UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended November 30, 1999 [ ] 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. - -------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) New York 13-2511270 - -------------------------------------------------------------------------------- (State or other jurisdiction (IRS employer of incorporation or organization) identification no.) 509 Westport Avenue, Norwalk, Connecticut 06851 (Address of principal executive offices) (zip code) Registrant's telephone number, including area code: (203) 750-1000. - -------------------------------------------------------------------------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.10 per share Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this Form 10-K. ____ As of February 15, 2000, the aggregate market value of the voting stock held by non-affiliates of the Registrant was $46,098,656. As of February 15, 2000, there were 11,524,664 shares outstanding of the Registrant's Common Stock. Documents Incorporated by Reference Portions of the Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission in connection with the Registrant's 2000 Annual Meeting of Stockholders are incorporated by reference into Part III. TABLE OF CONTENTS PART I Item 1. Business Item 2. Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters Item 6. Selected Financial Data Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures about Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure PART III Item 10. Directors and Executive Officers of the Registrant Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management Item 13. Certain Relationships and Related Transactions PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K Signatures Index to Financial Statements The statements contained in this Report that are not historical facts are "forward-looking statements" which can be identified by the use of forward-looking terminology, such as "estimates," "projects," "plans," "believes," "expects," "anticipates," "intends," or the negative thereof or other variations thereon, or by discussions of strategy that involve risks and uncertainties. Management wishes to caution the reader of the forward-looking statements, that such statements, which are contained in this Report, reflect our current beliefs with respect to future events and involve known and unknown risks, uncertainties and other factors, including, but not limited to, economic, competitive, regulatory, technological, key employee, and general business factors affecting the Company's operations, markets, growth, services, products, licenses and other factors discussed in the Company's 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 the Company, and actual events may differ from the assumptions underlying the statements that have been made regarding anticipated events. Factors that may cause actual results, performance or achievements of the Company, 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 the Company's business plan; (2) the Company's ability to maintain, attract and integrate internal management, technical information and management information systems; (3) the time and expense to construct the Company's planned network operating center and digital subscriber line network; (4) the cooperation of incumbent carriers in implementing the unbundled network elements platform required by the Federal Communications Commission; (5) the Company's ability to market its services to current and new customers and generate customer demand for its products and services in the geographical areas in which the Company can operate; (6) the Company's success in gaining regulatory approval to access new markets; (7) the Company's 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 impact of changes in telecommunication laws and regulations; (10) 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 the Company or persons acting on its 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-K, we will refer to eLEC Communications Corp., a New York Corporation, as "eLEC," the "Company," "we," "us," and "our." Item 1. - Business Overview eLEC Communications Corp. is a full-service telecommunications company that focuses on developing integrated telephone service in the emerging competitive local exchange carrier industry. We offer an integrated set of telecommunications products and services, including local exchange, local access, domestic and international long distance telephone, calling cards, paging, Internet access, dedicated access, Web site design, Web site hosting, Internet-based yellow-pages directory listings and other enhanced and value-added telecommunications services tailored to meet the needs of our customers and the growing marketplace demand from small- and medium-sized businesses for reliability and speed. As part of our nationwide expansion plan, we have completed the deployment of our first network node in a planned 18-node build-out to provide high speed Internet access via digital subscriber lines ("DSL"), and for the anticipated provisioning of Voice over DSL. We believe that the Telecommunications Act of 1996 (the "Telecommunications Act"), which opened the local exchange market to competition, has created an attractive opportunity for competitive local exchange carriers ("CLECs"), such as eLEC. Like most CLECs, our entry in this industry was dependent upon the provisions of the Telecommunications Act that allow CLECs to lease various elements of the networks of the incumbent local exchange carriers ("ILECs") that are necessary to provide local telephone service in a cost-effective manner. This aspect of the Telecommunications Act is referred to as "unbundling" the ILEC networks, and allows us to lease unbundled network elements on an as-needed basis and provide such elements to our customers at a lower cost than that which the ILEC is charging. The majority of our installed access lines are provisioned on the unbundled network elements platform ("UNE-P"). We believe that the use of this platform is the most cost-effective manner in which we can provide voice service. Other CLECs have invested a substantial amount of capital to buy switches and rollout fiber, only to find that their equipment is severely underutilized and that there is a significant shortfall in their revenue stream when compared to their capital investment. We refer to this strategy as a "facilities-first" strategy, because the CLEC has invested in its equipment and placed the equipment in service before the CLEC has developed a customer base. Our strategy is a "customer-first," or a "deferred-build" strategy. We therefore lease facilities on an as-needed basis from ILECs while we build our customer base. After we have a substantial geographical concentration of customers, we make decisions regarding the purchase and installation of our own network equipment. This strategy allows us to be very flexible with our customer base as we grow our business. We can move our customer base to alternative access, if appropriate, and we do not become a captive of our own underutilized equipment, as can happen with a "facilities-first" CLEC. The technological advances in equipment and the lowering of equipment prices have validated our deferred-build strategy and have enabled us to preserve our capital. Our strategy for building our data network is similar to our strategy for building our voice network. We currently provide dial-up access and dedicated access on our own network in Connecticut, where we have a geographical concentration of customers, and we lease facilities from another Internet service provider to provide our customers with nation-wide dial-up access. As of February 15, 2000, we have installed one Point of Presence ("POP") in Miami, Florida for high-speed Internet access via DSL and for Voice over DSL. We chose the Miami location because we have, through an affiliated company, an established customer base in the Miami area of approximately 2,000 customers. We are planning to build out an 18-node data network throughout the East coast to carry DSL and Voice over DSL to our customer base. We believe we can provide competitive service in every state in which we can utilize UNE-P and we plan a nationwide rollout to take advantage of a recent Federal Communications Commission ("FCC") ruling mandating the UNE-P service offering. Our marketing and expansion efforts are focused primarily on states that have quickly adopted the UNE-P service offerings, which initially included the nine states served by BellSouth Corporation ("BellSouth"), plus New York and Massachusetts. Under UNE-P, we can provide service with significantly lower capital requirements than either fiber-based or wireless CLECs, and offer our services to a broader customer base faster and at a lower cost. The ability to quickly provision accounts and to deliver reliable service at a lower cost than offered by the ILECs should provide us with certain competitive advantages as we market our services to small- and medium-sized businesses. Development of Business The Company was incorporated in the state of New York under the name Sirco Products Co. Inc. in 1964, and we subsequently changed our name to Sirco International Corp. We initially developed a line of high quality handbags, totes, luggage and sport bags to be sold at competitive prices. In 1995, we divested our handbag operations, which had experienced several years of operating losses. Although we were profitable in fiscal 1996, declining revenues in our next two fiscal years, combined with operating losses, forced us to analyze other business opportunities. In August 1997, to help bolster luggage division sales and to provide a channel of distribution to a mobile customer base that would be a potential target for online Internet sales, we acquired a retail operation, Airline Ventures, Inc. ("AVI"), which sells travel and aviation related products to professional airline crew members. In October 1997, we made our first investment in a CLEC, Access One Communications, Inc. ("Access One"), when we purchased approximately 28% of Access One's outstanding capital stock. Access One was a newly-formed CLEC with approximately 2,000 installed local access lines that looked to us for growth capital to meet its business plan. Our Board of Directors believed that Access One's "customer-first" growth strategy of obtaining a customer base first and later building an equipment network around a geographically concentrated customer base was a compelling strategy that would utilize capital wisely and yield high valuations in the future. At February 15, 2000, we were the largest shareholder of Access One, owning approximately 21% of Access One's capital stock. Access One has advised us that, at February 15, 2000, they had approximately 60,000 installed local access lines. We commenced operations in the telecommunications industry in fiscal 1998 by acquiring on February 27, 1998, 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. We provisioned our first line in May 1998 and, including lines for which we have contracts to install, we had over 20,000 lines as of February 15, 2000. Essex has customers in Florida, Massachusetts, New York, New Jersey and Virginia. In furtherance of our telecommunications strategy, on August 14, 1998, we acquired WebQuill Internet Services, LLC ("WebQuill"), an Internet service provider ("ISP") based in Connecticut. WebQuill is a full-service, value-added ISP providing national dial-up access, dedicated access, high-speed DSL access, Web site design, Web site hosting, Internet-based yellow-pages directory listing, and E-commerce sites. Due to our increased focus on E-commerce sites, Internet access and telecommunications services, and the significant decrease in luggage division sales in recent fiscal years, our Board of Directors decided in July 1999 to divest the Company's luggage division, and we sold a substantial portion of the assets of our U.S. luggage operations in August 1999. Since such time, we have liquidated the remaining operating assets of our U.S. and Canadian luggage businesses. Our luggage segment has been classified as a discontinued operation in our income statement, and this segment has reported significant net operating losses for each of the last three fiscal years. See Note 8 of the Notes to Consolidated Financial Statements. To signify our new business focus, we recommended, and in November 1999 our shareholders approved, a name change to eLEC Communications Corp. Our main business focus had changed to the local exchange market, which is estimated to be more than $50 billion in annual revenues and one of the most profitable segments in the communications industry. With this new focus, we wanted our company name to include the letters LEC, representing our focus on being a local exchange carrier. However, in this electronic age and with our wholly-owned ISP to provide Internet access, DSL services and Web site design and hosting, we believed the term "e" LEC more appropriately described our new business operations. We consequently changed our name to eLEC Communications Corp., our ticker symbol to ELEC and our domain name to www.elec.net. In January 2000, we acquired a New Jersey-based CLEC, Telecarrier Services, Inc. ("Telecarrier"). Telecarrier currently operates as a CLEC in the states of Massachusetts, New Jersey, New York and Rhode Island. It also resells long distance service in 13 states. The addition of Telecarrier is an important step in creating an additional marketing channel for eLEC. See "Sales and Marketing Strategies." Information concerning sales, business segment operations and identifiable assets attributable to each of our reportable industry segments can be found in Note 9 of the Notes to Consolidated Financial Statements and is incorporated herein by reference. eLEC's Telecommunications Services We tailor our service offerings to meet the specific needs of small businesses, not-for-profit organizations, governmental agencies and other institutional customers in our target markets. We primarily market our services through three different distribution channels. We use third-party telemarketers to attract small-business accounts (typically two to ten lines in size), we use third-party agents and interconnect companies to attract medium-sized business accounts (typically ten to 100 lines in size), and we use our own management team to attract wholesale accounts (typically 100 lines or more in size). Based upon feedback received from our customers and analysis of the types of services the entities in each of these groups need, we tailor a basic telecommunications service package, which can be promptly adjusted to the specific needs of individual customers. We creatively package our services to provide "one-stop shopping" solutions for our customers, so they can purchase all their communications services directly from us. 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, 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 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 international calling, toll-free services (800, 888, 877), calling card and other enhanced services. o Internet and Data Services. We offer dedicated and dial-up Internet access services via conventional modem connections, integrated services digital networks, T-1s and higher speed dedicated connections. In addition, we have installed our first node to carry DSL services, and we plan to offer Voice over DSL before the end of fiscal year 2000. o Web Site Design and Hosting Services. We offer Web site design services and Web site hosting on our own computer servers to provide customers with a complete, user-friendly product for presence on the World Wide Web. We have built and are currently providing for our customers E-commerce sites, an interactive comparative insurance rater site, and an interactive auction site. o Yellow Pages Directory Services. Our local telephone service customers are given a free Web page for six months in our Internet yellow pages directory. This page is also sold for $24.95 per month to non-telephone customers. The site is accessed by more than 80% of Internet search engines, and offers links to other sites and the ability for our customers to receive a fax or email message directly from the user who has found the site. In the second quarter of fiscal 2000, we intend to market this product on a wholesale basis for business-to-business applications. o Facilities and System Integration Services. We offer individual customer consultation services with regard to the design and implementation of complete telecommunications systems to meet customers' specific needs, including the selection of customer premises equipment, interconnection of local area networks and wide area networks, and implementation of virtual private networks. o Hosted Applications. We plan to offer hosted applications to our customers, especially to small-sized businesses that do not have the resources to hire their own management information services director. We anticipate that such application hosting will be important to entities that use high-speed Internet access services, such as DSL, and will help differentiate us from other DSL providers that only provide access services. Business Strategy Our goal is to be a premier facilities-based integrated communications provider to small- and medium-sized businesses. We are taking the following action steps in order to achieve this goal: o Target Small- and Medium-sized Businesses. We focus our telecommunications sales efforts for local and long distance services on small- and medium-sized businesses having two to 100 business lines in any one location. We believe that these customers prefer a single source for all their telecommunications services. We have chosen to focus on this segment based on our ability to obtain ample gross margins on UNE-P