UNITED STATES | ||||||||
SECURITIES AND EXCHANGE COMMISSION | ||||||||
WASHINGTON, D.C. 20549 | ||||||||
FORM 10-Q | ||||||||
(Mark One) | ||||||||
[ X ] | QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE | |||||||
SECURITIES EXCHANGE ACT OF 1934. | ||||||||
For the quarterly period endedFebruary 28, 2007. | ||||||||
OR | ||||||||
[ ] | TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE | |||||||
SECURITIES EXCHANGE ACT OF 1934. | ||||||||
For the transition period from to . | ||||||||
Commission file number0-4465 | ||||||||
eLEC Communications Corp. | ||||||||
(Exact Name of Registrant as Specified in Its Charter) | ||||||||
New York | 13-2511270 | |||||||
(State or Other Jurisdiction | (I.R.S. Employer | |||||||
of Incorporation or Organization) | Identification No.) | |||||||
75 South Broadway, Suite 302, White Plains, New York | 10601 | |||||||
(Address of Principal Executive Offices) | (Zip Code) | |||||||
Registrant’s Telephone Number, Including Area Code | 914-682-0214 | |||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by | ||||||||
Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the | ||||||||
registrant was required to file such reports), and (2) has been subject to such filing requirements for the past | ||||||||
90 days. Yes X No . | ||||||||
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a | ||||||||
non-accelerated filer. See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the | ||||||||
Exchange Act. (Check one): | ||||||||
Large Accelerated Filer Accelerated Filer Non-Accelerated Filer X . | ||||||||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the | ||||||||
Exchange Act). Yes No X | ||||||||
The number of outstanding shares of the Registrant’s Common Stock as of April 16, 2007 was | ||||||||
22,459,282. |
PART 1. FINANCIAL INFORMATION | ||||||||||
Item 1. | Financial Statements | |||||||||
eLEC Communications Corp. and Subsidiaries | ||||||||||
Condensed Consolidated Balance Sheet | ||||||||||
Feb. 28, 2007 | Nov. 30, 2006 | |||||||||
(Unaudited) | (See Note 1) | |||||||||
Assets | ||||||||||
Current assets: | ||||||||||
Cash and cash equivalents | $ 311,353 | $1,337,525 | ||||||||
Accounts receivable, net | 627,143 | 630,197 | ||||||||
Prepaid expenses and other current assets | 66,764 | 154,749 | ||||||||
Deferred finance costs, net | 864,644 | 1,012,941 | ||||||||
Total current assets | 1,869,904 | 3,135,412 | ||||||||
Property, plant and equipment, net | 899,478 | 903,281 | ||||||||
Other assets | 167,383 | 149,525 | ||||||||
Total assets | $2,936,765 | $4,188,218 | ||||||||
Liabilities and stockholders’ equity deficiency | ||||||||||
Current liabilities: | ||||||||||
Current portion of long-term debt and capital lease obligations | $3,353,464 | $3,347,707 | ||||||||
Warrant liability | 2,211,404 | 1,251,182 | ||||||||
Accounts payable and accrued expenses | 2,626,043 | 2,897,495 | ||||||||
Taxes payable | 548,014 | 559,617 | ||||||||
Deferred Revenue | 151,900 | 166,100 | ||||||||
Total current liabilities | 8,890,825 | 8,222,101 | ||||||||
Long-term debt and capital lease obligations, less current maturities | 202,405 | 214,907 | ||||||||
Total liabilities | 9,093,230 | 8,437,008 | ||||||||
Stockholders’ equity deficiency: | ||||||||||
Preferred stock $.10 par value, 1,000,000 shares authorized, | ||||||||||
none issued and outstanding | - | - | ||||||||
Common stock $.10 par value, 50,000,000 shares authorized, | ||||||||||
22,459,282 and 22,434,282 shares issued and outstanding in 2007 and | ||||||||||
2006 | 2,245,928 | 2,243,428 | ||||||||
Capital in excess of par value | 27,163,323 | 27,071,584 | ||||||||
Deficit | (35,555,158) | (33,554,700) | ||||||||
Accumulated other comprehensive loss, unrealized loss on securities | (10,558) | (9,102) | ||||||||
Total stockholders’ equity deficiency | (6,156,465) | (4,248,790) | ||||||||
Total liabilities and stockholders’ equity deficiency | $2,936,765 | $4,188,218 | ||||||||
See notes to the condensed consolidated financial statements. |
eLEC Communications Corp. and Subsidiaries | ||||||||
Condensed Consolidated Statements of Operations and Comprehensive Loss | ||||||||
(Unaudited) | ||||||||
For the Three Months Ended | ||||||||
Feb. 28, 2007 | Feb. 28, 2006 | |||||||
Revenues | $1,741,123 | $2,496,854 | ||||||
Costs and expenses: | ||||||||
Costs of services | 1,202,749 | 1,419,837 | ||||||
Selling, general and administrative | 1,139,909 | 1,246,680 | ||||||
Provision for bad debts | 49,386 | 117,676 | ||||||
Depreciation and amortization | 173,539 | 86,625 | ||||||
Total costs and expenses | 2,565,583 | 2,870,818 | ||||||
Loss from operations | (824,460) | (373,964) | ||||||
Other income (expense): | ||||||||
Interest expense | (226,546) | (281,385) | ||||||
Change in warrant valuation | (960,222) | (22,257) | ||||||
Other income | 10,770 | 14,127 | ||||||
Total other income (expense) | (1,175,998) | (289,515) | ||||||
Net loss | (2,000,458) | (663,479) | ||||||
Other comprehensive loss - unrealized | ||||||||
loss on marketable securities | (1,456) | (915) | ||||||
Comprehensive loss | ($2,001,914) | ($664,394) | ||||||
Basic loss per share | ($0.09) | ($0.04) | ||||||
Weighted average number of common shares outstanding | ||||||||
Basic | 22,435,949 | 16,839,282 | ||||||
See notes to the condensed consolidated financial | ||||||||
statements. |
eLEC Communications Corp. and Subsidiaries | ||||||||
Condensed Consolidated Statements of Cash Flows | ||||||||
(Unaudited) | ||||||||
For the Three Months Ended | ||||||||
Feb. 28, 2007 | Feb. 28, 2006 | |||||||
Net cash used in operating activities: | ($963,831) | ($836,555) | ||||||
Cash flows used in investing activities, purchase of property and | ||||||||
equipment | (51,500) | (122,899) | ||||||
Cash flows from financing activities: | ||||||||
Repayment of short-term debt | - | (328,324) | ||||||
Repayment of long-term debt | (10,841) | (3,230) | ||||||
Proceeds from notes | - | 1,753,500 | ||||||
Net cash (used in) provided by financing activities | (10,841) | 1,421,946 | ||||||
Increase (decrease) in cash and cash equivalents | (1,026,172) | 462,492 | ||||||
Cash and cash equivalents at beginning of period | 1,337,525 | 205,998 | ||||||
Cash and cash equivalents at the end of period | $311,353 | $668,490 | ||||||
�� | ||||||||
See notes to the condensed consolidated financial statements. |
eLEC COMMUNICATIONS CORP. |
Notes To Condensed Consolidated Financial Statements (Unaudited) |
Note 1-Basis of Presentation |
The accompanying unaudited condensed consolidated financial statements have been prepared in |
accordance with generally accepted accounting principles for interim financial information and |
