continued)
-----------------------
Capital Lease Obligations (Continued)
The future minimum lease payments under the capital lease and net present
value of future minimum lease payments for the ensuing years are
summarized as follows:
Year ended November 30,
-----------------------
2005 $40,689
Less amount representing interest 8,589
-------
Present value of future minimum
lease payments (Note 6) $32,100
=======
Other Commitments
In January 2005, the Company entered into a minimum purchase agreement
with a wholesale VOIP (Voice Over Internet Protocol) provider. The
agreement requires minimum fees aggregating approximately $108,000 through
January 2006.
11. Related Party Transactions
--------------------------
TSI has an agreement, effective January 2, 2002, with Telco Services, Inc.
("Telco"), a corporation owned by a former shareholder, under which Telco
provides TSI with collection, sales and other services. Expenses incurred
in connection with this agreement, which are included in selling, general
and administrative expenses in the consolidated statement of operations,
amounted to $21,127 for the year ended November 30, 2003. The President of
Telco is also the President of Glad Holdings LLC ("Glad Holdings") (see
Note 12).
During the years ended November 30, 2004 and 2003, the Company billed
Cordia, a related party (see Note 3), $338,087 and $197,224 for rent,
telemarketing services, commissions, and other costs. Cordia billed the
Company $585,397 and $ 395,232 for the years ended November 30, 2004 and
2003 for telecommunications services and other costs. As of November 30,
2004, the Company owed Cordia $59,384.
F-25
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
12. Asset Sale
----------
On September 3, 2002, the Company entered into an agreement with Essex
Acquisition Corp. ("EAC"), a wholly-owned subsidiary of BiznessOnline.com,
Inc. ("Biz"), to sell substantially all the assets of Essex Communications
Inc., ("Essex") a former wholly-owned subsidiary, (amounting to $1,102,103
at November 30, 2002), for five dollars plus the assumption of certain
liabilities of Essex, amounting to $10,081,382 at November 30, 2002,
including all obligations due and payable to Essex's largest vendor,
Verizon Services Corp. ("Verizon"). EAC entered into an agreement with
Verizon that provided a payment schedule for the liabilities assumed from
Essex and Verizon granted EAC a discount on the assumed liabilities
provided EAC adhered to the payout schedule. EAC also paid the Company
$270,000 to reimburse the Company for amounts paid by the Company to
Essex's lender. The sale closed on December 31, 2002. As the creditors of
Essex did not consent to the assignment of their claims, Essex had
remained liable for substantially all the obligations assumed in the sale
until such time as they were paid. The June 30, 2002 unaudited financial
statements of Biz indicated that Biz had a stockholders' equity deficiency
of approximately $20,500,000 and had negative working capital of
approximately $3,500,000. The most recent independent auditor's report of
Biz expressed significant doubt about Biz's ability to continue as a going
concern. These factors indicated that there was significant uncertainty as
to Biz and its subsidiaries' ability to repay the obligations described
above. Accordingly, the Company did not record any gain until Essex was
released from the assumed obligations. During the period December 1, 2002
through September 11, 2003, EAC had settled liabilities of approximately
$3,511,000 and accordingly, gain was recorded for such amount.
On September 11, 2003, the Company sold all the outstanding capital stock
of Essex to Glad Holdings (see Note 11), a New Jersey limited liability
company, for an aggregate purchase price of $100 and a general release
from Glad Holdings with respect to any and all matters arising prior to
September 11, 2003. The Company, based on all available information and
consultation with counsel, concluded that it was unlikely that any
creditor of Essex would be able to hold the Company responsible for any
debts or liabilities of Essex. As a result thereof, the Company believed
it had been released of all the liabilities related to Essex, which
amounted to approximately $7,314,000 on such date, and accordingly,
recorded such amount as gain in the fourth quarter fiscal of 2003.