for the services provided to these customers. We also believe that, as compared to larger businesses, the ILECs and facilities-first CLECs may be less likely to apply significant resources to obtaining or retaining these customers. We expect to attract and retain these customers through telemarketers and agents, by offering bundled local and long distance services at competitive rates, as well as enhanced telecommunication services, by responsive customer service and support and by offering new and innovative products, such as our yellow pages directory Web sites known as QuillPages. o Achieve Market Share with Competitive Pricing. We always price our services at a discount to the exact same services provided by an ILEC. We believe we know what the ILECs charge because we have access to the rates they have filed with the various state public service commissions, and we typically review the telephone bill of a potential customer before we switch them to our network so that we are aware of the prices they were paying and of any contractual obligations. We anticipate that some ILECs may reduce their prices as increased competition begins to erode their market share. We believe, however, that we will be able to compete as prices decrease, because of our low network costs and because we will be providing a variety of bundled telecommunications services and will not have to rely on price alone to maintain our core customer base. o Develop Brand Awareness. With the change of our name to eLEC Communications Corp., we are applying for the right to do business under the brand name eLEC Communications in all of the states in which we operate. We want to invoice the customers of our wholly-owned subsidiaries, Essex, WebQuill and Telecarrier, under the eLEC Communications name, and use the eLEC name to create and develop a brand awareness in the territories in which we operate. We are positioning eLEC as a high quality, service-orientated company that provides reliable telecommunications quality, service and advice at competitive prices. o Rapidly Deploy New Customers. We intend to take advantage of our ability to rapidly provision new accounts in our existing service areas, and to rapidly enter new service areas because of our low capital requirements to enter new states. Our choice of states on which to focus will depend on when the particular state adopts the use of UNE-P. We anticipate that Pennsylvania and Texas will be the next two major states that we target. We typically provision a new account within two or three days after we have received a letter of authorization to place a new customer on our network. We know of no facilities-first carrier that can provision lines this quickly. o Provide our Customers More than Local Telephone Services. Although our focus is on the more than $50 billion local exchange market, and we anticipate that the sales growth and margins associated with this market will represent our core business, the additional products and services we offer, including Internet access, email addresses, Web site design and Web site hosting, yellow pages directory listing, DSL access, applications hosting and virtual private networks, will be an important attraction to our customers. We believe the more services we can provide, the more integral we will become to our customers. Sales and Marketing Strategies We offer an integrated package of local exchange, local access, domestic and international long distance, and calling cards and a full suite of Internet access, Web site design and Web site hosting to small- and medium-sized businesses. Virtually all of our customers have no telecommunications manager and look to us to suggest an appropriate telecommunications solution. Each account is assigned a customer service representative and we answer the telephone during business hours with a live person instead of sending our customers through several voice mail loops before reaching a person to whom they can speak. We have a three-tiered sales and marketing strategy to sell to our target market. o Telemarketing Programs. We use third-party telemarketing firms to sell our smaller accounts. Most accounts in this group choose our telephone service because they do not like the customer service they receive from their ILEC and because they will save money using our services. We have proven that this strategy works for us, as almost all of our first 10,000 customer lines came from the telemarketing channel, and most of the organic growth at our affiliate, Access One, came from third-party telemarketers. This method allows us to keep our marketing costs variable-based and minimizes the need to have fixed overhead committed to our sales force. o Agent and Interconnect Company Programs. We also use agents and interconnect companies to generate leads for new customers. We pay a success fee to the agents and interconnect companies for recommending our services. Most of these referrals are current equipment customers or long distance customers of the agent or interconnect company. Therefore, it is important that the agents and interconnect companies understand the benefits of the services that we offer because they do not want to tarnish an existing customer relationship by inappropriately recommending us. We find that our pricing and the flexibility of our services, combined with our special customer service group for the interconnect companies, allows us to satisfy the needs of the referrals we receive in this distribution channel. Two executives from our recently acquired subsidiary, Telecarrier, have extensive established business relationships with interconnect companies. Many of their current accounts were referrals from established business relationships, and we believe our Telecarrier employees will continue to develop for us this market segment. o Wholesale Programs. We offer special wholesale pricing for accounts with several hundred local access lines. One such customer has agreed to provide us with a minimum of 9,000 local access lines, and we anticipate that during fiscal 2000 we will be able to attract other wholesale customers who will bring us thousands of new lines. We use a direct sales effort to sell in this market. Separate customer service representatives are assigned to support this customer base. This sales and marketing strategy minimizes the need for us to invest in fixed sales and marketing overhead. Unlike the facilities-first CLECs, who need to rapidly attract customers for their underutilized telecommunications equipment, and who invest substantial amounts of salary and rent expense to open sales offices in their targeted markets, we do not have the same pressure to find qualified leads for our facilities. Furthermore, under UNE-P, our reach is ubiquitous, as we can serve any customer that is being served by the ILEC. A facilities-first CLEC typically searches only for customers that it can provision on the switches and fiber that it has installed in the hope of finding customers to utilize such equipment. Consequently, we believe our deferred-build strategy not only saves us from unnecessarily building a network without customers, it also allows us to more wisely expend our sales and marketing dollars by limiting the amount of fixed overhead that is required to rapidly grow our business. Competition in the Telecommunications Industry Local Telecommunications Market The local telecommunications market is a highly competitive environment and is dominated by the Regional Bell Operating Companies ("RBOCs") and other ILECs. Based upon the geographical locations in which we currently sell services, Bell Atlantic Corporation ("Bell Atlantic") and BellSouth are our largest competitors. Both entities have "win-back" programs through which they approach former customers lost to a CLEC or other competitor in an attempt to have the former customers switch back to the RBOC. Most of our actual and potential competitors, including most of the facilities-first CLECs, have substantially greater financial, technical, marketing and other resources (including brand name recognition) than we do. Furthermore, the continuing trend toward business alliances in the telecommunications industry and the lack of substantial barriers to entry in the data and Internet services markets could help to generate substantial new competition. We anticipate that we will be able to compete based upon our pricing, reliability, customer service and rapid ability to provision accounts and respond to customer requests. Our established competitors, such as the RBOCs, 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 reduced barriers to entry into the local market, future regulatory decisions could provide RBOCs with more pricing flexibility, which would result in increased price competition. We also face competition in the local market from new entrants to the fixed wireless market, such as Winstar Communications, Inc., Teligent, Inc. and NextLink Communications, Inc. Many of these entrants have the strategy of bypassing the RBOCs in order to provide local access to their customers. By not having to rely on the RBOC for local service connections, the fixed wireless companies are able to keep more of their sales dollar for themselves. However, if this access method becomes more price competitive and reliable, we believe we will have the flexibility, with our current local customer base, to switch all or a portion of our customer base to the wireless facilities by negotiating appropriate terms with one or more wireless carriers. In addition to competition from RBOCs, other CLECs and wireless entities, several other entities currently offer or are capable of offering local service, such as long distance carriers, cable television companies, electric utilities and microwave carriers. 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 Corp., MCI WorldCom and Sprint Corporation, among other carriers, have each begun to offer local telecommunications services in major U.S. markets using the unbundled network elements platform or by reselling the ILECs' services. Long Distance Telecommunications Market 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 numerous such companies who do not offer any service other than long distance, and we compete with established major carriers such as AT&T and MCI WorldCom. We believe our bundled package of local services and a variety of data services will help us compete in this market. We will also have to maintain high quality and low cost services to compete effectively. In many instances, we must be in a position to reduce our rates to remain competitive. Such reduction could be harmful to us if we do not also provide other services to our long distance customers. With the advent of long distance voice services over the Internet, and our launch of Voice over DSL during fiscal year 2000, we anticipate substantial price reductions in long distance services for those customers who purchase a bundled package from us that includes routing the long distance voice traffic over the Internet. Internet and Other Data Services The Internet and data service industry is intensely competitive. We receive significant competition in the delivery of Internet services to small-and medium-sized businesses, our target market. Other ISPs, ILECs and CLECs are attempting to provide various dial-up, dedicated and high-speed Internet access services. We believe we can remain competitive to a certain niche because we also provide Web site design, Web site hosting, E-commerce sites, auction sites, yellow-pages service directory, DSL services and hosted applications, in addition to being a local telecommunications company. We anticipate that this diverse product range will help us attract new customers and reduce customer churn. Government Regulation Local and long distance telecommunications services 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 for interstate and international service with the FCC 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 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. Backlog When we invoice our customers for our telecommunications services, we invoice features and services in advance and usage in arrears. Due to the nature of our contractual agreements with the RBOCs, there is typically only an immaterial amount of backlog of unprovisioned customers at any given time, as a customer is typically switched from the RBOC to our network within two days of processing the provisioning order. As of February 15, 2000, we had orders from two customers for approximately 14,000 lines for which we were waiting to receive the provisioning information. Such lines may take up to one month to provision because of the large quantity of lines requested to be provisioned from just two customers. We are working with our customers to provision blocks of lines at a time so that there is an orderly transition of lines to our network. eLEC's Retail Services Our retail division is operated by our wholly-owned subsidiary, AVI, which is headquartered in Dallas, Texas. The objective of our retail division is to be a leading supplier of travel-related and telecommunications products to pilots and flight attendants. We operate in three retail stores that sell travel-related products primarily to American Airline employees, including the official pilot uniform and study guides for pilots. The stores also sell identification cards, uniform supplies and travel needs to flight attendants. In addition, the stores rent pagers to flight attendants who are on reserve duty and offer Internet access services and local and long distance telephone services. We plan to use the knowledge and experience gained with American Airlines to provide similar products and services to employees of other airlines and to develop effective E-commerce sites. We believe professional airline crew members are excellent targets for online retail purchases, as they are constantly mobile and frequently stay in touch with family and job-related duties via the Internet. We have developed and will continue to develop E-commerce sites to augment our in-store sales with sales to these and other online purchasers. We currently market our travel related products through the E-commerce sites, www.avishop.com and www.800bags.com. The target market for the retail division is professional airline crew members. Currently, we sell to pilots and flight attendants from American, Delta and Southwest Airlines. The business with American Airlines is the largest, as it includes selling the American Airlines pilot uniform and various approved apparel for both pilots and flight attendants. Two of the three retail locations we utilize are leased from American Airlines. Retail sales employees service walk-in customers and phone orders, and warehouse personnel process Internet orders. The sale of product to crew members has not demonstrated any seasonality, as the customers are using the products on a daily basis as part of their normal work routine. Our retail division operates without a backlog, as Internet orders and catalog orders are typically shipped within one day of receipt. We purchase products for our retail division from various domestic suppliers who have license agreements to sell product displaying the American Airlines, Inc. logo or trade name. We also buy non-logo product from a variety of domestic sources. The competition for retail sales to professional airline crew members is highly fragmented and has few barriers to entry. Our ability to compete effectively is directly related to the level of cooperation and publicity that airlines generate for our retail outlets. Currently, we enjoy an advantage with American Airlines because we are allowed to sell certain products to American Airlines' employees on a payroll deduct program and we are allowed to sell pilot uniforms. These agreements, in addition to two leases from American Airlines for retail sites in Dallas, Texas, help to limit the extent of competition in the Dallas area. However, we compete nationwide against several online retailers and against retail stores in various cities that are important airline hubs. Intellectual Property We rely on a combination of copyright, trademark and trade secret laws and contractual restrictions to establish and protect our intellectual property. We do not currently have any registered copyrights or trademarks. All key employees have signed confidentiality agreements and we intend to require each newly hired employee to execute a confidentiality agreement. These agreements provide that confidential information developed by or with an employee or consultant, or disclosed to such person during his or her relationship with us, may not be disclosed to any third party except in certain specified circumstances. These agreements also require our employees to assign their rights to any inventions to us. The steps taken by us may not, however, be adequate to prevent misappropriation of our proprietary rights or technology. We use several service marks in our business and intend to apply to register such service marks to protect our usage of such marks. There can be no assurance that we will be able to secure significant protection for all or any of our service marks. Our competitors or others could adopt product or service marks similar to our marks, or try to prevent us from using our marks, thereby impeding our ability to build brand identity and possibly lead to customer confusion. We have received correspondence from an unrelated third party claiming that our use of the mark "Essex" in connection with telephone services infringes one of the company's United States registered trademarks and requesting that we cease and desist from using the Essex mark. We have responded by denying any infringement and no legal proceedings have been commenced against us with respect to this matter. We are also aware of several