in accordance with the rules and regulations of the Securities and Exchange Commission for |
Form 10-Q. Accordingly, they do not include all of the information and footnotes required by |
generally accepted accounting principles for complete financial statements. In the opinion of |
management, all adjustments (consisting of normal recurring accruals) considered necessary for a |
fair presentation have been included. Operating results for the three-month period ended |
February 28, 2007 are not necessarily indicative of the results that may be expected for the year |
ended November 30, 2007. For further information, refer to the consolidated financial |
statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended |
November 30, 2006. |
Note 2-Major Customers |
During the three-month periods ended February 28, 2007 and 2006, no one customer accounted |
for more than 10% of revenue. |
Note 3-Loss Per Common Share |
Basic loss per common share is calculated by dividing net loss by the weighted average number |
of common shares outstanding during the period. |
Approximately 11,033,000 and 13,807,000 shares of common stock issuable upon the exercise of |
our outstanding stock options or warrants or, in the three month period ending February 28, |
2006, the conversion of our outstanding convertible debt, were excluded from the calculation of |
loss per share for the three months ended February 28, 2007 and 2006, respectively, because the |
effect would be anti-dilutive. |
Note 4-Risks and Uncertainties |
We provide our wireline services by leasing a portion of the network owned by other larger |
telecommunications carriers, namely Verizon Services Corp. and Qwest Communications |
International, Inc., which are commonly referred to as Incumbent Local Exchange Carriers |
(“ILECs”). We have multi-state commercial service agreements with the ILECs that are subject |
to termination for material breach, including non-payment, upon written notice and our failure to |
cure. These agreements allow us to offer wireline telecommunications services to consumers |
throughout the ILECs’ territories without us having to incur network equipment expenditures. |
Although we continue to build an Internet Protocol (“IP”) telephony network, and our long-term |
plans are dependent upon the success of out IP telephony operations, the majority of our |
revenues are currently derived from the resale of ILEC services. In light of the foregoing, it is |
possible that the loss of our relationship with the ILECs would have a severe near-term impact on |
our ability to conduct our business and on our ability to sell our wireline services operation, for |
which we have a signed agreement to sell to a third party. Our long-term plans, however, are |
dependent upon the success of our IP operations. Future results of operations involve a number | ||
of risks and uncertainties. Factors that could affect future operating results and cash flows and | ||
cause actual results to vary materially from historical results include, but are not limited to: | ||
· | The availability of additional funds to successfully pursue our business plan; | |
· | The acceptance of IP telephony by mainstream consumers; | |
· | Our ability to market our services to current and new customers and generate customer | |
demand for our products and services in the geographical areas in which we operate; | ||
· | Our ability to comply with provisions of our financing agreements; | |
· | The impact of changes the Federal Communications Commission or State Public Service | |
Commissions may make to existing telecommunication laws and regulations, including | ||
laws dealing with Internet telephony; | ||
· | The highly competitive nature of our industry; | |
· | Our ability to retain key personnel; | |
· | Our ability to maintain adequate customer care and manage our churn rate; | |
· | The cooperation of incumbent carriers and industry service partners that have signed | |
agreements with us; | ||
· | Our ability to maintain, attract and integrate internal management, technical information | |
and management information systems; | ||
· | The availability and maintenance of suitable vendor relationships, in a timely manner, at | |
reasonable cost; | ||
· | Our ability to manage rapid growth while maintaining adequate controls and procedures; | |
· | Failure or interruption in our network and information systems; | |
· | Our inability to adapt to technological change; | |
· | The perceived infringement of our technology on another entity’s patents; | |
· | Our inability to manage customer attrition and bad debt expense; | |
· | Failure or bankruptcy of other telecommunications companies upon whom we rely for | |
services and revenues; | ||
· | Our lack of capital or borrowing capacity, and inability to generate cash flow; | |
· | The decrease in telecommunications prices to consumers; and | |
· | General economic conditions. | |
Note 5-Stock-Based Compensation Plans | ||
We issue stock options to our employees and outside directors pursuant to stockholder-approved | ||
and non-approved stock option programs. In December 2004, the Financial Accounting | ||
Standards Board (“FASB”) issued SFAS No. 123R, “Share-Based Payment”. SFAS 123R is a | ||
revision of SFAS 123, and supersedes APB 25. Among other items, SFAS 123R eliminates the | ||
use of APB 25 and the intrinsic value method of accounting, and requires companies to recognize | ||
in their financial statements the cost of employee services received in exchange for awards of | ||
equity instruments, based on the grant date fair value of those awards. SFAS 123R permits | ||
companies to adopt its requirements using either a “modified prospective” method, or a | ||
“modified retrospective” method. Under the “modified prospective” method, compensation cost | ||
is recognized in the financial statements beginning with the effective date, based on the | ||
requirements of SFAS 123R for all share-based payments granted after that date, and based on | ||
the requirements of SFAS 123 for all unvested awards granted prior to the effective date of SFAS | ||
123R. Under the “modified retrospective” method, the requirements are the same as under the |
“modified prospective” method, but this method also permits entities to restate financial |
statements of previous periods based on proforma disclosures made in accordance with SFAS |
123. Beginning in fiscal 2006, we account for stock-based compensation in accordance with the |
provisions of SFAS 123R and have elected the “modified prospective” method and have not |
restated prior financial statements. For the three months ended February 28, 2007 and 2006, we |
recorded approximately $45,000 and $52,000, respectively, in employee stock-based |