F-26
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
12. Asset Sale (Continued)
----------------------
The following unaudited pro forma summary presents information as if the
sale of Essex's assets had occurred at the beginning of the year ended
November 30, 2003. The pro forma amounts include certain adjustments that
eliminate all the operations of Essex for the periods presented. The pro
forma information does not necessarily reflect the actual results that
would have occurred had the sale taken place for the periods presented,
nor is it necessarily indicative of the future results of operations of
the remaining company:
2003
-----------
(Unaudited)
-----------
Revenues $4,674,808
-----------
Net loss ($2,106,605)
-----------
Basic and diluted loss per share ($ .13)
===========
13. Accounts payable and accrued expenses
-------------------------------------
As of November 30, 2004 approximately $198,000 of liabilities related to
the discontinued luggage business remain on the Company's balance sheet
under the capiton accounts payable and accrued expenses. There has not
been any demand for payment of liabilities. The Company intends to reverse
these liabilities in 2006 when the statute of limitations expires if
payment is not demanded.
F-27
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
14. Stockholders' Equity
--------------------
The Company was authorized to issue up to 1,300 shares of Series B
Preferred stock $.10 par value, and such stock was entitled to receive
dividends when as, and if dividends were declared by the Company on its
common stock. Each holder of Series B preferred stock had the right, at
the option of the holder, to convert each share of such stock into 1,000
shares of common stock. The holders of shares of Series B preferred stock
were entitled to that number of votes on all matters presented to
shareholders equal to the number of shares of common stock then issuable
upon conversion of such shares of preferred stock.
During 2001, certain of the Series B shareholders elected to convert their
shares to common shares, resulting in the issuance of 100,000 shares of
common stock. During 2003, the remaining Series B shareholder converted
its shares to common shares, resulting in the issuance of 16,000 shares of
common stock.
The following is a summary of outstanding options:
Weighted-
Average
Number Exercise Price Exercise
of Shares Per Share Price
--------- -------------- ---------
Outstanding December 1, 2002 1,618,453 $.05 - $4.88 $1.60
Granted during year ended
November 30, 2003 740,000 $.10 $ .10
Canceled during year ended
November 30, 2003 (635,119) $.58 - $4.88 $1.91
----------
Outstanding November 30, 2003 1,723,334 $.05 - $2.50 $ .84
Granted during year ended
November 30, 2004 2,185,000 $.16 - $.28 $ .23
Canceled during year ended
November 30, 2004 (435,834) $.10 - $2.25 $1.35
----------
Outstanding November 30, 2004 3,472,500 $.05 - $2.50 $ .40
----------
Options exercisable,
November 30, 2004 937,500 $.05 - $2.50 $ .40
----------
Options exercisable,
November 30, 2003 621,334 $.72 - $2.50 $1.43
----------
F-28
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
14. Stockholders' Equity (Continued)
--------------------------------
The following table summarizes information about the options outstanding
at November 30, 2004:
Options Outstanding Options Exercisable
--------------------------------------- ------------------------
Weighted-
Average Weighted- Weighted-
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life (Years) Price Outstanding Price
------------- ----------- ------------ ---------- ----------- ----------
$ .05 - $ .97 2,976,500 4.44 $ .22 791,500 $ .17
$1.41 - $1.44 470,000 1.00 $ 1.41 120,000 $ 1.43
$1.41 - $2.50 26,000 .48 $ 2.50 26,000 $ 2.50
On October 24, 1996, the shareholders of the Company adopted the eLEC
Communications Corp. 1996 Restricted Stock Award Plan (the "Restricted
Stock Award Plan"). An aggregate of 400,000 shares of common stock of the
Company have been reserved for issuance in connection with awards granted
under the Restricted Stock Award Plan. Such shares may be awarded from
either authorized and unissued shares or treasury shares. The maximum
number of shares that may be awarded under the Restricted Stock Award Plan
to any individual officer or key employee is 100,000. No shares were
awarded during 2004 and 2003.
As of November 30, 2004 and 2003, warrants were outstanding to purchase up
to 550,000 shares of the Company's common stock at prices ranging from
$1.54 to $2.50. The warrants expire through October 23, 2010.