other parties that use marks that are the same or similar to marks that we use, though in most instances, to the best of our knowledge, these parties are not in the same business as we are. There can be no assurance that others with marks similar to our marks will not bring suit to prevent us from using a particular mark. Defending or losing any litigation relating to intellectual property rights could materially adversely affect our business, results of operations and financial condition. Other Affiliates In addition to our investment in Access One, we have made investments in other entities for which we have performed Web site design services and may have future strategic relationships. At February 15, 2000, we had investments in the following entities: (See Note 14 of Notes to Financial Statements). RiderPoint, Inc. RiderPoint specializes in the development of comparative rating insurance software and sells motorcycle insurance through its wholly-owned subsidiary, RP Insurance Agency, Inc. RiderPoint provides fully integrated insurance solutions for carriers, agents, dealers and consumers through its innovative integration of the insurance process with Internet technology. Through its comparison rating insurance Web site, www.riderpoint.com, consumers are able to receive instant online motorcycle insurance quotes from top-rated insurance carriers, which gives the consumer the ability to comparatively shop for and purchase motorcycle insurance at one location. SkyClub Communications Holding Corp. SkyClub offers digital satellite systems for the reception of direct television (over 200 channels of programming) and high speed Internet services. SkyClub features direct to home (DTH) satellite products from Hughes Network Systems, RCA, Sony and other licensed DIRECTV manufacturers. SkyClub markets satellite services that include DirecTV and DirecPC's Turbo Internet, which provides customers with high-speed (up to 400 Kbps) Internet services. SkyClub also recently began offering DIRECTV PARA TODOS(TM) to Spanish speaking communities. Employees At February 15, 2000, we employed 63 employees, of which 59 were employed on a full-time basis and five were employed on a part-time basis. At such date, 17 of our employees were employed in our executive offices in Norwalk, Connecticut; 28 were employed in Melville, New York, at our wholly-owned subsidiary, Essex; 12 were employed in our retail division stores in Dallas, Texas; five were employed in Edison, New Jersey, at our telecommunications subsidiary, Telecarrier; and one was employed in Mississauga, Canada. We are not subject to any collective bargaining agreement and believe that our relationship with our employees is good. Item 2. - Properties The following table sets forth pertinent facts concerning our material properties at February 15, 2000, all of which are owned or leased by us or one of our subsidiaries: Property Owned: Location Use Approximate Square Feet - ------------------------------------------------------------------------------------------- 1321 Blundell Road Rental property (2) 35,000 (leases out 35,000 SF) Mississauga Ontario, Canada L4Y 1M6 Properties Leased: Approximate Lease Annual Location Use Square Feet Expires Rent(1) -------- --- ----------- ------- ------- 509 Westport Ave Executive Office 14,000 2/28/05 $132,000 Norwalk, CT 06851 48 South Service Road Office 5,486 4/30/03 $ 93,000 Melville, NY 11747 1090 King Georges Post Rd Sales Office 2,500 10/31/01 $ 40,000 Edison, NJ 08837 24 Richmond Hill Avenue Office 3,000 4/06/00 $ 42,000 Stamford, CT 06901 1930 W. Airfield Drive Warehouse 2,000 7/31/00 $ 39,000 DFW Airport, TX 75261 Terminal C Retail 1,700 8/24/00 $ 30,000 DFW Airport, TX 75261 8412 Sterling Suite B Warehouse 2,470 9/30/00 $ 15,000 Irving, TX 75063 37 North Avenue Office 2,400 expired $ 38,400 Norwalk, CT 06851 - ------------------ (1) We are required to pay our proportionate share of any increase during the term of the lease in real estate taxes and expenses of maintaining the premises computed on the basis of the percentage of the total square footage of the premises occupied by us. (2) The property owned in Mississauga, Canada was formerly used as a warehouse for our luggage operations that have been discontinued. It is fully rented to two tenants. Our owned and leased space is fully utilized for the purposes set forth in the table above under the caption "Use," except for the new space in Norwalk, Connecticut which is currently being developed as our new executive offices and a network operating center. We believe the existing properties are suitable and adequate for our existing business. 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 We held our 1999 Annual Meeting of Shareholders on November 10, 1999. The following are descriptions of the matters voted on and the results of such meeting: Number of Shares ---------------- Matter Voted On For Against Abstain - --------------- --- ------- ------- 1. Election of Directors Joel Dupre 9,895,868 44,496 Eric M. Hellige 9,897,968 42,396 Paul H. Riss 9,896,978 43,386 Anthony Scalice 9,896,978 43,386 2. Proposal to change the name of the Company to eLEC Communications Corp. 9,907,332 30,332 2,700 3. Approval of an amendment to the Sirco International Corp. 1995 Employee Stock Option Plan to increase the number of shares of Common Stock reserved for issuance thereunder by 1,200,000 shares. 5,581,798 242,234 9,200 Part II Item 5. - Market for the Company's Common Equity and Related Stockholder Matters Our common stock trades on The Nasdaq Small Cap Stock Market(R)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 1998 ----------- 1st Quarter $5.750 $1.563 2nd Quarter 7.188 3.563 3rd Quarter 6.750 1.000 4th Quarter 1.969 0.656 Fiscal 1999 ----------- 1st Quarter $4.000 $0.750 2nd Quarter 6.000 1.250 3rd Quarter 2.594 1.313 4th Quarter 3.219 1.250 As of February 15, 2000, there were 215 holders of record of the common stock and approximately 3,200 beneficial holders. We have not declared any cash dividends during the past fiscal year with respect to the common stock. The declaration by our Board of Directors of any cash dividends in the future will depend upon the determination of as to whether, in light of our earnings, financial position, cash requirements and other relevant factors existing at the time, it appears advisable to do so. We do not plan to declare any dividends on our common stock in the foreseeable future. During the fourth quarter of fiscal 1999, we acquired from RiderPoint, Inc. 500,000 shares of common stock of RiderPoint, Inc., in consideration of the issuance by us of 300,000 shares of our common stock; we issued 1,255,555 shares of our common stock, in conjunction with a private placement to raise $1,412,500; we issued 100,000 shares of our common stock to the former shareholders of Essex in conjunction with the attainment of certain performance objectives agreed to in connection with the acquisition of Essex; We issued 272,000 shares of our common stock to Joel Dupre, the Chairman of the Board to cancel indebtedness to Mr. Dupre and others; and we issued 69,000 shares of our common stock in conjunction with the acquisition of Peconic Telco, Inc. Such transactions were effected pursuant to Section 4(2) of the Securities Act of 1933, as amended. Item 6. - Selected Financial Data The following selected financial information has been taken from our consolidated financial statements. The information set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and related notes included elsewhere in this report. Fiscal Years Ended November 30, 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Earnings Statement: Net Sales $ 4,170 $ 1,485 $ 276 $ -- $ -- Gross Profit 1,167 541 92 -- -- Income(Loss) From C ontinuing Operations Before Provision for Income Taxes (3,562) (2,204) (105) -- -- Income(Loss)From Discontinued Operations (3,943) (2,772) (2,763) 622 (996) Net Income (Loss) (7,506) (4,977) (2,868) 622 (996) Net Income (Loss) From Continuing Operations per Common Share: Basic (0.41) (0.43) (0.03) -- -- Diluted (0.41) (0.43) (0.03) -- -- Cash Dividends -- -- -- -- -- Balance Sheet: Working Capital $ (101) $ 334 $ 5,107 $ 1,553 $ 1,142 Property, Plant, Equipment 212 835 827 888 650 Total Assets 7,297 11,029 14,042 9,577 10,013 Long-Term Debt(Less Current Maturities) 198 291 4,522 348 590 Stockholders' Equity 3,458 3,754 3,216 2,780 1,897 Item 7. - Management's Discussions and Analysis of Financial Condition and Results of Operations 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 3 of this Annual Report on Form 10-K for additional factors relating to such statements. Item 7. Management's Analysis and Discussion of Financial Condition and Results of Operations Fiscal Year 1999 Compared to Fiscal Year 1998 Continuing operations Net sales for fiscal 1999 increased by approximately $2,686,000 or approximately 181%, to approximately $4,170,000 as compared to approximately $1,484,000 reported in fiscal 1998. The following table presents our net sales by industry segment for the fiscal years ended November 30, 1999 and 1998: Fiscal years ended November 30, ------------ Industry segment 1999 1998 Increase - ---------------- ---------- ---------- ---------- Retail sales $1,895,000 $1,111,000 $ 784,000 Telecommunications 2,275,000 373,000 1,902,000 ---------- ---------- ---------- Total $4,170,000 $1,484,000 $2,686,000 ========== ========== ========== Net sales of our telecommunications division, which consisted of the operations of Essex and WebQuill, increased by approximately $1,902,000, or approximately 510%, to approximately $2,275,000 in fiscal 1999 as compared to approximately $373,000 in fiscal 1998. This increase was attributable to the rapid growth in the number of installed access lines provisioned by us during the third and fourth quarters of fiscal 1999. Installed access lines amounted to approximately 2,400 on August 1, 1999 and grew to approximately 9,100 lines on November 30, 1999. Revenue for each installed access line averages approximately $50 per month. Net sales of our retail division, consisting of the operations of Airline Venture, Inc. ("AVI"), increased by approximately $784,000, or approximately 71%, to approximately $1,895,000 in fiscal 1999 as compared to approximately $1,111,000 in fiscal 1998. The increase was partially attributable to the acquisition in January 1999 of Tag Air and partially attributable to increased product offerings. AVI operates three retail stores in Texas for professional airline flight crew members and sells pilot uniforms, study guides and travel products. Its products are also sold on the E-commerce sites www.avishop.com and www.800bags.com. The Company's gross profit increased by approximately $626,000, to approximately $1,167,000 reported in fiscal 1999 from approximately $540,000 reported in fiscal 1998, and the gross profit percentage decreased to 28% in fiscal 1999 from 36% reported in fiscal 1998. The decrease in gross profit percentage was primarily attributable to the significant increase in sales of our telecommunications division, which has lower margins than our retail sales division. Gross profit percentages amounted to 41% for the retail division and 17% for the telecommunications division, respectively, for fiscal 1999. We expect the retail division's gross margin to continue at its current level and the telecommunication division's gross margin to increase as Essex converts its customer base from a resale service offering to the Unbundled Network Elements Platform ("UNE-P") service offering that is now available through Bell Atlantic Corporation in the States of New York and Massachusetts. Approximately 56% of our customer lines were converted from resale to UNE-P as of November 30, 1999. Furthermore, effective February 17, 2000, the FCC has mandated that the UNE-P service offering be offered in every state. This ruling should help us convert more of our installed access lines to UNE-P and obtain higher gross margins in our telecommunications division. We estimate that in most states, the gross profit achieved from the UNE-P service offering should be approximately 40%, as compared to a resold line, which generates a gross margin of approximately 9%. Selling, general and administrative expenses increased by approximately $1,559,000, or approximately 132%, to approximately $2,741,000 in fiscal 1999 as compared to approximately $1,182,000 in fiscal 1998. A major portion of the increase was directly attributable to increased labor and facility expenses incurred by our telecommunications division. This increase in expense is directly related to the significant increase in sales in fiscal 1999 as compared to fiscal 1998. Interest expense from continuing operations amounted to approximately $15,000 in fiscal 1999. There was less than $1,000 of interest expense from our continuing operations during fiscal 1998. At November 30, 1999, we were the largest shareholder of Access One Communications Corp. ("Access One"), owning approximately 21% of Access One's capital stock. As our investment in Access One is accounted for under the equity method of accounting, we are required to include our portion of Access One's net loss, up to the amount of our investment in Access One, in our results of operations. In fiscal 1999, we have recorded a loss of approximately $1,662,000 as compared to a loss of approximately $1,423,000 in fiscal 1998. We have been advised by Access One that their losses related to funding aggressive customer growth and the related costs associated with hiring employees to provision lines and provide customer service. As a result of the losses, our investment is now carried at $0. Discontinued operations On August 11, 1999, we sold certain assets and assigned certain licenses of our domestic luggage division to Interbrand L.L.C., an unrelated accessories company, in furtherance of our previously announced plans to discontinue the operations of our wholesale luggage segment. In addition to purchasing inventory, equipment and other assets, Interbrand also hired certain of our employees, including our current Chairman of the Board, Joel Dupre. Upon being hired by Interbrand, Mr. Dupre resigned his position as our Chief Executive Officer, and we no longer employ him. The operating results of our wholesale luggage segment have been accounted for as a discontinued operation and the results of operations have been excluded from continuing operations in our consolidated statements of operations for all periods presented, including the prior period financial statements in which we have restated the operating results of our wholesale luggage segment as a discontinued operation. Interest expense relating to borrowings by our former wholesale luggage segment is included as operating expenses of such discontinued segment. For fiscal 1999, we reported a loss from discontinued operations of approximately $3,179,000 and a loss on disposal of discontinued operations of approximately $764,000. A cumulative loss on foreign currency translation adjustment of approximately $572,000, which formerly was presented as a separate component of shareholder's equity, is now reflected as a loss related solely to the discontinued segment. Fiscal Year 1998 Compared to Fiscal Year 1997 Net sales for fiscal 1998 increased by approximately $1,209,000 to approximately $1,485,000 as compared to approximately $276,000 reported in fiscal 1997. Net sales of our retail division, consisting of the operations of AVI, increased by approximately $835,000 in fiscal 1998 to approximately $1,111,000 from approximately $276,000 in fiscal 1997 as we reported a full year of retail operations in fiscal 1998 as compared to only three months in fiscal 1997. Net sales of our telecommunications division amounted to approximately $374,000 in fiscal 1998, its first year of operation. Essex operated as a reseller of local telephone services and value-added products in the states of Connecticut, Massachusetts, New Jersey, New York and Virginia. WebQuill, which was acquired in August 1998, provided dial-up and dedicated Internet access, Web design, hosting and E-commerce development to small-and medium-sized businesses. Our gross margin increased in fiscal 1998 by approximately $448,000 to approximately $540,000 from approximately $92,000 in fiscal 1997. The gross margin percentage increased to 36% in fiscal 1998, as compared to 33% in fiscal 1997. The increase in gross margin percentage is primarily due to the 44% gross margin from the retail division in fiscal 1998 as compared to 33% in fiscal 1997. The increases both in gross margin and gross margin percentage of the retail division are attributable to the operation of that business for a full year in fiscal 1998, as compared to a partial year of operations in fiscal 1997, which included start-up costs and operational expenses related to establishing appropriate vendor relationships and product offerings. The telecommunications division reported a gross margin of 14% in its first year of operations. Selling general and administrative expenses increased in fiscal 1998 by approximately $993,000, or approximately 525%, to approximately $1,182,000 from approximately $189,000 reported in fiscal 1997. This increase in expenses was primarily attributable to our telecommunications operations, which were not in operation in fiscal 1997, and to our retail division, which was only in operation for three months in fiscal 1997. Interest expense amounted to less than $1,000 in fiscal 1998 as compared to no interest expense in fiscal 1997. Both divisions operated without requiring a lending facility. At the end of fiscal 1998, we were the largest shareholder of Access One, owning approximately 31%. As our investment in Access One is accounted for under the equity method of accounting, we were required to include our portion of Access One's net loss in our results of