compensation expense, which is included in our selling, general and administrative expenses. As |
of February 28, 2007, there was approximately $183,000 of unrecognized stock-compensation |
expense for previously granted unvested options that will be recognized over a three-year period. |
Note 6-Accounts Payable and Accrued Expenses |
At February 28, 2007, we are disputing payments on invoices from Verizon amounting to |
approximately $537,000 because we believe Verizon overcharged us for certain calls made by |
our customers. Although we are not currently required to pay the disputed amount, Verizon |
initially rejected our claims. We have escalated many of our claims and hired a firm that |
specializes in telecom disputes to analyze past call records, resubmit and pursue the claims. This |
firm has escalated many of the claims and estimated that at a minimum $125,000 of the various |
claims will be honored. Consequently, we have recorded $412,000 of the disputed charges as a |
liability and have not recorded the $125,000 amount. |
Note 7-Defined Benefit Plan |
We sponsor a defined benefit plan covering one active employee and a number of former |
employees. Our funding policy with respect to the defined benefit plan is to contribute annually |
not less than the minimum required by applicable law and regulation to cover the normal cost |
and to fund supplemental costs, if any, from the date each supplemental cost was incurred. |
Contributions are intended to provide not only for benefits attributable to service to date, but also |
for those expected in the future. |
For each of the three-month periods ended February 28, 2007 and 2006, we recorded pension |
expense of $24,000. In the first fiscal period of 2007, we contributed $10,000 while in the first |
fiscal period 2006 we contributed $52,500 to our defined benefit plan. We expect to contribute |
approximately $50,000 to our defined benefit plan in fiscal 2007. The current investment |
strategy for the defined benefit plan is to invest in conservative debt and equity securities. The |
expected long-term rate of return on plan assets is 8%. |
We also sponsor a 401(k) profit sharing plan for the benefit of all eligible employees, as defined. |
The plan provides for the employees to make voluntary contributions not to exceed the statutory |
limitation provided by the Internal Revenue Code. We may make discretionary contributions. |
There were no discretionary contributions made for the three months ended February 28, 2007 or |
2006. |
Note 8 – Principal Financing Arrangements |
We have completed three financings with our principal lender and each financing requires a |
certain amount of monthly principal payments. We have negotiated with our principal lender a |
principal deferral of nine months until August 1, 2007 for one of our notes and a deferral until |
June 1, 2007 on another note that we anticipate paying off if we close on the definitive purchase |
agreement we signed on December 14, 2006 to sell our CLEC subsidiaries. In consideration for | ||||||
the principal deferral, on April 16, 2007 we issued to our lender a seven-year warrant to purchase | ||||||
1,200,000 shares of our common stock at a price of $0.25. We are in default with our lender for | ||||||
not filing this Report on a timely basis, and we anticipate that we will not be able to make the | ||||||
principal payments due on June 1, 2007 unless we are successful in the selling of our CLEC | ||||||
subsidiaries before then. Because of the default on such debt, the debt can be called | ||||||
immediately, and we have classified it as a current liability on our balance sheet and the related | ||||||
debt finance costs are shown as a current asset. | ||||||
Note 9-Income Taxes | ||||||
At November 30, 2005, we had net operating loss carryforwards for Federal income tax purposes | ||||||
of approximately $25,400,000 expiring in the years 2008 through 2026. There is an annual | ||||||
limitation of approximately $187,000 on the utilization of approximately $2,400,000 of such net | ||||||
operating loss carryforwards under the provisions of Internal Revenue Code Section 382. We did | ||||||
not provide for a tax benefit, since it is more likely than not that any such benefit would not be | ||||||
realized. | ||||||
Note 10 - Sale of Subsidiaries | ||||||
On December 14, 2006, we entered into two separate definitive purchase agreements | ||||||
(“Agreements”) to sell our two wholly-owned subsidiaries that function as competitive local | ||||||
exchange carriers (“CLECs”) to Cyber Digital, Inc. (“Purchaser”), a publicly-traded shell | ||||||
company. The planned sales are subject to the receipt of required regulatory approvals, and the | ||||||
Purchaser has reported that the approvals have been issued and the written orders will be | ||||||
forthcoming during the first week of May 2007. | ||||||
In accordance with an amendment to the Agreements, if the closing of the transaction has not | ||||||
occurred by May 12, 2007, the Purchaser or we may terminate the Agreements with no penalty to | ||||||
the terminating party, so long as such delay in closing the transaction is not the result of willful | ||||||
and material breach by the terminating party of any of its obligations under the Agreement. | ||||||
Since the Purchaser is a shell company with no significant tangible assets that requires financing | ||||||
in order to complete this purchase, we are precluded from presenting these subsidiaries as | ||||||
discontinued operations for the quarter ended February 28, 2007. The consummation of this | ||||||
transaction will require the approval of our principal lender. | ||||||
Note 11 - Business Segment Information | ||||||
The Company has two reportable business segments: Wireline Telecommunications Services and | ||||||
IP Telecommunications Services. The operating results of these business segments are | ||||||
distinguishable and are regularly reviewed by the Company’s chief operating decision maker. | ||||||
The Wireline Telecommunication Services business segment resells telephone services that run | ||||||
on a wireline network provided by Verizon and Qwest. The IP Telecommunications business | ||||||
segment provides a range of voice telephony service that run over the Internet. | ||||||
Wireline | IP | |||||||
Telecommunication | Telecommunication | |||||||
Services | Services | Corporate | Total | |||||
Quarter ended February 28, 2007 | ||||||||
Revenues | $1,552,233 | $188,890 | - | $1,741,123 | ||||
Operating income (loss) | 131,516 | (614,831) | (341,145) | (824,460) | ||||
Depreciation and amortization | 3,120 | 51,402 | 119,017 | 173,539 | ||||