15. Net Income Per Common Share
---------------------------
Net income per common share data was computed as follows:
2004 2003
----------- -----------
Net income $ 170,253 $ 8,323,211
=========== ===========
Weighted average common shares outstanding 16,254,282 15,771,219
Effect of dilutive securities, stock options and preferred stock 461,526 70,722
----------- -----------
Weighted average dilutive common shares outstanding 16,715,808 15,841,941
=========== ===========
Net income per common share - basic $ .01 $ .53
=========== ===========
Net income per common share - diluted $ .01 $ .53
=========== ===========
F-29
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
16. Subsequent Events
-----------------
On December 17, 2004, the Company sold a promissory note ("Note") in the
principal amount of $328,767 and 160,000 shares of restricted common stock
of the Company to an unaffiliated party for $300,000. The Note is payable
on December 17, 2005 and is unsecured. The Note requires the Company to
expend the proceeds of the Note on sales and marketing efforts.
On February 8, 2005, the Company consummated a private placement pursuant
to which the Company issued a secured convertible term note in the
principal amount of $2,000,000 (the "Convertible Note"), and the Company
issued a common stock purchase warrant (the "Warrant") to the holder of
the Convertible Note, exercisable at any time through February 8, 2012, to
purchase up to 793,650 shares of the Company's common stock, par value
$.10 per share (the "Common Stock"). The exercise price is $.72 for the
first 264,550 shares, $.79 for the next 264,550 shares, and $.95 for any
additional shares. The proceeds received by the Company, net of related
fees and expenses was approximately $1,744,000. The Company agreed to use
the proceeds only for marketing, general working capital and general
business purposes. Interest on the Convertible Note is payable monthly on
the first day of each month during the term of the Convertible Note, at 3%
above the prime rate commencing March 1, 2005. Commencing May 1, 2005, the
Company is required to make monthly principal payments of $60,606 per
together, with any accrued and unpaid interest payable on such date, the
"Monthly Payment Amount". All or a portion of the outstanding principal
and interest due under the Convertible Note shall be paid in shares of
Common Stock upon satisfaction of certain conditions. The Convertible Note
is initially convertible into shares of Common Stock at a price of $0.63
per share (together with any adjustments, the "Fixed Conversion Price").
The Fixed Conversion Price is subject to anti-dilution protection
adjustments, on a weighted average basis, upon the Company's issuance of
additional shares of Common Stock at a price that is less than the
then-current Fixed Conversion Price. This agreement prohibits the payment
of any dividends as long as the Convertible Note remains outstanding. The
Convertible Note is secured by a blanket lien on substantially all of the
Company's assets and the common stock of all subsidiaries, and contains
prepayment penalty provisions.
F-30
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
16. Subsequent Events (Continued)
-----------------------------
Absent earlier redemption by the Company or earlier conversion by the
investor, the Convertible Note originally matured on February 8, 2006.
Since the Company entered into a service provider agreement with a
wholesale telephone service provider, the maturity date of the Convertible
Note has been extended to February 8, 2008.
On February 24, 2005, New Rochelle Telephone Company ("NRTC"), a
wholly-owned subsidiary of the Company, completed its negotiations with
Verizon Services Corp. ("Verizon") and signed a Wholesale Advantage
Services Agreement (the "Agreement"). The Agreement is a long-term
commercial alternative to the unbundled network elements platform
("UNE-P") and allows NRTC to purchase from Verizon wholesale dial tone
services on terms that preserve, in all material respects, the features,
functionality and ordering processes previously available to NRTC under
Verizon's UNE-P service offering. The rates and charges for such services
are fixed at agreed upon price levels that should allow NRTC to continue
to offer its existing telephone services at competitive prices. Pursuant
to the Agreement, NRTC and the Company are required to keep confidential
all additional terms and provisions of the Agreement. The Company has
minimum line commitments in connection with the agreement.
17. Risks and Uncertainties
-----------------------
The Company buys substantially all of the telecommunication services that
it resells from Regional Bell Operating Companies ("RBOC's"), and long
distance carriers and is, therefore, highly dependent upon them. The
Company believes that its relationships with them are satisfactory. The
Company believes there are less desirable suppliers of telecommunication
services in the geographical location in which the Company conducts
business. In addition, the Company is at risk to regulatory agreements
that govern the rates to be charged to the Company. In light of the
foregoing, it is reasonably possible that the loss of the Company's
relationship with such vendors or a significant unfavorable change in the
regulatory agreements structure would have a severe near-term impact on
the Company's ability to conduct its telecommunications business.