operations. For fiscal 1998, we recorded a loss of approximately $1,423,000 relating to our investment in Access One. We have been advised by Access One that Access One's losses in fiscal 1998 were primarily the result of funding aggressive customer growth and the related costs associated with hiring employees to verify and provision lines, to staff a customer service operation and to develop a management information system. In addition, in fiscal 1998, Access One purchased local telephone service from BellSouth at a wholesale discount of 16.8% and passed on almost half of its discount to its customer base. The gross profit on this business was not large enough to cover the selling, general and administrative expenses associated with operating a local telephone company. Liquidity and Capital Resources At November 30, 1999, the Company had cash and cash equivalents of approximately $591,000 and a working capital deficit of approximately $101,000, an increase of approximately $239,000 and a decrease of approximately $435,000, respectively, over amounts reported at November 30, 1998. The decrease in working capital resulted primarily from the losses incurred from our former luggage segment and the costs associated with disposing of that segment. Net cash provided by (used in) operating activities (including discontinued operations) aggregated approximately $610,000, $1,783,000 and ($6,627,000) in fiscal 1999, 1998 and 1997, respectively. The decrease in the net cash provided by operating activities in fiscal 1999 as compared to fiscal 1998 is primarily due to our ability to reduce our accounts receivable balances in fiscal 1998 by approximately $1,289,000, as compared to a reduction in fiscal 1999 of approximately $213,000. Although we disposed of a substantial portion of the assets of our luggage division in August 1999, by November 30, 1999, we were successful in increasing the sales of our telecommunications division and consequently created new accounts receivable balances. The increase in net cash provided by operating activities (which primarily reflected the operations of our discontinued luggage division) in fiscal 1998 as compared to fiscal 1997, primarily reflected a decrease in inventory and accounts receivable offset by the increase in our net loss from operations. The reduction in inventory levels was primarily due to our ability to better manage purchases relative to sales forecasts and the lack of import quota purchase constraints in fiscal 1998 that existed in fiscal 1997. The reduction in accounts receivable primarily reflects tighter credit and collection policies. Net cash used in investing activities aggregated approximately $95,000, $158,000 and $58,000 in fiscal 1999, 1998 and 1997, respectively. The principal uses of cash from investing activities in fiscal 1999, 1998 and 1997 were for the purchase of fixed assets. In addition, we used approximately $24,000 for the 1999 acquisition of Peconic Telco, Inc. and $150,000 for the 1998 payment of certain obligations in conjunction with the acquisition of WebQuill. In fiscal 1999, 1998 and 1997, the principal sources of net cash provided by investing activities were proceeds from the sale of a subsidiary. Net cash (used in) provided by financing activities aggregated approximately ($270,000), ($1,399,000) and $6,391,000 in fiscal 1999, 1998 and 1997, respectively. In fiscal 1999, net cash used in financing activities resulted in the repayment of a revolving credit line of approximately $2,769,000, which was partially offset by the proceeds from a private placement of common stock of approximately $2,026,000, a loan from an officer in the net amount of approximately $227,000, the proceeds from the issuance of preferred stock in the amount of approximately $196,000 and the proceeds from the exercise of stock options of approximately $44,000. In fiscal 1998, net cash used in financing activities resulted from a repayment of a revolving credit line of approximately $2,528,000, which was partially offset by proceeds of approximately $18,000 from the exercise of stock options, proceeds of approximately $651,000 from a private equity placement and proceeds of approximately $468,000 from the exercise of stock warrants. In fiscal 1997, repayments of short-term debt of approximately $1,601,000 were offset by an increase of approximately $5,714,000 in net cash provided by a revolving credit facility. This increase was the result of a working capital agreement (see below) under which we were able to borrow up to 80% of the dollar amount of our eligible accounts receivable and 50% of our eligible inventory. During fiscal 1997, we also received approximately $166,000 in proceeds from the exercise of stock options; approximately $609,000 in proceeds from a private equity placement; and approximately $1,509,000 in proceeds from the exercise of stock warrants. On December 17, 1996, we entered into a financing agreement with Coast Business Credit ("Coast"), a division of Southern Pacific Thrift and Loan Association, pursuant to which Coast made available to us a line of credit of $7,000,000 with advances based on 80% of our eligible accounts receivable and 50% of our eligible inventory. This loan was scheduled to mature on December 31, 1999, and was paid in full on December 29, 1999. On March 3, 1999, our subsidiary, Essex, entered into a Receivable Sale Agreement with Receivables Funding Corp. ("RFC") that provides for Essex to sell up to $500,000 of its eligible receivables to RFC on a periodic basis and to grant RFC a security interest in the receivables purchased by RFC. The Receivables Sale Agreement does not transfer the risk of loss to RFC, and has been treated by us as a financing for financial statement purposes. As of November 30, 1999, Essex was indebted to RFC for the principal amount of approximately $198,000. Essex borrows from RFC at approximately five percentage points above the prime rate, which was 8.5% per annum at November 30, 1999. In December 1999, Essex increased the amount of eligible receivables it can sell to RFC to $1,000,000. Our Canadian subsidiary has a mortgage on its real property in the amount of $304,000. The mortgage is payable in monthly installments of approximately $3,000, which includes interest at the rate of 10.25% per annum, with a balloon payment of approximately $291,000 in the year 2000. We have received an appraisal of the building of approximately $1,000,000, and we intend to sell the building in an orderly manner during fiscal 2000. The rental income from the current tenants covers the debt service and maintenance requirements of the building. In fiscal 1999, our capital expenditures amounted to approximately $121,000. We expect to make additional capital expenditures of approximately $350,000 for equipment for our telecommunications division over the next 12 months. Such expenditures will be made in conjunction with the establishment of a network operating center in Norwalk, Connecticut and with the planned expansion to become a nationwide CLEC. We anticipate we will be able to finance equipment purchases through equipment leases or with working capital. At February 15, 2000 we owned approximately 21% of Access One, which had at such date approximately 60,000 installed access lines and revenues of approximately $3,000,000 per month. Although Access One has approximately 750 shareholders, it is not publicly traded, there is no readily ascertainable market for its stock, and the shares held by us bear a restrictive legend stating that the shares have not been registered under the Securities Act of 1933. Despite the trading restriction, we have received offers to purchase a portion of our Access One stock for amounts ranging from $4.00 to $5.00 per share and subsequent to November 30, 1999, we sold 17,000 shares of stock in this price range. At February 15, 2000 we owned 3,918,500 shares of Access One and warrants to purchase 500,000 additional shares at $1.20 per share. Our investment in Access One is recorded on our books by the equity method of accounting and is carried at $0 as of November 30, 1999. We believe that the retail division's working capital and cash flow from operations will be sufficient to meet the cash and capital requirements for our retail division for the next 12 months. Our plan for the growth of our telecommunications division includes an aggressive strategy to finish fiscal 2000 with more than 65,000 installed access lines. Although we anticipate that we will have reached profitability on a monthly basis at this level of operation, we will need to expend cash and we expect to incur additional losses before we are able to grow our business to a profitable level. Subsequent to November 30, 1999, we received net proceeds of approximately $2,000,000 from the exercise of warrants and from a private placement of our common stock. We believe our cash and cash equivalents at February 28, 2000 provide us with enough liquidity to carry out our fiscal 2000 growth plans. The inability to carry out our plans may result in the continuance of unprofitable operations, which would adversely affect our financial condition and results of operations. Impact of Year 2000 The Year 2000 ("Y2K") issue is the result of computer-controlled systems using two digits rather than four to define the applicable year. For example, computer programs that have time sensitive software may recognize a date using "00" as the year 1900 instead of the year 2000. This reading could result in a system failure or miscalculations and cause a disruption in operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activity. Since 1998, we have devoted significant efforts to address Y2K issues. We have developed a comprehensive, company-wide plan to identify, evaluate and remediate Y2K issues. In addition to the planning and testing that occurred throughout fiscal 1999, our technical support team reevaluated all our equipment during the month of December 1999, to assure the maintenance of uninterrupted service to our customers. In addition, our plan included a review of the Y2K readiness of our vendors and suppliers who have material relationships with us. The major phases of the plan with respect to each of these categories included an inventory of all hardware and software components with possible date implications, an assessment of the Y2K readiness of all Web sites and E-commerce sites, the remediation of all Y2K issues which have been identified in the assessment phase, and validation testing and certification as to Y2K compliance. Our estimate of the total cost of our Y2K compliance efforts, based on amounts expended to date, plus estimated amounts of additional remediation costs, if any, is immaterial to the operations of the Company. The estimated Y2K costs have not been independently verified and may vary in the event of unforeseen Y2K remediation costs or costs related to the unanticipated costs from a third party vendor. Certain costs budgeted for the procurement of upgrades or replacements of servers and business information systems have not been included in this amount since these upgrades or replacements were being made by us independent of Y2K readiness. The estimated Y2K costs did not include our internal costs, such as compensation and benefits of employees delegated Y2K responsibilities, related to our Y2K plan since such costs are not internally allocated by us. We expect to fund any additional Y2K compliance efforts with cash flows from operations. We have contacted various mission-critical external parties and have conducted testing procedures with certain of these external parties in order to confirm Y2K readiness. Some of our internal data networks are interconnected with, or dependent upon, systems operated by third parties, including telecommunications/data service providers and public utilities. Since external parties are responsible for addressing their own Y2K readiness, we are only able to determine at this time an estimate as to the extent to which any such conditions exist, and if they do exist, the extent to which they may have a material impact on our results of operations, financial condition or liquidity. Subsequent to December 31, 1999, we experienced no significant events, nor received any significant reports indicating any material Y2K issues. We are unaware of any uncorrected problems regarding the Y2K issue at this time, but will continue to monitor for any potential problems throughout 2000. New Accounting Standards In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard 130, "Reporting Comprehensive Income" ("Statement 130"). Statement 130 establishes standards for the reporting and display of comprehensive income and its components in financial statements. Comprehensive income, as defined, is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The provisions of Statement 130 are effective for periods beginning after December 15, 1997. Accordingly, we adopted this standard for our fiscal year ending November 30, 1999. In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards 131, "Disclosures about Segments of an Enterprise and Related Information" ("Statement 131"), which establishes standards for segment reporting and disclosure of additional information on products and services, geographic areas and major customers. The provisions of Statement 131 are effective for periods beginning after December 15, 1997. Accordingly, we adopted this standard for our fiscal year ending November 30, 1999. Item 7A. - Quantitative and Qualitative Disclosure About Market Risk Our debt is currently limited to $1,000,000 under our current borrowing arrangements and such borrowings are at an effective rate of five percent over the prime rate. We currently do not use interest rate derivative instruments to manage our exposure to interest rate changes. Item 8. - Financial Statements and Supplementary Data The financial statements and supplementary data to be provided pursuant to this Item 8 are included under Item 14 of this Report. Item 9. - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. Part III Item 10. - Directors and Executive Officers of the Company The information required by this Item is incorporated here by reference to our definitive proxy statement for our 2000 Annual Meeting of Stockholders. Item 11. - Executive Compensation The information required by this Item is incorporated here by reference to our definitive proxy statement for our 2000 Annual Meeting of Stockholders. Item 12. - Security Ownership of Certain Beneficial Owners and Management The information required by this Item is incorporated here by reference to our definitive proxy statement for our 2000 Annual Meeting of Stockholders. Item 13. - Certain Relationships and Related Transactions The information required by this Item is incorporated here by reference to our definitive proxy statement for our 2000 Annual Meeting of Stockholders. PART IV Item 14. - Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) 1. Financial Statements 2. Financial Statement schedules 3. Exhibits (3) Articles of Incorporation and By-laws (a) Certificate of Incorporation, as amended, incorporated by reference to the Company's 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 the Company's definitive proxy statement filed with the Securities and Exchange Commission in connection with the Company's 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 the Company's 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 the Company's 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 the Company's Quarterly Report on Form 10-Q for the quarter ended August 31, 1995. (f) Certificate of Amendment of the Certificate of Incorporation, incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 31, 1998. (g) Certificate of Amendment of the Certificate of Incorporation, incorporated by reference to Exhibit 3.2 to the Company's 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 the Company's 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 the Company's 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 the Company's 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 the Company's Proxy Statement dated October 24, 1996. (c) Employment Agreement, dated November 5, 1996 between the Company and Paul Riss, incorporated by reference to Exhibit 10(f) to the Company's Annual Report on Form 10-K for the year ended November 30, 1996. (d) Agreement and Plan of Merger dated January 21, 2000 between eLEC Communications Corp., eLEC Communications Sub I, Inc., and Telecarrier Services, Inc., Michael Lagana and Zina Hassel, incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K, dated January 21, 2000. (22) Subsidiaries of Company - The significant subsidiaries of Company, all of which are wholly-owned by Company and included in its consolidated financial statements, are as follows: Name Jurisdiction of Organization ---- ---------------------------- American Telecom LLC Connecticut Airline Ventures, Inc. Texas Essex Communications, Inc. New York Peconic Telco, Inc. New York Sirco Industries, Limited Hong Kong Sirco International (Canada) Limited Canada Telecarrier Services, Inc. Delaware WebQuill Internet Services LLC Connecticut (23) Consent of Nussbaum Yates & Wolpow, P.C. (27) Financial Data Schedule (b) Reports on Form 8-K. We filed a Current Report on Form 8-K dated August 11, 1999 reporting the approval by our Board of Directors of a corporate name change to eLEC Communications Corp., subject to shareholder approval, and providing the pro forma financial information with respect to the previously reported sale of certain assets of our former luggage division pursuant to the asset purchase agreement with Interbrand L.L.C. (Items 2 and 7). We filed a Current Report on Form 8-K dated November 16, 1999 reporting the change of our corporate name from Sirco International Corp. to eLEC Communications Corp. (Item 5). We filed a Current Report on Form 8-K dated January 21, 2000 reporting our acquisition of Telecarrier Services, Inc. At the time of the filing it was impracticable for us to provide the required pro forma financial information, if any, with respect to such transaction. We intend to file such information, if required, by amendment to the Form 8-K as soon as practicable, but in any event within 60 days of the filing of the initial Form 8-K. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on the 28th day of February 2000. 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 February 28, 2000 ---------------- Paul H. Riss Chief Financial Officer (Principal Accounting Officer) Director /s/ Joel Dupre Chairman of the Board of Directors February 28, 2000 -------------- Joel Dupre /s/ Eric M. Hellige Director February 28, 2000 ------------------- Eric M. Hellige /s/ Anthony Scalice Director February 28, 2000 ------------------- Anthony Scalice FORM 10-K ITEM 14(a)(1) AND (2) eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES The following consolidated financial statements of eLEC Communications, Inc. and Subsidiaries are included in Item 8: Report of Independent Auditors F-2 Consolidated balance sheets - November 30, 1999 and 1998 F-3 - F-4 Consolidated statements of operations - Years ended November 30, 1999, 1998 and 1997 F-5 Consolidated statements of stockholders' equity - Years ended November 30, 1999, 1998 and 1997 F-6 - F-7 Consolidated statements of cash flows - Years ended November 30, 1999, 1998 and 1997 F-8 - F-9 Notes to consolidated financial statements - Years ended November 30, 1999, 1998 and 1997 F-10 - F-34 The following consolidated financial statement schedules of eLEC Communications, Inc. and Subsidiaries are included in Item 14(d): Schedule II - Valuation and qualifying accounts - Years ended November 30, 1999, 1998 and 1997 F-35 Access one Communications Corp. and Subsidiaries: Report of Independent Auditors F-36 Consolidated balance sheets - October 31, 1999 and 1998 F-37 Consolidated statements of operations - Years ended October 31, 1999 and 1998 F-38 Consolidated statements of stockholders' equity (deficiency) - Years ended October 31, 1999 and 1998 F-39 Consolidated statements of cash flows - Years ended October 31, 1999 and 1998 F-40 Notes to consolidated financial statements - Years ended October 31, 1999 and 1998 F-41 - F-54 All other schedules are omitted because they are not required, are inapplicable, or the information is included in the financial statements or notes thereto. F-1 Report of Independent Auditors The Board of Directors and Shareholders eLEC Communications, Inc. Norwalk, Connecticut We have audited the accompanying consolidated balance sheets of eLEC Communications, Inc. (formerly known as Sirco International Corp.) and Subsidiaries as of November 30, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years ended November 30, 1999, 1998 and 1997. 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 generally accepted auditing standards. 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, based on our audits, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of eLEC Communications, Inc. and its subsidiaries as of November 30, 1999 and 1998, and the consolidated results of their operations and their consolidated cash flows for the years ended November 30, 1999, 1998 and 1997, in conformity with generally accepted accounting principles. We have also audited Schedule II for each of the years in the period ended November 30, 1999. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein. /s/NUSSBAUM YATES & WOLPOW, P.C. -------------------------------- NUSSBAUM YATES & WOLPOW, P.C. Melville, New York February 21, 2000 (February 25, 2000 as to the last paragraph of Note 15) F-2 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS NOVEMBER 30, 1999 AND 1998 ASSETS 1999 1998 ----------- ---------- Current assets: Cash and cash equivalents $ 591,299 $ 352,489 ---------- ----------- Accounts receivable, principally trade - net of allowance of $424,000 and $337,000 in 1999 and 1998 1,245,078 1,565,727 Inventories 876,460 4,397,635 Prepaid expenses 52,636 199,805 Other current assets 177,680 36,791 Land and building held for sale 596,304 -- Recoverable income taxes -- 149,902 ---------- ----------- Total current assets 3,539,457 6,702,349 ---------- ----------- Property, plant and equipment - at cost: Land -- 185,279 Building -- 459,788 Machinery and equipment 322,734 941,127 Leasehold improvements -- 320,132 ---------- ----------- 322,734 1,906,326 Less accumulated depreciation and amortization 111,036 1,070,852 ---------- ----------- 211,698 835,474 ---------- ----------- Other assets: Investment in and advances to subsidiary 424,575 464,573 Goodwill, net of accumulated amortization of $352,966 and $110,302 in 1999 and 1998 1,554,370 1,377,958 Investment in affiliate under equity method 0 1,476,434 Investments under cast method 1,469,929 --- Other 97,108 172,254 ---------- ----------- 3,545,982 3,491,219 ---------- ----------- Total assets $7,297,137 $11,029,042 ---------- ----------- See accompanying notes to consolidated financial statements. F-3 (Continued) eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (CONTINUED) NOVEMBER 30, 1999 AND 1998 LIABILITIES AND STOCKHOLDERS' EQUITY 1999 1998 ------------- ---------- Current liabilities: Loans payable to financial institutions and current maturities of long-term debt $ 523,695 $ 3,193,344 Due to related parties 34,725 519,596 Accounts payable 1,302,714 993,779 Accrued expenses and taxes 1,779,704 1,661,420 ------------ ----------- Total current liabilities 3,640,838 6,368,139 ------------ ----------- Long-term debt, less current maturities 197,772 290,994 ------------ ----------- Due to related parties and accounts payable refinanced -- 615,829 ------------ ----------- Commitments and contingencies Stockholders' equity: Preferred stock, Series A, $.10 par value; 1,000,000 shares authorized, 700 shares issued in 1998 (none in 1999), liquidation preference $1,000 per share -- 70 Preferred stock, Series B, $.10 par value; 1,300 shares authorized, 196 shares issued in 1999, liquidation preference $1,000 per share 20 -- Common stock, $.10 par value; 20,000,000 shares authorized in 1999 and 1998, 11,287,164 and 6,343,316 shares issued in 1999 and 1998 1,128,715 634,331 Capital in excess of par value 18,808,397 12,851,015 Deficit (16,370,088) (8,864,535) Treasury stock at cost, 11,000 shares (27,500) (27,500) Treasury stock held by equity investee -- (159,396) Accumulated other comprehensive income (loss), accumulated foreign currency translation adjustment (81,017) (679,905) ------------ ----------- Total stockholders' equity 3,458,527 3,754,080 ------------ ----------- Total liabilities and stockholders' equity $ 7,297,137 $11,029,042 ------------ ----------- See accompanying notes to consolidated financial statements. F-4 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 1999 1998 1997 ----------- ----------- ----------- Revenues: Telecommunications services $ 2,275,474 $ 373,885 $ -- Specialty retail travel products 1,894,557 1,111,339 275,871 ----------- ----------- ----------- Total revenues 4,170,031 1,485,224 275,871 ----------- ----------- ----------- Costs and expenses: Costs of telecommunication services 1,884,949 321,430 -- Cost of specialty retail travel product sales 1,117,749 623,242 183,505 Selling, general and administrativ 2,741,264 1,181,873 188,860 Depreciation and amortization 330,054 139,451 8,678 Equity in loss of Access One Communications Corp 1,661,630 1,423,300 -- ----------- ----------- ----------- Total costs and expenses 7,735,646 3,689,296 381,043 ----------- ----------- ----------- Loss from operations (3,565,615) (2,204,072) (105,172) Other income (expense): Interest expense (15,419) (467) -- Interest income 18,546 -- -- ----------- ----------- ----------- Loss from continuing operations (3,562,488) (2,204,539) (105,172) ----------- ----------- ----------- Discontinued operations: Loss from discontinued operations (3,179,361) (2,772,464) (2,762,993) Estimated loss on disposal of discontinued operations (763,704) -- -- ----------- ----------- ----------- Loss from discontinued operations (3,943,065) (2,772,464) (2,762,993) ----------- ----------- ----------- Net loss ($7,505,553) ($4,977,003) ($2,868,165) ----------- ----------- ----------- Basic and diluted loss per share: Continuing operations ($ .41) ($ .43) ($ .03) Discontinued operations ($ .45) ($ .53) ($ .85) ----------- ----------- ----------- Net loss ($ .86) ($ .96) ($ .88) ----------- ----------- ----------- Weighted-average number of common shares outstanding 8,717,554 5,184,748 3,243,392 ----------- ----------- ----------- See accompanying notes to consolidated financial statements. F-5 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 Capital Preferred Stock Common Stock In Excess of Shares Amount Shares Amount Par Value Deficit Stock ------ ------ ------ ------ --------- ------- ----- Balance, November 30, 1996 -- $-- 2,630,400 $ 263,040 $ 4,136,014 ($1,019,367) ($27,500) Net loss -- -- -- -- -- (2,868,165) -- Translation adjustment -- -- -- -- -- -- -- Comprehensive income (loss) -- -- -- -- -- -- -- Exercise of stock options -- -- 145,000 14,500 151,750 -- -- Issuance of common stock in private placement -- -- 400,000 40,000 569,000 -- -- Exercise of warrants -- -- 700,000 70,000 1,439,104 -- -- Stock issued for equity investment in Access One Communications Corp. -- -- 425,000 42,500 1,457,500 -- -- Treasury stock acquired by equity investee -- -- -- -- -- -- -- --- --- --------- ----------- ----------- ----------- -------- Balance, November 30, 1997 -- -- 4,300,400 430,040 7,753,368 (3,887,532) (27,500) Net loss -- -- -- -- -- (4,977,003) -- Translation adjustment -- -- -- -- -- -- -- Comprehensive income (loss) -- -- -- -- -- -- -- Exercise of stock options -- -- 15,000 1,500 16,688 -- -- Stock issued for debt retirement -- -- 260,000 26,000 1,144,000 -- -- Exercise of warrants -- -- 212,000 21,200 446,704 -- -- Stock issued for acquisition of Essex Communications, Inc. -- -- 350,000 35,000 702,820 -- -- Stock issued for acquisition of Webquill Internet Services, LLC -- -- 375,000 37,500 637,500 -- -- Issuance of preferred stock 700 70 -- -- 651,315 -- -- Stock issued for services -- -- 30,916 3,091 19,520 -- -- Stock issued for equity investment in Access One Communications -- -- 800,000 80,000 1,479,100 -- -- Reduction in treasury stock held by equity investee -- -- -- -- -- -- -- --- --- --------- ----------- ----------- ----------- -------- Balance, November 30, 1998 700 70 6,343,316 634,331 12,851,015 (8,864,535) (27,500) Accumulated Treasury Other Stock Held Comprehensive Total by Equity Income Stockholders' Investee (Loss) Equity -------- ------ ------ Balance, November 30, 1996 $ -- ($571,691) $ 2,780,496 Net loss -- -- (2,868,165) Translation adjustment -- (61,060) (61,060) ----------- Comprehensive income (loss) -- -- (2,929,225) Exercise of stock options -- -- 166,250 Issuance of common stock in private placement -- -- 609,000 Exercise of warrants -- -- 1,509,104 Stock issued for equity investment in Access One Communications Corp. -- -- 1,500,000 Treasury stock acquired by equity investee (420,000) -- (420,000) ----------- --------- ----------- Balance, November 30, 1997 (420,000) (632,751) 3,215,625 Net loss -- -- (4,977,003) Translation adjustment -- (47,154) (47,154) ----------- Comprehensive income (loss) -- -- (5,024,157) Exercise of stock options -- -- 18,188 Stock issued for debt retirement -- -- 1,170,000 Exercise of warrants -- -- 467,904 Stock issued for acquisition of Essex Communications, Inc. -- -- 737,820 Stock issued for acquisition of Webquill Internet Services, LLC -- -- 675,000 Issuance of preferred stock -- -- 651,385 Stock issued for services -- -- 22,611 Stock issued for equity investment in Access One Communications -- -- 1,559,100 Reduction in treasury stock held by equity investee 260,604 -- 260,604 ----------- --------- ----------- Balance, November 30, 1998 (159,396) (679,905) 3,754,080 (Continued) See accompanying notes to consolidated financial statements. F-6 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 Capital Preferred Stock Common Stock In Excess of Shares Amount Shares Amount Par Value Deficit ------ ------ ------ ------ --------- ------- Balance, November 30, 1998 700 70 6,343,316 634,331 12,851,015 (8,864,535) Net loss (7,505,553) Translation adjustment, including a reclassification adjustment of $572,170 related to dissolution of Hong Kong subsidiary -- -- -- -- -- -- Comprehensive income (loss) -- -- -- -- -- -- Stock issued for services -- -- 25,000 2,500 35,000 -- Issuance of common stock -- -- 1,890,055 189,005 1,836,719 -- Exercise of stock options -- -- 37,000 3,700 40,050 -- Stock issued for debt retirement -- -- 1,484,780 148,478 1,945,953 -- Stock issued for acquisition of Tag Air, Inc. -- -- 149,210 14,921 158,014 -- Stock issued for acquisition of Peconic Telco, Inc. -- -- 69,000 6,900 113,850 -- Stock issued for investment in Riderpoint, Inc. -- -- 550,000 55,000 1,201,250 -- Stock issued for investment in Skyclub Communications -- -- 120,149 12,015 158,801 -- Stock issued for equity investment in Access One Communications Corp -- -- 1,420,000 142,000 1,689,800 -- Access One Communications Corp. put exercise -- -- (1,400,000) (140,000) (1,666,000) -- Reduction in treasury stock held by equity investee -- -- -- -- -- -- Stock issued for performance con- ditions of Essex Communications -- -- 225,000 22,500 212,650 -- Conversion of Series A preferred stock to common stock (700) (70) 373,654 37,365 (37,295) -- Issuance of Series B preferred stock 196 20 -- -- 195,909 -- Adjustment of expenses incurred in raising equity -- -- -- -- 72,681 -- ----------- ---------- ---------- ------------ ------------ Balance, November 30, 1999 196 $ 20 11,287,164 $1,128,715 $ 18,808,397 ($16,370,088) --------- ----------- ---------- ---------- ------------ ------------ Accumulated Treasury Other Stock Held Comprehensive Total Treasury by Equity Income Stockholders' Stock Investee (Loss) Equity ----- -------- ------ ------ Balance, November 30, 1998 (27,500) (159,396) (679,905) 3,754,080 Net loss (7,505,553) Translation adjustment, including a reclassification adjustment of $572,170 related to dissolution of Hong Kong subsidiary -- -- 598,888 598,888 ---------- Comprehensive income (loss) -- -- -- (6,906,665) Stock issued for services -- -- -- 37,500 Issuance of common stock -- -- -- 2,025,774 Exercise of stock options -- -- -- 43,750 Stock issued for debt retirement -- -- -- 2,094,431 Stock issued for acquisition of Tag Air, Inc. -- -- -- 172,935 Stock issued for acquisition of Peconic Telco, Inc. -- -- -- 120,750 Stock issued for investment in Riderpoint, Inc. -- -- -- 1,256,250 Stock issued for investment in Skyclub Communications -- -- -- 170,816 Stock issued for equity investment in Access One Communications Corp -- -- -- 1,831,800 Access One Communications Corp. put exercise -- -- -- (1,806,000) Reduction in treasury stock held by equity investee -- 159,396 -- 159,396 Stock issued for performance con- ditions of Essex Communications -- -- -- 235,150 Conversion of Series A preferred stock to common stock -- -- -- -- Issuance of Series B preferred stock -- -- -- 195,929 Adjustment of expenses incurred in raising equity -- -- -- 72,681 -------- ----------- --------- ----------- Balance, November 30, 1999 ($27,500) $ -- ($ 81,017) $ 3,458,527 -------- ----------- --------- ----------- See accompanying notes to consolidated financial statements. F-7 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 1999 1998 1997 ----------- ----------- ----------- Operating activities: Net loss ($7,505,553) ($4,977,003) ($2,868,165) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 375,958 227,005 110,168 Abandonment of property plant and equipment 227,232 -- -- Translation adjustment related to liquidation of Hong Kong subsidiary 572,170 -- -- Loss on equity investment including goodwill amortization of $375,000 in 1999 and 1998 1,661,630 1,423,300 -- Stock issued for services 37,500 22,611 -- Provision for losses on accounts receivable and other assets 108,000 299,000 278,000 Loss on sale of property, plant and equipment 7,499 -- 7,012 Estimated gain on sale of land and building of discontinued operations (169,650) -- -- Changes in operating assets and liabilities, net of effects of acquisitions and other transactions: Accounts receivable 213,107 1,289,333 (594,077) Inventories 3,526,891 3,275,479 (3,325,876) Prepaid expenses 146,827 42,988 12,926 Other current assets (140,889) 6,595 79,014 Other assets 75,146 41,839 (60,538) Accounts payable, related parties and accrued expenses 1,324,545 156,498 182,538 Income taxes 149,902 (24,930) (448,240) ----------- ----------- ----------- Net cash provided by (used in) operating activities 610,315 1,782,715 (6,627,238) ----------- ----------- ----------- Investing activities, net of effects of acquisitions: Purchases of property, plant and equipment (120,935) (57,765) (87,045) Proceeds from sale of property, plant and equipment 9,840 -- 3,607 Cash inflow from agreement to sell subsidiary 39,998 50,224 25,700 Payment of certain obligations of WebQuill Internet Services, LLC -- (150,000) -- Acquisition of Peconic Telco, Inc., net of cash acquired (24,053) -- -- ----------- ----------- ----------- Net cash used in investing activities (95,150) (157,541) (57,738) ----------- ----------- ----------- (Continued) See accompanying notes to consolidated financial statements. F-8 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 1999 1998 1997 ----------- ----------- ----------- Financing activities: Repayment of loans payable to financial institutions and short-term loans payable to related parties, net $ -- $ -- ($1,600,821) Proceeds from (repayment of) revolving credit line, net (2,768,944) (2,527,977) 5,714,056 Repayment of long-term debt, net of exchange rate 6,073 (8,470) (6,550) Officer loan, net of repayment 227,000 -- -- Proceeds from exercise of stock options 43,750 18,188 166,250 Proceeds from private placement of common stock 2,025,774 -- 609,000 Proceeds from exercise of warrants -- 467,904 1,509,104 Proceeds from issuance of preferred stock 195,929 651,385 -- ----------- ----------- ----------- Net cash provided by (used in) financing activities (270,418) (1,398,970) 6,391,039 ----------- ----------- ----------- Effect of exchange rate changes on cash (5,937) 12,095 18,084 ----------- ----------- ----------- Increase (decrease) in cash and cash equivalents 238,810 238,299 (275,853) Cash and cash equivalents at beginning of year 352,489 114,190 390,043 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 591,299 $ 352,489 $ 114,190 ----------- ----------- ----------- Cash paid during the year for: Interest $ 297,209 $ 502,005 $ 510,869 ----------- ----------- ----------- Income taxes $ -- $ -- $ 300,015 ----------- ----------- ----------- Supplemental disclosure of non-cash investing and financing activities: See Notes 2, 3, 7 and 8. See accompanying notes to consolidated financial statements. F-9 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 1. Description of Business and Summary of Accounting Principles Description of Business and Concentration of Credit Risk eLEC Communications, Inc. ("eLEC" or the "Company") (formerly known as Sirco International Corp.) presently has two active business segments. The first active business segment, and the principal focus of the Company, is as a competitive local exchange carrier through its wholly-owned subsidiaries, Essex Communications, Inc. ("Essex") and WebQuill Internet Services LLC ("WebQuill"), to resell and provide low cost alternative telecommunication services and other bundled services, focusing on small and medium-sized business users. The second active business segment is as a specialty retail business through its wholly-owned subsidiary, Airline Ventures, Inc. ("AVI"), that sells travel products, uniforms and study guides via retail stores, E-commerce sites and a Web site primarily to professional airline crew members. Trade receivables potentially subject the Company to credit risk. The Company extends credit to its customers based upon an evaluation of the customer's financial condition and credit history and generally does not require collateral. As part of its telecommunications strategy, the Company has acquired an ownership interest in Access One Communications, Inc. ("Access"), which is a competitive local exchange carrier and reseller of telecommunication services to businesses and residential customers in the southeastern United States. The Company's investment in Access is accounted for on the equity method. During the fiscal year ended November 30, 1999, the Company discontinued the operations of its wholesale luggage business segment which, in prior years, had represented substantially all of the business operations of the Company (see "Discontinued Operations"). 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 20% to 50% owned affiliated companies are accounted for on the equity method. Investments of less than 20% in companies that do not have readily determinable fair values are carried at cost. Inventories Inventories, consisting primarily of finished goods purchased for resale, are stated at the lower of cost (first-in, first-out and average) or market. F-10 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 1. Description of Business and Summary of Accounting Principles (Continued) Property, Plant and Equipment and Depreciation 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 20 years for building, 5 to 10 years for machinery and equipment, and the life of lease for leasehold improvements. Foreign Currency Translation Assets and liabilities of the Company's foreign subsidiaries are translated at year-end exchange rates, and income and expenses are translated at average exchange rates prevailing during the year with the resulting adjustments accumulated in stockholders' equity. 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 reduce the deferred tax assets as it is more likely than not that such portion of the deferred tax assets will not be realized. Revenue Recognition Revenue from providing telecommunication related services is recognized in the period related services are provided. Revenue from the Company's specialty retail business and from the Company's discontinued luggage business is recognized upon shipment or delivery of merchandise. Earnings (Loss) Per Share Basic earnings (loss) per share is computed by dividing net income by the weighted-average number of shares outstanding. Diluted earnings (loss) per share includes the dilutive effect of stock options, warrants and convertible preferred stock. Such options, warrants and convertible preferred stock have not been included in the computations as they were antidilutive in 1999, 1998 and 1997, but may become dilutive in the future. F-11 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 1. Description of Business and Summary of Accounting Principles (Continued) Cash Equivalents The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Goodwill and Other Intangible Assets The excess cost over net assets acquired (goodwill) is being amortized on a straight-line basis over 7 years. Goodwill and other intangible assets are periodically reviewed for impairment based on an assessment of current and future levels of operating income and cash flows, as well as other factors. Impairment of Long-Lived Assets The Company reviews long-lived assets and certain identifiable intangibles 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 net 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 value. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. 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. Actual results could differ from those estimates. F-12 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 1. Description of Business and Summary of Accounting Principles (Continued) Advertising Advertising costs are expensed as incurred. Advertising expense, principally related to discontinued operations, amounted to approximately $48,000 in 1999, $78,000 in 1998, and $55,000 in 1997. 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 Investments in and Advances to Subsidiary The fair value of investments in and advances to subsidiary is estimated based on discounted cash flow analyses using estimated interest rates and an appropriate allowance for uncollectibility. The carrying amount approximates its fair value. o Long-Term Debt The fair value of the Company's long-term debt 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. Recent Accounting Pronouncements Effective December 1, 1998 the Company adopted SFAS No. 130, "Reporting Comprehensive Income." SFAS 130 establishes standards for the display of comprehensive income and its components in a full set of financial statements. Comprehensive income (loss) includes all changes in equity during a period except those resulting from the issuance of shares of stock and distributions to shareholders. F-13 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 1. Description of Business and Summary of Accounting Principles (Continued) Recent Accounting Pronouncements (Continued) In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which established accounting and reporting standards for derivative instruments and for hedging activities. In June 1999, the FASB issued SFAS No. 137 which deferred the effective date of SFAS No. 133 for the Company to the beginning of its fiscal 2001. Presently, the Company has no use of derivative financial instruments and believes that SFAS No. 133 will not have a material impact on its results of operations. Reclassifications Certain amounts have been reclassified to conform to the 1999 presentation. 2. Acquisitions On February 27, 1998, the Company acquired all of the outstanding shares of common stock of Essex in exchange for 250,000 shares of the Company's common stock and warrants to purchase up to 225,000 shares of the Company's common stock at $2.75 per share, of which warrants to purchase 75,000 shares vested immediately and warrants to purchase 150,000 shares will vest if certain performance conditions are met, of which 75,000 became vested during the fiscal year ended November 30, 1999. In addition, if certain performance conditions are met, up to 600,000 additional shares of common stock may be issued. As of November 30, 1999, 325,000 of such shares had been issued to the former shareholders of Essex as certain performance conditions were met. The transaction was accounted for as a purchase. The purchase price exceeded the fair value of net assets acquired by approximately $737,000, which is being amortized on a straight-line basis over 7 years. The results of operations of Essex are included in the accompanying financial statements from the date of acquisition. On August 14, 1998, the Company acquired all of the membership interests of WebQuill in exchange for 525,000 shares of the Company's common stock (of which 375,000 shares were delivered to the sellers and 150,000 shares were deposited in an escrow account and will be delivered upon attainment of certain performance conditions) and the payment of $150,000 of Webquill's obligations. As of November 30, 1999, such conditions were not met. The transaction was accounted for as a purchase. The purchase price exceeded the fair value of net assets acquired by approximately $750,000, which is being amortized on a straight-line basis over 7 years. The results of operations of WebQuill are included in the accompanying financial statements from the date of acquisition. F-14 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 2. Acquisitions (Continued) In January 1999, the Company acquired all of the outstanding shares of Tag Air, Inc. ("Tag Air") in exchange for 149,210 shares of the Company's common stock valued at approximately $173,000 in a transaction accounted for as a purchase. Tag Air is a retailer that sells name brand luggage, apparel and travel-related accessories to airline pilots and flight crews. This transaction was accounted for as a purchase. The purchase price exceeded the fair value of net assets acquired by approximately $47,000, which is being amortized on a straight-line basis over seven years. On November 17, 1999, the Company acquired all of the outstanding shares of common stock of Peconic Telco, Inc. ("Peconic") in exchange for 69,000 shares of its common stock, valued at $120,750, plus a cash payment of $28,000. Peconic is an installer of telephones and telephone equipment. The purchase price exceeded the fair value of net assets acquired by approximately $135,000, which is being amortized on a straight-line basis over seven years. Pro forma financial statements of the Tag Air and Peconic acquisitions as if they occurred as of December 1, 1997 have not been presented since the results were not material. On April 6, 1999, the Company issued 250,000 shares of its common stock, valued at $412,500, in exchange for a 19% interest in RiderPoint Inc. ("RiderPoint"). On November 30, 1999, an additional 300,000 shares, valued at $862,500, were issued, thereby increasing its ownership in Riderpoint to 27% on such date. RiderPoint is a developer, marketer, and administrator of insurance and financial service programs. On May 25, 1999, the Company issued 120,149 shares of its common stock, valued at $170,816, in exchange for a 19% interest in Skyclub Communications Holding Corp. ("Skyclub"). Skyclub provides digital satellite systems for the reception of direct television and high-speed Internet services. The investment is carried at cost. 3. Loans Payable to Financial Institutions and Long-Term Debt In connection with the financing of its discontinued luggage business, the Company had entered into a financing agreement with Coast Business Credit, a division of Southern Pacific Thrift and Loan Association. As of November 30, 1999 and 1998, the Company had a loan outstanding of $219,363 and $3,186,079 under the agreement. The loan was repaid in full in December 1999. The loan, which was available to the Company based upon a portion of the eligible inventory and accounts receivable of the discontinued luggage business, had an interest rate of 2% above the prime rate, was collateralized by a security interest in substantially all assets of the Company, and contained various restrictions, including a restriction on the payment or declaration of any cash dividends. F-15 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 3. Loans Payable to Financial Institutions and Long-Term Debt (Continued) On March 3, 1999, Essex entered into a Receivable Sales Agreement ("the Agreement") with Receivables Funding Corporation ("RFC"). The Agreement provides for Essex to sell up to $500,000 ($1,000,000 effective December 1999) of its eligible receivables (as defined) to RFC on a periodic basis and to grant RFC a security interest in the receivables purchased by RFC. As of November 30, 1999, approximately $198,000 was outstanding under the Agreement. The Agreement, in substance, does not transfer the risk of loss to RFC, and has been treated as a financing for financial statement purposes. In substance, Essex borrows under the Agreement at approximately five percentage points above the prime rate. The Agreement has a termination date of the earlier of (a) March 3, 2001; (b) a termination event as defined in the Agreement; (c) the occurrence of an event of seller default as defined in the Agreement; or (d) ninety days following the Company's delivery of written notice to RFC setting forth the Company's desire to terminate the Agreement and the payment of a termination fee (as defined). The Company's Canadian subsidiary has a real property mortgage of approximately $368,000, payable in monthly installments of approximately $3,138 including interest at 10.25% with a balloon payment of approximately $291,000 in the year 2000. Substantially all of the assets of the Canadian subsidiary have been pledged as collateral for the above loans. The Canadian subsidiary has agreed to certain financial covenants (current ratio, debt-to-equity ratio, debt service coverage) and may not pay dividends to the parent. Long-term debt consists of the following: 1999 1998 ------- ----------- Loan payable to Coast $219,363 $3,186,079 Loan payable to RFC 197,772 - Subsidiary mortgage payable 304,332 298,259 --------- ------------ 721,467 3,484,338 Less current maturities 523,695 3,193,344 --------- ----------- $197,772 $ 290,994 -------- ----------- F-16 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 3. Loans Payable to Financial Institutions and Long-Term Debt (Continued) Principal payments are due as follows: Year ended November 30, 2000 $523,695 2001 197,772 --------- $721,467 ======== 4. Income Taxes At November 30, 1999, the Company had net operating loss carryforwards for Federal income tax purposes of approximately $15,000,000 expiring in the years 2001 through 2019. There is an annual limitation of approximately $187,000 on the utilization of approximately $2,300,000 of such net operating loss carryforwards under the provisions of Internal Revenue Code Section 382. 