Other income and (expense) | - | (8,422) | (1,167,576) | (1,175,998) | ||||
Total assets at February 28, 2007 | 838,228 | 1,077,259 | 1,021,278 | 2,936,765 | ||||
Quarter ended February 28, 2006 | ||||||||
Revenues | $2,471,993 | $24,861 | - | $2,496,854 | ||||
Operating income (loss) | 334,744 | (435,096) | (273,612) | (373,964) | ||||
Depreciation and amortization | 2,011 | 29,657 | 54,957 | 86,625 | ||||
Other income and (expense) | 817 | (2,282) | (288,050) | (289,515) | ||||
Total assets at February 28, 2006 | 1,392,624 | 842,504 | 843,500 | 3,078,628 | ||||
Item 2. Management’s Analysis and Discussion of Financial Condition and Results of | ||||||||
Operations | ||||||||
The statements contained in this Report that are not historical facts are “forward- | ||||||||
looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 | ||||||||
with respect to our financial condition, results of operations and business, which can be | ||||||||
identified by the use of forward-looking terminology, such as “estimates,” “projects,” “plans,” | ||||||||
“believes,” “expects,” “anticipates,” “intends,” or the negative thereof or other variations | ||||||||
thereon, or by discussions of strategy that involve risks and uncertainties. Management wishes | ||||||||
to caution the reader of the forward-looking statements that such statements, which are | ||||||||
contained in this Report, reflect our current beliefs with respect to future events and involve | ||||||||
known and unknown risks, uncertainties and other factors, including, but not limited to, | ||||||||
economic, competitive, regulatory, technological, key employee, and general business factors | ||||||||
affecting our operations, markets, growth, services, products, licenses and other factors | ||||||||
discussed in our other filings with the Securities and Exchange Commission, and that these | ||||||||
statements are only estimates or predictions. No assurances can be given regarding the | ||||||||
achievement of future results, as actual results may differ materially as a result of risks facing | ||||||||
us, and actual events may differ from the assumptions underlying the statements that have been | ||||||||
made regarding anticipated events. Factors that may cause our actual results, performance or | ||||||||
achievements, or industry results, to differ materially from those contemplated by such forward- | ||||||||
looking statements include, without limitation those factors set forth under Note 4 – Risks and | ||||||||
Uncertainties. | ||||||||
These forward-looking statements are subject to numerous assumptions, risks and | ||||||||
uncertainties that may cause our actual results to be materially different from any future results | ||||||||
expressed or implied by us in those statements. These risk factors should be considered in | ||||||||
connection with any subsequent written or oral forward-looking statements that we or persons | ||||||||
acting on our behalf may issue. All written and oral forward looking statements made in | ||||||||
connection with this Report that are attributable to us or persons acting on our behalf are | ||||||||
expressly qualified in their entirety by these cautionary statements. Given these uncertainties, | ||||||||
we caution investors not to unduly rely on our forward-looking statements. We do not undertake | ||||||||
any obligation to review or confirm analysts’ expectations or estimates or to release publicly any | ||||||||
revisions to any forward-looking statements to reflect events or circumstances after the date of | ||||||||
this Report or to reflect the occurrence of unanticipated events. Further, the information about |
our intentions contained in this Report is a statement of our intention as of the date of this | ||
Report and is based upon, among other things, the existing regulatory environment, industry | ||
conditions, market conditions and prices, the economy in general and our assumptions as of such | ||
date. We may change our intentions, at any time and without notice, based upon any changes in | ||
such factors, in our assumptions or otherwise. | ||
Overview | ||
We are a provider of local, long distance and international voice telephone services. | ||
We provide these services over wirelines, using leased facilities of other carriers, and over | ||
broadband services, using our own IP telephony product. IP telephony is the real time | ||
transmission of voice communications in the form of digitized “packets” of information over the | ||
Internet or a private network, which is analogous to the way in which e-mail and other data is | ||
transmitted. We use proprietary softswitch technology that runs on Cisco and Dell hardware to | ||
provide broadband telephone services to other service providers, such as cable operators, Internet | ||
service providers, WiFi and fixed wireless broadband providers, data integrators, value-added | ||
resellers and satellite broadband providers. Our technology enables these carriers to quickly and | ||
inexpensively offer premiere broadband telephone services, complete with order flow | ||
management for efficient provisioning, billing and support services and user interfaces that are | ||
easily customized to reflect the carrier’s unique brand. | ||
The worldwide rollout of broadband voice services has allowed consumers and | ||
businesses to communicate at dramatically reduced costs in comparison to traditional telephony | ||
networks. Traditionally, telephone service companies have built networks based on circuit | ||
switching technology, which creates and maintains a dedicated path for individual telephone | ||
calls until the call is terminated. While circuit-switched networks have provided reliable voice | ||
communications services for more than 100 years, transmission capacity is not efficiently utilized | ||
in a circuit-switched system. Under circuit-switching technology, when a person makes a | ||
telephone call, a circuit is created and remains dedicated for the entire duration of that call, | ||
rendering the circuit unavailable for the transmission of any other calls. Because of the high cost | ||
and inefficiencies of a circuit-switched network, we have never owned a circuit-switched | ||
network. Instead, we have leased circuit-switched network elements from other carriers in order | ||
to provide wireline services to customers. | ||
Data networks, such as IP networks, utilize packet switching technology that divides | ||
signals into packets and simultaneously routes them over different channels to a final destination | ||
where they are reassembled into the original order in which they were transmitted. No dedicated | ||