F-31
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
17. Risks and Uncertainties (Continued)
-----------------------------------
Future results of operations involve a number of risks and uncertainties.
Factors that could affect future operating results and cash flows and
cause actual results to vary materially from historical results include,
but are not limited to:
- The Company's business strategy with respect to bundled local and
long distance services may not succeed.
- Failure to manage, or difficulties in managing, the Company's growth
operations or restructurings including attracting and retaining
qualified personnel and opening up new territories for its service
with favorable gross margins.
- Dependence on the availability or functionality of incumbent local
telephone companies' networks, as they relate to the unbundled
network element platform or the resale of such services.
- Increased price competition in local and long distance service.
- Failure or interruption in the Company's network and information
systems.
- Changes in government policy, regulation and enforcement.
- Failure of the Company's collection management system and credit
controls efforts for customers.
- Inability to adapt to technological change.
- Competition in the telecommunications industry.
- Inability to manage customer attrition and bad debt expense.
- Adverse change in Company's relationship with third party carriers.
- Failure or bankruptcy of other telecommunications companies upon
whom the Company relies for services and revenues.
- Lack of capital or borrowing capacity, and inability to generate
cash flow.
F-32
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2004 AND 2003
18. Fourth Quarter Adjustments (Unaudited)
--------------------------------------
During the fourth quarter of the year ended November 30, 2004, the Company
made a year-end adjustment that was material to the results of the fourth
quarter. The net effect of the year-end adjustment was to increase net
income in the fourth quarter by approximately $115,000, to record as
recoverable certain telecommunication excise taxes previously expensed as
part of cost of sales.
F-33
Item 8. - Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 8A. Controls and Procedures.
Internal Control Over Financial Reporting. There have not been any changes
in our internal control over financial reporting (as such term is defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fourth quarter
of 2004 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting. Management is aware that
there is a lack of segregation of duties due to the small number of employees
within our financial and administrative functions. We will continue to evaluate
the employees involved, the additional control procedures in place to help
compensate for the lack of segregation of duties, the risks associated with such
lack of segregation and whether the potential benefits of adding employees to
clearly segregate duties justifies the expense associated with such increases.
In addition, we are aware that many of the internals controls that are in place
are undocumented controls. Although we have documented many of our systems and
processes, we will need to expend a substantial amount of time over the coming
year to obtain the full documentation required to be in compliance with Section
404 of the Sarbanes-Oxley Act of 2002.
We have also identified certain deficiencies and issues with our internal
controls that occurred in the fiscal year ended November 30, 2004. These
deficiencies and issues include, but are not limited to:
After the end of our fiscal year, when we were preparing state tax
returns for telecommunication taxes, we identified that we had been
overstating telecom taxes payable for certain taxes that were paid by us
directly to our carrier instead of being paid directly to the taxing
authorities. We have adjusted our controls to mitigate this type of event
from occurring in future periods.
Due to the voluminous nature of state and local telecom taxes and
the small quantity of taxes payable to certain municipalities, we do not
remit all our telecom taxes in a timely manner. Certain taxes that we
should be remitting on a monthly basis, we remit quarterly or
semi-annually because many of the checks and returns that we are
processing are for payments of less than $50. We are aware of other
telephone companies that follow this process. We continue to monitor the
responses, if any, we receive from the tax authorities regarding late
filings and we do not intend to remit such taxes on a timely manner in the
future, unless we determine that it would be more cost-effective to us to
do so.
18
PART III
Item 9. - Directors and Executive Officers of the Registrant.
Information relating to our directors is set forth under the caption
entitled "Election of Directors" in our 2005 proxy statement and is incorporated
herein by reference. Information relating to our executive officers is set forth
in our 2005 proxy statement under the caption "Executive Officers, Directors and
Key Employees" and is incorporated herein by reference.
Item 10. - Executive Compensation.
The information regarding compensation of our officers and directors is
set forth under the caption entitled "Executive Compensation" in our 2005 proxy
statement and is incorporated herein by reference.
Item 11. - Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
Information regarding ownership of certain of our securities is set forth
under the captions entitled "Security Ownership of Certain Beneficial Owners"
and "Security Ownership of Management" in our 2005 proxy statement and is
incorporated herein by reference.