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, 1999 and 1998 are as follows: 1999 1998 ---------- ----------- Deferred tax assets: Net operating loss carryforwards $5,250,000 $ 3,250,000 Allowance for doubtful accounts and accruals 120,000 270,000 Inventory 10,000 230,000 Depreciation 80,000 100,000 ---------- ----------- 5,460,000 3,850,000 Deferred tax liabilities: Installment sale of investment -- (50,000) ---------- ----------- Valuation allowance 5,460,000 (3,800,000) ---------- ----------- Net deferred tax assets $ -- $ -- ---------- ----------- The valuation allowance at November 30, 1997 was $3,040,000. F-17 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 4. Income Taxes (Continued) The following is a reconciliation of the tax provisions for the three years ended November 30, 1999 with the statutory Federal income tax rates: Percentage of Pre-Tax Income 1999 1998 1997 ---- ---- ---- Statutory Federal income tax rate (34.0%) (34.0%) (34.0%) State and local income taxes, net of Federal income tax benefit -- .1 Equity loss on investment in Access One (7.5) (9.7) -- Utilization of foreign tax loss carryforwards/ carryback -- (3.2) (4.3) Operating losses generating no current tax benefit, United States 41.5 43.7 34.0 Other items, net -- -- .1 ---- ---- ---- -- (3.2%) (4.1%) ---- ---- ---- 5. Pension Plans The Company has a defined benefit plan covering substantially all of its domestic employees. The benefits provided are primarily based upon years of service and compensation, as defined. The Company's funding policy is to contribute annually the minimum amount required to cover the normal cost and to fund supplemental costs, if any, from the date each supplemental cost was incurred. Contributions were intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. Plan assets consist primarily of investments in money market funds. Effective June 30, 1995, the plan was frozen, ceasing all benefit accruals and resulting in a plan curtailment. F-18 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 5. Pension Plans (Continued) Net periodic pension cost (gain) included the following components: 1999 1998 1997 -------- -------- -------- Interest cost on projected benefit obligation $ 57,734 $ 56,393 $ 57,257 Return on assets( 61,874) (63,704) (66,110) Net amortization and deferral (584) (4,112) (4,112) -------- -------- -------- ($ 4,724) ($11,423) ($12,965) -------- -------- -------- Following is a summary of significant actuarial assumptions used: 1999 1998 1997 ---- ---- ---- Weighted-average discount rates 7.0% 7.0% 7.5% Rates of increase in compensation levels 5.0% 5.0% 5.0% Expected long-term rate of return on assets 8.0% 8.0% 8.0% The following table sets forth the Plan's funded status and amounts recognized in the Company's statement of financial position at: November 30, 1999 1998 --------- --------- Accumulated benefit obligation, including vested benefits of $835,772 and $820,734 at November 30, 1999 and 1998, respectively ($837,685) ($823,568) -------- -------- Projected benefit obligation for service rendered to date ($869,592) ($823,568) Plan assets at fair value, primarily money market funds 744,098 786,343 --------- --------- Plan assets in excess of (deficiency in) unfunded projected benefit obligation (125,494) (37,225) --------- ---------- Accrued pension cost ($125,494) ($ 37,225) -------- --------- F-19 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 6. Commitments The Company conducts a substantial portion of its operations utilizing leased facilities. Rent expense, charged to operations, was $705,000, $825,000 and $704,000 in 1999, 1998 and 1997, 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 rental commitments under all operating leases including a lease entered into on February 4, 2000 that have remaining non-cancelable terms in excess of one year are approximately as follows: Year ended November 30, 2000 $ 291,000 2001 275,000 2002 294,000 2003 229,000 2004 169,000 Thereafter 43,000 ------------- $ 1,301,000 The Company had previously entered into various licensing agreements under which it had obtained the right to market children's bags, tote bags and related products with trade names. The terms of such agreements varied through 2001. The agreements provided for royalties based upon net sales with certain stated minimum annual amounts. In connection with the discontinued operation, the Company has negotiated releases on certain of these obligations and has accrued for the estimated liability remaining on those obligations for which the Company has not yet obtained a release. Royalty expense amounted to $208,000, $545,000 and $660,000 in fiscal 1999, 1998 and 1997, respectively. As of November 30, 1999 and 1998, approximately $447,000 and $560,000, respectively, had been accrued for unpaid royalties. F-20 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 7. Related Party Transactions As of November 30, 1998, the Company owed its Chairman, Mr. Joel Dupre ("Dupre"), approximately $8,000. During 1999, the Company borrowed an additional $235,000 from Dupre, resulting in a balance due of approximately $243,000. On September 10, 1999, the Company issued 272,000 shares of common stock (with a market value of approximately $357,000) and Dupre agreed to cancel indebtedness of $204,000, and Dupre also agreed to repay certain luggage creditors approximately $153,000 of the Company's indebtedness to such creditors, relieving the Company of its obligations to such creditors. As of November 30, 1999, the Company owes Dupre approximately $35,000, which is payable upon demand, and bears interest at 8%. The Company imported substantially all of its luggage segment inventory from foreign vendors. In May 1998, the Company issued 260,000 shares to foreign vendors valued at $1,700,000 or $4.50 per share in satisfaction of certain existing trade accounts payable to foreign vendors. Included in this amount were 155,556 shares issued to companies controlled by then existing shareholders. The agreement with such vendors provided that if the vendors were to sell such shares within one year at a price below $4.50 per share (subject to a $2.25 floor), up to an additional 260,000 shares would be issued to the vendors. Subsequent thereto, the Company incurred additional obligations to foreign vendors, and the price of the Company's common stock fell substantially below $4.50 per share. During fiscal 1999, the Company agreed to issue 1,152,780 shares of the Company's common stock in complete satisfaction of indebtedness to such vendors. In fiscal 1999, the Company recorded an increase in stockholders' equity of approximately $1,803,000 related to this issuance along with a related decrease in accounts payable. During the years ended November 30, 1999, 1998 and 1997, the Company purchased approximately $809,000, $2,287,000 and $891,000, respectively, of luggage and backpack products from companies controlled by stockholders. During the years ended November 30, 1999, 1998 and 1997, the Company incurred buying commission of approximately $103,000, $312,000 and $208,000, respectively, to companies controlled by stockholders. As of November 30, 1999 and 1998, there was outstanding $11,312 and $926,205 to such related parties. F-21 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 8. Discontinued Operations On July 19, 1999, the Board of Directors of the Company adopted a plan to discontinue the Company's luggage business as part of the Company's strategic focus on telecommunications and Internet services. The expected manner of disposal of the luggage business is by sale of assets. As of November 30, 1999, a substantial portion of the luggage business had already been disposed of, and the Company anticipates that the remainder of the luggage business will be fully disposed of by June 30, 2000. The luggage business segment has been accounted for as discontinued operations in accordance with Accounting Principles Board Opinion (APB) 30, which, among other provisions, requires the plan of disposal to be carried out within one year. The estimated loss on disposal of the luggage business included a charge of $572,170 applicable to a previously recorded foreign translation adjustment for the Company's Hong Kong subsidiary which was dissolved during 1999. Interest expense allocated to the discontinued operation is based on the direct borrowings of such operations and amounted to approximately $306,000 in 1999, $514,000 in 1998, and $574,000 in 1997. The operating results and remaining assets of the discontinued operations are summarized as follows: 1999 1998 1997 Sales $ 6,774,265 $ 15,552,285 $ 15,732,112 Net loss (3,943,065) (2,772,464) (2,762,993) Net loss per share of common stock (.45) (.53) (.85) 1999 1998 Current assets $1,300,726 $6,156,872 Property and equipment net 426,654 686,662 Other assets 9,118 94,986 ---------- ---------- $1,736,498 $6,938,520 ========== ========== F-22 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 F-23 9. Segment Reporting Effective for the fiscal year ended November 30, 1999, the Company adopted SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information." Prior period amounts have been restated to conform to the requirements of this statement. The accounting policies of the operating segments are the same as those described in the summary of accounting policies. The Company evaluates the performance of its operating segments based on the operating income of the respective business units. Geographical information is not presented, as the continuing operations of the Company operate solely within the United States. A summary of business data for the Company's reportable segments for the fiscal years 1999, 1998 and 1997 are as follows: Retail Investments Related Carried Total of Telecom- Travel Under Cost Continuing munications Products Method Operations ----------- -------- ------ ---------- Revenue (external 1999 $ 2,275,474 $ 1,894,557 $ - $ 4,170,031 customers) 1998 373,885 1,111,339 - 1,485,224 1997 - 275,871 - 275,871 Segment income (loss) 1999 (1) ($3,619,345) $ 56,857 $ - ($ 3,562,488) 1998 (1) (2,116,530) (88,009) - (2,204,539) 1997 - (105,172) - (105,172) Segment assets 1999 $2,750,759 $ 915,376 $ 1,894,504 $ 5,560,639 1998 3,239,015 386,934 464,573 4,090,522 1997 1,080,000 - 514,797 1,594,797 Depreciation and 1999 (2) $ 667,667 $ 37,387 $ - $ 705,054 amortization 1998 (2) 504,370 11,790 - 516,160 1997 - 5,145 - 5,145 Interest expense 1999 $ 15,419 $ - $ - $ 15,419 1998 467 - - 467 1997 - - - - Segment capital 1999 $ 72,501 $ 48,434 $ - $ 120,935 expenditures 1998 39,713 - - 39,713 1997 - 45,127 - 45,127 (1) Losses from the investment in Access have been included in the Telecommunications business. (2) Includes amortization of goodwill related to investment in Access of $375,000 in 1999 and 1998. Discontinued Operations of Luggage Total Segment Company ------- ------- Revenue (external 1999 $ 6,774,265 $ 10,944,296 customers) 1998 15,552,245 17,037,469 1997 15,732,112 16,007,983 Segment income (loss) 1999 (1) ($ 3,943,065) ($ 7,505,553) 1998 (1) (2,772,464) (4,977,003) 1997 (2,762,993) (2,868,165) Segment assets 1999 $ 1,736,498 $ 7,297,137 1998 6,938,520 11,029,042 1997 12,446,851 14,041,648 Depreciation and 1999 (2) $ 45,904 $ 750,958 amortization 1998 (2) 85,845 602,005 1997 105,023 110,168 Interest expense 1999 $ 305,518 $ 320,937 1998 513,566 514,033 1997 573,544 573,544 Segment capital 1999 $ - $ 120,935 expenditures 1998 18,052 57,765 1997 41,918 87,045 (1) Losses from the investment in Access have been included in the Telecommunications business. (2) Includes amortization of goodwill related to investment in Access of $375,000 in 1999 and 1998. F-23 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 9. Segment Reporting (Continued) Major Customers of Discontinued Operations Sales to one customer amounted to 31%, 23%, and 27% of net sales in fiscal 1999, 1998 and 1997, respectively. Sales to another customer amounted to 19%, 23% and 17% of net sales in fiscal 1999, 1998 and 1997, respectively. Sales to another customer amounted to 14% of net sales in fiscal 1997. 10. Investment In and Advances to Subsidiary Effective July 15, 1992, the Company entered into an agreement to sell all of the stock of its then wholly-owned subsidiary, Sirco Leatherwares Limited (the "Subsidiary"). In exchange for the stock, the Company received a non-interest bearing $650,000 note. The note is guaranteed by an officer of the Subsidiary who is also an officer of the buyer and, until December 1996, served on the Board of Directors of the Company. The agreement also requires the Company to forgive a portion of the amounts due to it from the Subsidiary. The Company's ability to collect the note receivable and the balance of the receivable from the Subsidiary is dependent upon cash flows from the Subsidiary's operations and/or the buyer's ability to refinance the obligations. As the risks and other incidents of ownership have not transferred to the buyer with sufficient certainty, this transaction has not been accounted for as a sale for accounting purposes. The Company recorded a loss on this transaction in fiscal 1992, as the present value of the amounts to be received under the note and the revised accounts receivable were less than (i) the carrying value of the Company's investment in the Subsidiary plus (ii) the amounts receivable from the Subsidiary. The non-interest bearing $650,000 note received in exchange for stock in the Subsidiary ("the Stock Note") was due in thirty-two equal quarterly installments of $20,213 beginning in August 1992. During fiscal 1996, the parties agreed to a one-year payment moratorium as to the Stock Note. On February 6, 1997, the parties agreed to modify the remaining repayment terms and to resume payments. The note, as modified, is to be repaid as follows: $10,156 on February 7, 1997, $10,156 on March 10, 1997, four quarterly payments of $10,156 commencing on May 1, 1997 and ending on February 1, 1998, five quarterly payments of $20,313 commencing on May 1, 1998 and ending on May 1, 1999, and four quarterly payments of $50,781 commencing on August 1, 1999 and ending on May 1, 2000. Payments are being received on a current basis. F-24 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 10. Investment In and Advances to Subsidiary (Continued) Also, pursuant to the agreement to sell the Company's investment in the Subsidiary, the Subsidiary agreed to pay interest quarterly at 8.5% per annum on a receivable of approximately $720,000. If the Subsidiary is not in default on the payment of interest, the Company will forgive a portion of the receivable, in amounts as defined, through May 1, 2000. An amount of $60,000 was forgiven in 1998, and $50,000 in each of 1997 and 1996. The total amount forgiven will be $420,000. The remaining receivable of approximately $300,000 is payable in ten equal quarterly installments commencing in August 2000. Amounts outstanding after May 1, 2000 will bear interest at the prime rate. At November 30, 1998, the aggregate principal balance of $665,000 due on the above notes has been reduced for imputed interest of approximately $40,000 and an allowance of approximately $160,000 for uncollectibility, resulting in a net balance of $465,000 at November 30, 1998. During the fiscal year ended November 30, 1999, the notes were consolidated into a new note. The new note requires quarterly payments ranging from $17,840 to $34,350 through November 1, 2005. The present value of the new note, with interest imputed at 7.25%, was approximately $500,000, which has a remaining balance of approximately $465,000 at November 30, 1999. An allowance of $40,000 has been established for potential uncollectibility, resulting in a net carrying value of approximately $425,000 at November 30, 1999. 11. Stockholders' Equity The Company accounts for its stock option plans under APB Opinion No. 25, "Accounting for Stock Issued to Employees," under which no compensation expense is recognized. In fiscal 1997, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123), for disclosure purposes; accordingly, no compensation expense has been recognized in the results of operations for its stock option plans as required by APB Opinion No. 25. On August 17, 1995, the stockholders of the Company (i) approved an increase in the number of authorized shares of common stock from 3,000,000 shares to 10,000,000 shares; (ii) authorized the Company to issue 1,000,000 shares of preferred stock, par value $.10 per share, with rights and privileges to be determined by the Board of Directors; and (iii) approved the 1995 Stock Option Plan of the Company (the "Plan"). The Plan provides for the grant of incentive stock options, non-qualified stock options, tandem stock appreciation rights, and stock appreciation rights exercisable in conjunction with stock options to purchase a specified number of shares of common stock. During fiscal 1997, the stockholders of the Company approved an amendment to the Plan to increase the number of shares of common stock that may be issued to 1,200,000 shares. In 1999, the stockholders of the Company approved an amendment to the Plan to increase the number of shares of common stock that may be issued to 2,400,000 shares. F-25 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 11. Stockholders' Equity (Continued) In June 1998, the Company issued 700 shares of Series A preferred stock "Series A shares" having a par value of $.10 per share. Each Series A share is convertible at the option of the holder into common shares at a conversion rate of 300 shares of common stock through May 31, 1999; after May 31, 1999, $1,000 divided by the lesser of $3.33 or the market price of the Company's common stock subject to a floor of $1.67. The Company may cause the conversion of the Series A shares at any time after May 31, 1999 based upon the above conversion formula. The preferred shares have the same voting and dividend rights as common shares based upon the number of shares of common stock into which the preferred stock is convertible to. The preferred shares have a liquidation preference of $1,000 per share. During 1999,at the election of the shareholders, all of the Series A shares were converted into common shares, resulting in the issuance of 373,654 shares of common stock. During 1999, the Company established a new series of stock, Series B Preferred stock, $.10 par value. The Company may issue up to 1,300 shares of the Series B Preferred stock, and such stock in entitled to receive dividends when as, and if dividends are declared by the Company on its common stock. Each holder of Series B preferred stock has the right, at the option of the holder, to convert each share of such stock into 1,000 shares of common stock. The Company has the right to convert each share of Series B preferred stock into common stock at the same conversion ratio. The conversion price of shares of Series B preferred stock is subject to adjustment in the event of any reclassification, subdivision or combination of the Company's outstanding common stock into a greater or smaller number of shares by a stock split, stock dividend or other similar event. In the event of a dissolution, liquidation or winding up of the Company, the holders of Series B preferred stock are entitled to receive, if available, prior and in preference to the holders of common stock, an amount equal to $1,000 per share. Thereafter, any remaining assets, if any, would be distributed ratably to the holders of common stock. The holders of shares of Series B preferred stock are 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. Without the approval of the holders of at least a majority of the Series B preferred stock then outstanding voting separately as a class, the Company may not amend its Certificate of Incorporation in any way that adversely affects the rights and preferences of the holders of the Series B preferred stock as a class. During 1999, 196 shares of Preferred Series B were issued, resulting in net proceeds to the Company of $195,929. F-26 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 11. Stockholders' Equity (Continued) The following is a summary of outstanding options: Weighted- Average Number Exercise Price Exercise of Shares Per Share Price --------- --------- ----- Outstanding December 1, 1996 383,000 $1.00 - $1.6875 $ 1.26 Granted during year ended November 30, 1997 160,000 $1.94 - $2.13 $ 2.03 