circuits are required and a fixed amount of bandwidth is not needed for the duration of each call. | ||
The more efficient use of network capacity results in the ability to transmit significantly higher | ||
amounts of traffic over a packet-switched network than a circuit-switched network. Packet- | ||
switching technology enables service providers to converge traditional voice and data networks | ||
in an efficient manner by carrying voice, fax, video and data traffic over the same network. IP | ||
networks are therefore less expensive for carriers to operate, and these cost savings can be passed | ||
on to the consumer in the form of lower costs for local, long distance and international long | ||
distance telephone services. | ||
We have created our own Linux-based IP platform and have transitioned into a | ||
facilities-based broadband service provider to take advantage of the network cost savings that are | ||
inherent in an IP network. We have signed a contract to sell our leased lines telephone business |
to another company, so that we can focus our resources and our energies on our broadband voice |
product. In addition to the cost savings we obtain from the efficient use of network capacity, we |
believe our network equipment costs are lower than most other carriers as our network and |
technology require significantly less capital expenditures than a traditional Class 5 telecom |
switch in a circuit-switched network, and less equipment costs than our broadband voice |
competitors that utilize a packet-switched network. Our proprietary softswitch provides more |
than 20 of the Class 5 call features, voice mail and enhanced call handling on our own Session |
Initiation Protocol (“SIP”) server suite. We control all of the features we offer to broadband |
voice customers, because instead of a relying on a software vendor, we write the code for any |
new features that we desire to offer our customers. We have no software licensing fees and our |
other variable network costs are expected to drop as we increase our network traffic and as we |
attract more pure IP telephony users with traffic that does not incur the cost of originating or |
terminating on a circuit- switched network. |
Our SIP servers are part of a cluster of servers, which we refer to as a server farm, in |
which each server performs different network tasks, including back-up and redundant services. |
We believe the server farm structure can be easily and cost-effectively scaled as our broadband |
voice business grows. In addition, servers within our server farm can be assigned different tasks |
as demand on the network dictates. If an individual server ceases to function, our server farm is |
designed in a manner that subscribers should not have a call interrupted. We support origination |
and termination using both the G.711 and G.729 voice codecs. Codecs are the algorithms that |
enable us to carry analog voice traffic over digital lines. There are several codecs that vary in |
complexity, bandwidth required and voice quality. We primarily use G.711 and G.729 codecs. |
G.711 is a standard to represent 8 bit compressed pulse code modulation samples for signals of |
voice frequency. It creates a 64 kilobit per second bitstream, and we find that approximately |
90% of the current IP telephony traffic in the United States uses G.711. We frequently process |
G.711 traffic because some of our wholesale customers do not have the ability to handle G.729. |
We prefer the G.729 codec, which allows us to utilize the Internet in more cost effective ways. It |
allows for compressing more calls in limited bandwidth, reducing the call to 8 kilobits per |
second. For all of our retail customers and our more sophisticated wholesale accounts, we use |
G.729 to save cost and enhance the quality of the call. |
Plan of Operation |
Our objective is to build a profitable telephone company on a stable and scalable |
platform with minimal network costs. We want to be known for our high quality of service, |
robust features and ability to deliver any new product to a wholesale customer or a web store |
without delay. We believe that to achieve our objective we need to have “cradle to grave” |
automation of our back-office web and billing systems. We have written our software for |
maximum automation, flexibility and changeability. |
We know from experience in provisioning complex telecom orders that back-office |
automation is a key factor in keeping overhead costs low. Technology continues to work for 24 |
hours a day and we believe that the fewer people a company has in the back office, the more |
efficiently it can run, which should drive down the cost per order. |
Furthermore, our strategy is to grow rapidly by leveraging the capital, customer base and |
marketing strength of our wholesale customers. Many of our targeted wholesale customers and |
some of our existing wholesale customers have ample capital to market a private-labeled |
broadband voice product to their existing customer base or to new customers. We believe our |
strength is our technology-based platform. By providing our technology to cable companies, |
CLECs, ISPs, WiFi and fixed-wireless broadband providers, data integrators, value-added |
resellers, and satellite broadband providers and any other entity that desires to offer a broadband |
telephony product, we believe we will require significantly less cash resources than other |
providers will require to attract a similar number of subscribers. |
By taking a wholesale approach, our goal is to obtain and manage 500 customers that |
have an average customer base of 1,000 end-users. We believe we will be more successful and |
more profitable taking this approach to reaching 500,000 end-users than we would be if we tried |
to attract and manage 500,000 individual end-users by ourselves. |
Three Months Ended February 28, 2007 vs. Three Months Ended February 28, 2006 |
Our revenue for the three-month period ended February 28, 2007 decreased by |
approximately $756,000, or approximately 30%, to approximately $1,741,000 as compared to |
approximately $2,497,000 reported for the three-month period ended February 28, 2006. The |
reduction in revenues was directly related to the decrease in the customer base or number of local |
access lines served by our two CLECs, New Rochelle Telephone Corp. and Telecarrier Services |
Inc. In lieu of telemarketing new CLEC customers, over the past year we used our financial |
resources to further build and enhance our IP telephony operations. Consequently, while our |
CLEC sales declined in the first quarter of fiscal 2007 as compared to the comparative quarter of |
fiscal 2006, our IP telephony revenue increased by approximately $164,000 period over period. |