Item 12. - Certain Relationships and Related Transactions.
Information regarding certain relationships and related transactions with
our company is set forth under the caption entitled "Certain Relationships and
Related Transactions" in our 2005 proxy statement and is incorporated herein by
reference.
Item 13. - Exhibits List and Reports on Form 8-K.
(3) Articles of Incorporation and By-laws
(a) Certificate of Incorporation, as amended, incorporated by reference
to our Registration Statement on Form S-1 filed with the Securities
and Exchange Commission on August 27, 1969 under Registration Number
2-34436.
(b) Certificate of Amendment of the Certificate of Incorporation,
incorporated by reference to our definitive proxy statement filed
with the Securities and Exchange Commission in connection with our
Annual Meeting of Shareholders held in May 1984.
(c) Certificate of Amendment to the Certificate of Incorporation,
incorporated by reference to Exhibit 3(b) to our Annual Report on
Form 10-K for the year ended November 30, 1988.
(d) Certificate of Amendment to the Certificate of Incorporation,
incorporated by reference to Exhibit 3(e) to our Annual Report on
Form 10-K for the year ended November 30, 1994, as amended.
(e) Certificate of Amendment of the Certificate of Incorporation,
incorporated by reference to Exhibit 3 to our Quarterly Report on
Form 10-Q for the quarter ended August 30, 1995.
19
(f) Certificate of Amendment of the Certificate of Incorporation,
incorporated by reference to Exhibit 3(f) to our Annual Report on
Form 10-K for the year ended November 30, 1998.
(g) Certificate of Amendment of the Certificate of Incorporation,
incorporated by reference to Exhibit 3.2 to our Quarterly Report on
Form 10-Q for the quarter ended August 31, 1998.
(h) Certificate of Amendment of the Certificate of Incorporation,
incorporated by reference to Exhibit 3(1) to our Current Report on
Form 8-K dated November 16, 1999.
(i) By-laws, amended and restated as of December 1996, incorporated by
reference to Exhibit 3(e) to our Annual Report on Form 10-K for the
year ended November 30, 1996.
(10) Material Contracts
(a) 1995 Stock Option Plan, incorporated by reference to Exhibit 10(I)
to our Annual Report on Form 10-K for the year ended November 30,
1995, as amended.
(b) 1996 Restricted Stock Award Plan, incorporated by reference to
Exhibit A to our Proxy Statement dated October 24, 1996.
(c) Non-Employee Director Stock Option Plan, dated March 30, 2001,
incorporated by reference to Exhibit 10(c) to our Annual Report on
Form 10-KSB for the year ended November 30, 2003.
(d) Lease Agreement between South Broadway WP, LLC, Landlord, and New
Rochelle Telephone Corp., Tenant, dated August 2003, incorporated by
reference to Exhibit 10(d) to our Annual Report on Form 10-KSB for
the year ended November 30, 2003.
(e) Office Lease between Lexin Celebration, LLC, as Landlord, and Vox
Communications Corp., as Tenant, dated January 25, 2005.
(f) Securities Purchase Agreement, dated as of February 8, 2005, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.1 to our Current Report on Form 8-K dated
February 8, 2005.
(g) Secured Convertible Term Note, dated as of February 8, 2005, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.2 to our Current Report on Form 8-K dated
February 8, 2005.
(h) Master Security Agreement, dated as of February 8, 2005, among us,
New Rochelle Telephone Corp., Telecarrier Services, Inc., Vox
Communications Corp., Line One, Inc., AVI Holding Corp. and
TelcoSoftware.com Corp. in favor of Laurus Master Fund, Ltd.,
incorporated by reference to Exhibit 10.3 to our Current Report on
Form 8-K dated February 8, 2005.
(i) Stock Pledge Agreement, dated as of February 8, 2005, executed by
eLEC Communications Corp. in favor of Laurus Master Fund, Ltd.,
incorporated by reference to Exhibit 10.4 to our Current Report on
Form 8-K dated February 8, 2005.