from $25,000 in the first quarter of fiscal 2006 to $189,000 in the first quarter of fiscal 2007. We |
anticipate that our CLECs will be divested to a third-party purchaser during the second quarter of |
fiscal 2007 and that future revenues will be derived from IP telephony only. |
The roll-out of our broadband voice product has taken significantly longer than we |
anticipated. We believe a key reason for the delay was the extensive effort required for us to |
become a customized wholesale service provider. Because of the intense competition on the |
retail level and the high marketing costs that broadband voice providers have incurred to acquire |
a subscriber, we decided that we should not compete in the retail arena. Our goal is to obtain 500 |
customers that will private label and resell our broadband voice services to their customer base. |
We target cable operators that already are providing broadband Internet services, Internet service |
providers, WiFi and fixed wireless broadband providers, data integrators, value-added resellers, |
and satellite broadband providers. We anticipate that our wholesale customers will be able to |
obtain an average of at least 1,000 broadband voice end-users. We believe our approach, in |
which we are seeking at least 500 customers that we will manage, and a total of at least 500,000 |
end users, which our customers will manage, will provide us with the quickest and least |
expensive way to leverage our technology. Under our approach, we will avoid the expensive |
customer acquisition costs that other broadband voice carriers are experiencing as they try to find |
a broadband end-user to try their product. Instead of incurring these costs our self, our customer, |
which should be able to incur a reduced marketing expense because it has an imbedded customer |
base already buying broadband service, will incur them. We believe we can empower small and |
medium-sized broadband providers with the ability to take customers away from the traditional |
telephone companies. |
Our IP telephony facilities have significant unused capacity and we have begun to attract |
other types of customers to utilize our facilities. For example, we are actively pursuing both |
buyers and sellers of international cell phone termination minutes. We have sales personnel who |
have previously worked in these markets, and by targeting cell phone termination we are able to |
realize a higher per minute billing rate and profit, than we would realize on a wireline. |
Our gross profit for the three-month period ended February 28, 2007 decreased by |
approximately $539,000 to approximately $538,000 from approximately $1,077,000 reported in |
the three-month period ended February 28, 2006. During the same fiscal periods, our gross profit |
percentage decreased to 30.9% from 43.1%. The decrease in our gross profit resulted primarily |
from the decrease in the size of our customer base in first quarter of fiscal 2007 relative to the |
first quarter of fiscal 2006. The decrease in our gross profit percentage during the 2007 period |
resulted from the higher cost of services that we are now incurring under our wholesale services |
agreement with Verizon and the higher IP network costs we are now incurring due to the low |
utilization rate of our IP facilities. While it is difficult for us to predict the gross margins we will |
achieve on our IP lines because we are offering a variety of wholesale products and our gross |
margin will be impacted by the product mix, based on current pricing, we anticipate that when |
we have a sufficient quantity of subscribers, mature wholesale accounts will generate a gross |
margin of approximately 25% to 40%. |
Selling, general and administrative expenses decreased by approximately $107,000, or |
approximately 9%, to approximately $1,140,000 for the three-month period ended February 28, |
2007 from approximately $1,247,000 reported in the same prior year fiscal period. Our salary |
cost decreased by approximately $115,000 in the first quarter of 2007 over the same period last |
year. |
Our bad debt expense decreased by approximately $69,000, or approximately 58%, to |
approximately $49,000 for the three months ended February 28, 2006 from approximately |
$118,000 reported in the prior fiscal period. This decrease was related to the reduction in the |
number of customers we had during the 2007 period and the fact that the remaining customers |
represent a mature base that has consistently paid their bills. |
Depreciation and amortization expense increased by approximately $87,000 for the three |
months ended February 28, 2007 to approximately $174,000 as compared to approximately |
$87,000 for the same period in fiscal 2006. Approximately $66,000 of the increase was for |
deferred financing costs related to our financing agreements and approximately $21,000 related |
to our VoIP platform. |
Interest expense decreased by approximately $55,000 to approximately $227,000 for the |
three months ended February 28, 2007 as compared to approximately $281,000 for the three |
months period ended February 28, 2006. The decrease is due to lower effective borrowing rates |
in the 2007 quarter and the reversal of an accrual for default interest of approximately $42,000 |
that our lender has notified us that we will not have to pay. The cash payment portion of the |
$227,000 in interest expense amounted to approximately $129,000. The remaining balance |
represented the accretion of a debt discount using the effective interest method over the term of |
the related debt. |
Other income decreased by approximately $3,000, to approximately $11,000 for the |
three months ended February 28, 2007 as compared to approximately $14,000 for the three |
months ended February 28, 2006. The decrease resulted from a reduction in commission income. |
Warrant expense for the three months ended February 28, 2007, amounted to |
approximately $960,000 due to the significant increase in the market value of our common stock |
between the period of November 30, 2006 to February 28, 2007, as compared to the expense of |
approximately $22,000 for the same period in fiscal 2006. |
Liquidity and Capital Resources |
At February 28, 2007, we had cash and cash equivalents of approximately $311,000 and |
negative working capital of approximately $7,021,000. |
Net cash used in operating activities aggregated approximately $964,000 and $837,000 |
in the three-month periods ended February 28, 2007 and 2006, respectively. The principal use of |
cash in fiscal 2007 was the loss for the period of approximately $2,000,000 which was partially |
offset by a non-cash mark to market warrant adjustment of $960,000. The principal use of cash |
in fiscal 2006 was the loss for the period of $664,000. |
Net cash used in investing activities in the three-month periods ended February 28, 2007 |
and 2006 aggregated approximately $52,000 and $123,000, respectively, resulting primarily from |
expenditures related to our VoIP initiative. |
Net cash (used in) provided by financing activities aggregated approximately ($11,000) |
and $1,422,000 in the three-month periods ended February 28, 2007 and 2006, respectively. In |
fiscal 2007, net cash used in financing activities was the repayment of long-term lease |
obligations. In fiscal 2006, net cash provided by financing activities resulted from the proceeds |
of long-term notes of approximately $1,753,500, which was partially offset by the repayment of |
short-term debt of approximately $328,000. |
For the three months ended February 28, 2007, we had approximately $52,000 in capital |
expenditures primarily related to our IP telephony business. We expect to make equipment |
purchases of approximately $50,000 to $100,000 in the second fiscal quarter of 2007. We expect |
that other capital expenditures over the next 12 months will relate primarily to a continued roll- |
out of VoIP services and will only be required to support a growing customer base of IP |
telephony subscribers. |
Subsequent to February 28, 2007, we have negotiated with our primary lender a principal |
deferral of nine months for one of our notes and a deferral until June 1, 2007 on another note that |
we anticipate paying off if we close on the definitive purchase agreement we signed on |
December 14, 2006 to sell our CLEC subsidiaries. In consideration for the principal deferral, on |
April 16, 2007 we issued to our lender a seven-year warrant to purchase 1,200,000 shares of our |
common stock at a price of $0.25. We are in default with our lender for not filing this Report on |
a timely basis, and we anticipate that we will not be able to make the principal payments due on |
June 1, 2007 unless we are successful in selling of our CLEC subsidiaries before then. Because |
of the default on such debt, the debt can be called immediately, and we have classified it as a |
current liability on our balance sheet and the related debt finance costs are shown as a current |
asset. If our lender accelerates such debt, we will not be able to satisfy such indebtedness in full, |
which inability would adversely affect our ability to continue operating as a going concern. |
The report of our independent registered public accounting firm on our 2006 financial |
statements indicates there is substantial doubt about our ability to continue as a going concern. |
Our operating losses have been funded through the sale of non-operating assets, the issuance of |
equity securities and borrowings. We believe our current cash resources will not be sufficient to |
finance our operations. Accordingly, we have engaged a placement agent to raise us up to $1.5 |
million in equity to support our operating losses. There can be no assurance that such financing |
will be sufficient to get us to a break-even level, or that the agent will be able to raise the full |
amount. Our failure to generate sufficient revenues and raise additional capital will have an |
adverse impact on our ability to achieve our longer-term business objectives, and would |
adversely affect our ability to continue operating as a going concern. |
Item 3. Quantitative and Qualitative Disclosure About Market Risk |
Our outstanding debt is primarily under three borrowing arrangements with one lender |
and such borrowings are at the rate of 2% over the prime rate. We currently do not use interest |
rate derivative instruments to manage our exposure to interest rate changes. As a result of |
conversion features, warrant issuances and lender discounts, the effective rate of interest has |
been calculated at rates of approximately 38% on our February 2005 financing, 47% on our |
November 2005 financing, and 185% on the $650,000 portion of our May 2006 financing. |
Item 4. Controls and Procedures |
(a)Disclosure Controls and Procedures. Our management, with the participation of our |
chief executive officer/chief financial officer, has evaluated the effectiveness of our disclosure |
controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the |
Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period |
covered by this Report. Based on such evaluation, our chief executive officer/chief financial |
officer has concluded that, as of the end of such period, for the reasons set forth below, our |
disclosure controls and procedures were not effective. We are presently taking the necessary |
steps to improve the effectiveness of such disclosure controls and procedures. |
(b)Internal Control Over Financial Reporting. There have not been any changes in our |
internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d- |
15(f) under the Exchange Act) during the first quarter of 2007 that have materially affected, or |
are reasonably likely to materially affect, our internal control over financial reporting. In |
connection with our year-end November 30, 2006 audit, our management became aware of an |
inadequately designed accounting system as it pertains to our VoX subsidiary. As reported in |
fiscal 2006 and 2005, we also have a lack of staffing within our accounting department, both in |
terms of the small number of employees performing our financial and accounting functions and |
their lack of experience to account for complex financial transactions. Management believes the |
lack of qualified personnel, in the aggregate, and the inadequately designed accounting system, |
are both a material weakness in our internal control over financial reporting. We have updated |
and enhanced our internal reporting at VoX and we will continue to evaluate the number of |
accounting employees we utilize, the need to engage outside consultants with technical and |
accounting-related expertise to assist us in accounting for complex financial transactions and the |
hiring of additional accounting staff with complex financing experience. |
We also are evaluating our internal controls systems so that when we are required to do |
so, our management will be able to report on, and our independent auditors to attest to, our |
internal controls, as required by Section 404 of the Sarbanes-Oxley Act of 2002. We will be |
performing the system and process evaluation and testing (and any necessary remediation) |
required in an effort to comply with the management certification and auditor attestation |
requirements of Section 404 of the Sarbanes-Oxley Act. In connection with our year-end |