(j) Subsidiary Guaranty, dated as of February 8, 2005, executed by New
Rochelle Telephone Corp., Telecarrier Services, Inc., Vox
Communications Corp., Line One, Inc., AVI Holding Corp. and
TelcoSoftware.com Corp., incorporated by reference to Exhibit 10.5
to our Current Report on Form 8-K dated February 8, 2005.
(k) Registration Rights Agreement, dated as of February 8, 2005, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.6 to our Current Report on Form 8-K dated
February 8, 2005.
(l) Common Stock Purchase Warrant, dated as of February 8, 2005, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.7 to our Current Report on Form 8-K dated
February 8, 2005.
(m) Form of Common Stock Purchase Warrant, dated as of February 8, 2005,
issued by eLEC Communications Corp. to or on the order of Source
Capital Group, Inc., incorporated by reference to Exhibit 10.8 to
our Current Report on Form 8-K dated February 8, 2005.
20
(22) Subsidiaries - The significant wholly-owned subsidiaries are as follows:
Name Jurisdiction of Organization
---- ----------------------------
New Rochelle Telephone Corp. New York
Telecarrier Services, Inc. Delaware
VoX Communications Corp Delaware
(23) Consent of Nussbaum Yates & Wolpow, P.C.
(31.1) Certification of our Chief Executive Officer and Chief Financial
Officer, Paul H. Riss, pursuant to 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 Section 906 of the Sarbanes-Oxley Act
of 2002.
(b) Reports on Form 8-K.
None.
Item 14. Principal Accountant Fees and Services.
Audit Fees. The aggregate fees billed by Nussbaum Yates & Wolpow, P.C., our
principal accountants, for professional services rendered for the audit of our
annual financial statements for the last two fiscal years and for the reviews of
the financial statements included in our Quarterly Reports on Form 10-QSB during
the last two fiscal years was $103,936 and $99,651, respectively.
Audit-Related Fees. We did not engage our principal accountants to provide
assurance or related services during the last two fiscal years.
Tax Fees. The aggregate fees billed by our principal accountants for tax
compliance, tax advice and tax planning services rendered to us during the last
two fiscal years was $15,000 and $15,000, respectively.
All Other Fees. We did not engage our principal accountants to render services
to us during the last two fiscal years, other than as reported above.
Pre-Approval Policies and Procedures. Our Board of Directors has the sole
authority to appoint or replace our independent auditor. Our Board is directly
responsible for the compensation and oversight of the work of our independent
auditor (including resolution of disagreements between management and the
independent auditor regarding financial reporting) for the purpose of preparing
or issuing an audit report or related work. Our independent auditor is engaged
by, and reports directly to, our Board.
Our Board pre-approves all auditing services and permitted non-audit services
(including the fees and terms thereof) to be performed for us by our independent
auditor, subject to the de minimis exceptions for non-audit services described
in Section 10A(i)(1)(B) of the Exchange Act, all of which are approved by our
Board prior to the completion of the audit. In the event pre-approval for such
auditing services and permitted non-audit services cannot be obtained as a
result of inherent time constraints in the matter for which such services are
required, the Chairman of our Board may pre-approve such services, and will
report for ratification such pre-approval to our Board at its next scheduled
meeting.
21
Our Board has complied with the procedures set forth above and all services
reported above were approved in accordance with such procedures.
22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, we have duly caused this Report to be signed on our behalf
by the undersigned, thereunto duly authorized on the 11th day of March 2005.
eLEC COMMUNICATIONS CORP.
(Company)
By: /s/ Paul H. Riss
-------------------------------
Paul H. Riss
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated.
Signature Title Date
------------------------- ---------------------------------- --------------
/s/ Paul H. Riss Chief Executive Officer March 11, 2005
------------------------- Chief Financial Officer
Paul H. Riss (Principal Accounting Officer)
Director
/s/ Joel Dupre Chairman of the Board of Directors March 11, 2005
-------------------------
Joel Dupre
/s/ Greg M Cooper Director March 11, 2005
-------------------------
Greg M Cooper
/s/ Gayle Greer Director March 11, 2005
-------------------------
Gayle Greer
/s/ Michael Khalilian Director March 11, 2005
-------------------------
Michael Khalilian
23