November 30, 2006 and 2005 audits, we identified the following control deficiencies and issues |
with our internal controls over financial reporting that we believe amount in the aggregate to a |
significant deficiency in our internal controls over financial reporting: |
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 insignificant |
amounts. 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 |
intend to remit such taxes in a timely manner in the future. |
Due to the complex nature and changing regulations |
regarding telecom taxes, we do not always calculate and remit the |
appropriate amount of taxes due. We are challenging taxes that |
one state claims are owed to it. At least some of the taxes are due |
because of the improper calculation of taxes that should have |
been billed to and collected from our wireline telephone |
customers in one particular state. |
eLEC COMMUNICATIONS CORP. | ||||
PART II-OTHER INFORMATION | ||||
Item 6. | Exhibits | |||
Exhibit | ||||
Number | Description | |||
31.1 | Certification of our Chief Executive Officer and Chief Financial | |||
Officer, Paul H. Riss, Pursuant to 18 U.S.C. 1350 (Section 302 of | ||||
the Sarbanes-Oxley Act of 2002) | ||||
32.1 | Certification of our Chief Executive Officer and Chief Financial | |||
Officer, Paul H. Riss, Pursuant to 18 U.S.C. 1350 (Section 906 of | ||||
the Sarbanes-Oxley Act of 2002) |
SIGNATURES | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has | ||||
duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. | ||||
eLEC Communications Corp. | ||||
Date:April 20, 2007 | By: /s/ Paul H. Riss | |||
Paul H. Riss | ||||
Chief Executive Officer | ||||
(Principal Financial and | ||||
Accounting Officer) |
EXHIBIT INDEX | ||
Exhibit | ||
Number | Description | |
31.1 | Certification of our Chief Executive Officer and Chief Financial | |
Officer, Paul H. Riss, Pursuant to 18 U.S.C. 1350 (Section 302 of | ||
the Sarbanes-Oxley Act of 2002) | ||
32.1 | Certification of our Chief Executive Officer and Chief Financial | |
Officer, Paul H. Riss, Pursuant to 18 U.S.C. 1350 (Section 906 of | ||
the Sarbanes-Oxley Act of 2002) |
EXHIBIT 31.1 | ||||
CERTIFICATION | ||||
Pursuant to 18 U.S.C. 1350 | ||||
(Section 302 of the Sarbanes-Oxley Act of 2002) | ||||
I, Paul H. Riss, Chief Executive Officer and Chief Financial Officer of eLEC Communications | ||||
Corp., certify that: | ||||
1. | I have reviewed this quarterly report on Form 10-Q of eLEC Communications Corp.; | |||
2. | Based on my knowledge, this report does not contain any untrue statement of a material | |||
fact or omit to state a material fact necessary to make the statements made, in light of the | ||||
circumstances under which such statements were made, not misleading with respect to the period | ||||
covered by this report; | ||||
3. | Based on my knowledge, the financial statements, and other financial information | |||
included in this report, fairly present in all material respects the financial condition, results of | ||||
operations and cash flows of the registrant as of, and for, the periods presented in this report; | ||||
4. | I am responsible for establishing and maintaining disclosure controls and procedures (as | |||
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and I have: | ||||
(a) | Designed such disclosure controls and procedures, or caused such disclosure | |||
controls and procedures to be designed under my supervision, to ensure that material | ||||
information relating to the registrant, including its consolidated subsidiaries, is made | ||||
known to me by others within those entities, particularly during the period in which this | ||||
report is being prepared; | ||||
(b) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures | |||
and presented in this report our conclusions about the effectiveness of the disclosure | ||||
controls and procedures, as of the end of the period covered by this report based on such | ||||
evaluation; and | ||||
(c) | Disclosed in this report any change in the registrant’s internal control over | |||
financial reporting that occurred during the registrant’s most recent fiscal quarter that has | ||||
materially affected, or is reasonably likely to materially affect, the registrant’s internal | ||||
control over financial reporting; and | ||||
5. | I have disclosed, based on my most recent evaluation of internal control over financial | |||
reporting, to the registrant’s auditors and the audit committee of the registrant’s board of | ||||
directors (or persons performing the equivalent functions): | ||||
(a) | All significant deficiencies and material weaknesses in the design or operation of | |||
internal control over financial reporting which are reasonably likely to adversely affect | ||||
the registrant’s ability to record, process, summarize and report financial information; | ||||
and |
(b) | Any fraud, whether or not material, that involves management or other | |||
employees who have a significant role in the registrant’s internal control over financial | ||||
reporting. | ||||
Date: | April 20, 2007 | |||
/s/ Paul H. Riss | ||||
Paul H. Riss | ||||
Chief Executive Officer and Chief | ||||
Financial Officer |
EXHIBIT 32.1 | ||||
CERTIFICATION | ||||
Pursuant to 18 U.S.C. 1350 | ||||
(Section 906 of the Sarbanes-Oxley Act of 2002) | ||||
In connection with the Quarterly Report on Form 10-Q of eLEC Communications Corp. | ||||
(the "Company") for the quarter ended February 28, 2007, as filed with the Securities and | ||||
Exchange Commission on the date hereof (the "Report"), Paul H. Riss, as Chief Executive | ||||
Officer and Chief Financial Officer of the Company, hereby certifies, pursuant to 18 U.S.C. | ||||
§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that: | ||||
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of | ||||
the Securities Exchange Act of 1934, as amended; and | ||||
(2) The information contained in the Report fairly presents, in all material | ||||
respects, the financial condition and results of operations of the Registrant. | ||||
Date: April 20, 2007 | By: | /s/ Paul H. Riss | ||
Paul H. Riss | ||||
Chief Executive Officer and | ||||
Chief Financial Officer | ||||
This certification accompanies each Report pursuant to § 906 of the Sarbanes-Oxley Act | ||||
of 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be | ||||
deemed filed by the Company for purposes of §18 of the Securities Exchange Act of 1934, as | ||||
amended. | ||||
A signed original of this written statement required by Section 906 has been provided to | ||||
the Company and will be retained by the Company and furnished to the Securities and Exchange | ||||
Commission or its staff upon request. |