Exercised/canceled during year ended November 30, 1997 (148,000) $1.00 - $1.6875 $ 1.12 -------- Outstanding November 30, 1997 395,000 $1.00 - $2.13 $ 1.63 Granted during year ended November 30, 1998 299,500 $2.79 - $3.13 $ 2.96 Exercised/canceled during year ended November 30, 1998 (38,000) $1.00 - $2.84 $ 2.20 -------- Outstanding November 30, 1998 656,500 $1.00 - $3.13 $ 2.20 Granted during year ended November 30, 1999 1,013,500 $1.00 - $2.25 $ 1.49 Exercised/canceled during year ended November 30, 1999 (229,000) $1.00 - $2.84 $ 2.46 ---------- Outstanding November 30, 1999 1,441,000 $ 1.63 ---------- Options exercisable, November 30, 1997 140,000 $1.00 - $1.44 $ 1.33 ---------- Options exercisable, November 30, 1998 322,500 $1.00 - $2.13 $ 1.70 ---------- Options exercisable, November 30, 1999 661,500 $1.00 - $2.84 $ 1.71 ----------- F-27 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 11. Stockholders' Equity (Continued) The following table summarizes information about the options outstanding at November 30, 1999: 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 ------ ----------- ------------ ----- ----------- ----- $1.00 - $1.94 1,120,500 3.85 $1.42 492,500 $1.43 $2.13 - $2.84 320,500 3.72 $2.42 169,000 $2.50 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: annual dividends of $0.00 for all years, expected volatility of 88% for 1997, 117% for 1998 and 126% for 1999, risk-free interest rate of 6.03% for 1997, 5.66% for 1998 and 5.53% for 1999, and expected life of five years for all grants. The weighted-average fair value of stock options granted in 1999, 1998 and 1997 was $.97, $2.36 and $.91, respectively. Under the above model, the total value of stock options granted in 1999, 1998 and 1997 was $924,707, $652,976 and $146,041, respectively, which would be amortized ratably on a pro forma basis over the related vesting periods, which generally range from five to ten years. Had the Company determined compensation cost for these plans in accordance with SFAS No. 123, the Company's pro forma net loss would have been ($7,655,167) in 1999, ($5,131,886) in 1998, and ($2,906,052) in 1997, and the Company's pro forma loss per share would be ($.88) for 1999, ($.99) for 1998, and ($.90) for 1997. In April 1997, the Company raised $609,000, net of placement agent fees, through the private placement issuance of 400,000 units at $1.75 per unit, with each unit consisting of one share of common stock, one common stock Class A warrant exercisable at $2.06 per share for one year, and one common stock Class B warrant exercisable at $2.56 per share for one year. Additionally, 120,000 Class A warrants were granted to the placement agent and a consulting firm in connection with the transaction. As of November 30, 1998, substantially all the warrants had been exercised and the remaining warrants expired. F-28 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 11. Stockholders' Equity (Continued) On October 24, 1996, the shareholders of the Company adopted the eLEC Communications, Inc. 1996 Restricted Stock Award Plan (the "Restricted Stock Award Plan"). An aggregate of 400,000 shares of common stock of the Company has 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. Approximately five employees of the Company and its subsidiaries are currently eligible to participate in the Restricted Stock Award Plan. No shares were awarded during 1999, 1998 and 1997. 12. Fourth Quarter Adjustment During the fourth quarter of the year ended November 30, 1997, the Company recorded an adjustment of approximately $615,000 to write down certain inventory. 13. Investment in and Transactions with Affiliates Access One Communications Corp. On October 22, 1997, the Company acquired 3,000,000 common shares of Access One Communications Corp. and Subsidiaries ("Access"), formerly known as CLEC Holding Corp., in exchange for 375,000 shares of the Company's common stock, subject to certain price protection adjustments which required the Company to issue an additional 50,000 shares of common stock. During fiscal 1998, there were two additional exchanges of shares with Access. The first exchange occurred on April 23, 1998 when the Company exchanged 350,000 shares of its common stock for 300,000 shares of Access common stock. This exchange was valued at $1,233,750. Additionally, Access agreed to reimburse the Company $150,000 for expenses. The second exchange occurred on September 10, 1998 when the Company exchanged 400,000 shares of its common stock for 400,000 shares of Access common stock. This exchange was valued at $221,280. In February 1998, the Company exchanged 50,000 shares of its common stock for 200,000 shares of Access common stock during 1998 with a private investor. This exchange was valued at $104,070. F-29 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 13. Investment in and Transactions with Affiliates (Continued) Access One Communications Corp. (Continued) In March 1999, the Company issued to Access 1,420,000 shares of common stock in consideration for the issuance by Access to the Company of 1,775,000 shares of its common stock. In connection with such transaction, Access was granted an option to put to the Company for repurchase at any time on or before December 1, 1999 at the original purchase price, all or a portion of the shares of common stock it purchased in March 1999. In connection with any such exercise of its put option, in whole or in part, Access was required to issue to the Company warrants to purchase 500,000 shares of Access One common stock at a purchase price of $1.00 per share, which are carried at no value. Prior to October 31, 1999, Access notifed the Company of its intention to exercise its option. On December 1, 1999, Access exercised its option with respect to 1,400,000 shares of our common stock, which has been reflected in the accompanying financial statements as of November 30, 1999. The Company's investment in Access is carried on the equity method of accounting. At November 30, 1998, the cost of the investment in Access had been reduced by $159,396, attributable to the Company's portion (at cost) of the Company's common stock held by Access, with a corresponding charge to treasury stock. As of November 30, 1998, the Company owned approximately 28% of Access. The Company, for its fiscal year ended November 30, 1999 and 1998, included its share of Access' operations based on Access' year-end of October 31, 1998. All of the Company's investment at November 30, 1998 represents goodwill, which was being amortized over seven years, based on original cost. The Company recorded a loss of $1,661,630 and $1,423,000 (including goodwill amortization of $375,000 in 1999 and 1998) on its equity in the operations of Access for the years ended November 30, 1999 and 1998. As of November 30, 1999, the Company's investment in Access has been reduced to zero. Access was formed in 1991 and was inactive until September 1997, when Access acquired 95% of the capital stock of The Other Phone Company, Inc. ("OPC"), an integrated telecommunications provider based in Florida. Substantially all of Access' revenues represent the resale of telephone services pursuant to a resale agreement with one supplier, BellSouth Corporation. F-30 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 13. Investment in and Transactions with Affiliates (Continued) Access One Communications Corp. (Continued) The results of operations for the years ended October 31, 1999, 1998 and 1997 and financial position of Access as of October 31, 1999 and 1998 are summarized below: Condensed Income Statement Information 1999 1998 1997 ----------- ---------- ----------- Revenue $15,412,640 $5,811,038 $ 479,516 ----------- ---------- ----------- Cost of service 12,177,793 5,045,514 366,243 Gross profit 3,234,847 765,524 113,273 Net loss (4,994,124) (4,761,333) (158,098) Condensed Balance Sheet Information 1999 1998 ---- ---- Current assets, including investment in eLEC Communications, Inc. common shares carried at $675,000 and $396,175 at October 31, 1999 and 1998 $3,111,715 $1,621,223 Non-current assets 852,680 630,394 Goodwill and other intangible assets 2,322,714 1,633,732 Current liabilities 4,806,419 4,200,705 Non-current liabilities 6,837,119 181,124 Stockholders' equity (deficiency) (5,356,429) (496,480) In addition, options have been granted by Access to purchase common shares of Access to the Chief Executive Officer of the Company (150,000 shares at $1.20 per share) and to another officer of the Company who serves on the Board of Directors of Access (100,000 shares at $1.00 per share). F-31 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 13. Investment in and Transactions with Affiliates (Continued) Riderpoint, Inc. On April 15,1999, the Company purchased 600,000 shares of the voting stock (19%) of Riderpoint, Inc. ("Riderpoint") by issuing 250,000 shares of its common stock, in a transaction valued at $412,500. On November 30, 1999, the Company increased its ownership interest in Riderpoint by purchasing an additional 500,000 shares of the voting stock of Riderpoint by issuing 300,000 shares of its common stock, in a transaction valued at $862,500, thereby increasing its ownership interest in Riderpoint to 27% on such date. For the year ended November 30, 1999, the investment in Riderpoint was accounted for on the cost method. Commencing on December 1, 1999, the Company will begin to account for its investment in Riderpoint on the equity method of accounting. In 1999, the Company charged Riderpoint a $75,000 fee for assistance in developing Riderpoint's website. Riderpoint was incorporated in 1997. Riderpoint has developed an Internet website which provides an online insurance rating program for, comparing, and buying motorcycle insurance. The following summarizes the results of operations and net assets (unaudited) of Riderpoint. Condensed Income Statement Information Year ended December 31, 1999 1998 ---- ---- Revenue $251,244 $ 26,539 Costs and expenses 617,452 110,502 --------- --------- Net loss ($366,208) ($ 83,963) -------- --------- F-32 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 13. Investment in and Transactions with Affiliates (Continued) Riderpoint, Inc. (Continued) Condensed Balance Sheet Information December 31, December 31, 1999 1998 ---- ---- Current assets $ 34,319 $ 12,437 Non-current assets (1) 1,196,780 31,813 Current liabilities 198,581 - Non-current liabilities 90,339 - Stockholders' equity (2) 942,179 44,250 (1) Including 400,000 shares of common stock of eLEC at December 31, 1999. (2) Including, in 1999, $1,275,000 of capital in a capital transaction with eLEC common stock. 14. Risks and Uncertainties The Company buys substantially all of the telecommunication services that it resells from one supplier, Bell Atlantic Corporation, and is, therefore, highly dependent upon Bell Atlantic Corporation. Management of the Company believes that its relationship with Bell Atlantic Corporation is good. Management of the Company believes that 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 Bell Atlantic Corporation 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-33 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 15. Subsequent Events On January 21, 2000, the Company acquired Telecarrier Services, Inc. ("Telecarrier"), a competitive local exchange carrier located in New Jersey. The acquisition will be accounted for as a purchase and was effectuated by the Company issuing 500,000 shares of its common stock for all the issued and outstanding shares of Telecarrier, of which 400,000 shares were issued at the closing of the merger and 100,000 shares were reserved for issuance upon completion of an audit of Telecarrier's financial statements, and an additional 280,000 shares of the Company's common stock which will be issued in such amounts and at such times as set forth in the related merger agreement. In addition, the Company repaid certain promissory notes of Telecarrier by issuing a total of 32,000 shares of the Company's common stock and paying $14,200 in cash. Subsequent to November 30, 1999 and through February 25, 2000, the Company received net proceeds of approximately $2,000,000 from the exercise of warrants for 345,750 shares and a private placement of 538,000 shares of common stock. F-34 eLEC COMMUNICATIONS, INC. AND SUBSIDIARIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED NOVEMBER 30, 1999, 1998 AND 1997 Column A Column B Column C Column D Column E -------- -------- -------- -------- -------- Additions Balance at Charged to Accounts Balance at Beginning Costs and Written End of Description of Period Expenses* Off Period ----------- --------- --------- --- ------ Year ended November 30, 1999: Allowance for doubtful accounts $ 337,000 $ 205,000 $118,000 $ 424,000 Valuation allowance for deferred tax asset $3,800,000 $1,650,000 $ -- $5,450,000 Year ended November 30, 1998: Allowance for doubtful accounts $ 200,000 $ 299,000 $162,000 $ 337,000 Valuation allowance for deferred tax asset $3,040,000 $ 760,000 -- $3,800,000 Year ended November 30, 1997: Allowance for doubtful accounts $ 276,000 $ 278,000 $354,000 $ 200,000 Valuation allowance for deferred tax asset $1,970,000 $1,070,000 -- $3,040,000 * Net of recoveries F-35 Report of Independent Auditors Board of Directors Access One Communications Corp. Orlando, Florida We have audited the accompanying consolidated balance sheets of Access One Communications Corp. and subsidiaries as of October 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity (deficiency), and cash flows for the years ended October 31, 1999, 1998 and 1997. These consolidated 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 generally accepted auditing standards. 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 Access One Communications Corp. and subsidiaries as of October 31, 1999 and 1998, and the consolidated results of their operations and cash flows for the years ended October 31, 1999, 1998 and 1997, in conformity with generally accepted accounting principles. /s/NUSSBAUM YATES & WOLPOW, P.C. ------------------------------- NUSSBAUM YATES & WOLPOW, P.C. Melville, New York January 28, 2000 F-36 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS OCTOBER 31, 1999 AND 1998 ASSETS 1999 1998 Current assets: Cash and cash equivalents $ 913,596 $ 118,042 Investment securities 675,000 396,175 Accounts receivable, net of allowance for doubtful accounts of $645,865 and $333,946 in 1999 and 1998 1,472,429 1,057,271 Prepaid expenses and other current assets 50,690 49,735 ------------ ----------- Total current assets 3,111,715 1,621,223 ------------ ----------- Property and equipment, net 300,206 254,060 ------------ ----------- Other assets: Deferred financing costs, net of accumulated amortization of $32,908 263,265 -- Purchased customer accounts, net of accumulated amortization of $626,677 701,021 -- Goodwill, net of accumulated amortization of $568,750 and $293,446 in 1999 and 1998 1,358,428 1,633,732 ------------ ----------- Deposits 552,474 376,334 2,875,188 2,010,066 ------------ ----------- $ 6,287,109 $ 3,885,349 ------------ ----------- LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) Current liabilities: Note payable, e.spire Communications, Inc. $ 850,811 $ -- Loans payable, Receivables Funding Corporation -- 1,054,046 Due to related parties -- 185,000 Current portion of long-term debt - 227,291 Accounts payable 3,121,390 2,148,609 Accrued expenses and other current liabilities 834,218 585,759 ------------ ----------- Total current liabilities 4,806,419 4,200,705 Long-term debt, less current portion 6,837,119 181,124 ------------ ----------- 11,643,538 4,381,829 ------------ ----------- Stockholders' equity (deficiency): Common stock, $.001 par value, authorized 25,000,000 shares; issued and outstanding 12,801,000 and 12,776,000 shares in 1999 and 1998 12,801 12,776 Additional paid-in capital 4,090,605 4,534,905 Accumulated other comprehensive income (loss), unrealized holding gain (loss) on investment securities 453,720 (124,730) Accumulated deficit (9,913,555) (4,919,431) ------------ ----------- (5,356,429) (496,480) ------------ ----------- $ 6,287,109 $ 3,885,349 ============ =========== See accompanying notes to consolidated financial statements. F-37 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 1999 1998 1997 ------------ ------------ ----------- Revenue $ 15,412,640 $ 5,811,038 $ 479,516 Cost of service 12,177,793 5,045,514 366,243 ------------ ------------ ----------- Gross profit 3,234,847 765,524 113,273 ------------ ------------ ----------- Operating expenses: Selling 998,949 725,574 70,283 Administrative 5,848,935 3,427,414 184,716 ------------ ------------ ----------- Total operating expenses 6,847,884 4,152,988 254,999 ------------ ------------ ----------- Loss from operations (3,613,037) (3,387,464) (141,726) ------------ ------------ ----------- Other expense: Interest and loan fees, net of interest income of $4,130 in 1999 1,166,462 312,869 16,372 Loss on sale of investment securities 214,625 1,061,000 -- ------------ ------------ ----------- 1,381,087 1,373,869 16,372 ------------ ------------ ----------- Net loss ($ 4,994,124) ($ 4,761,333) ($ 158,098) ------------ ------------ ----------- Basic and diluted loss per common share ($ .39) ($ .41) ($ ,05) ------------ ------------ ----------- Weighted average number of common shares outstanding 12,792,575 11,641,592 3,180,000 ------------ ------------ ----------- See accompanying notes to consolidated financial statements. F-38 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY) YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 Accumulated Other Additional Comprehensive Common Stock Paid-in Income Shares Amount Capital (Loss) ------ ------ ------ ------ Balance, November 1, 1996 2,500,000 $ 2,500 ($ 2,500) $ -- Capital contributed -- -- 100 -- Stock issued to reimburse Chairman for expenses 750,000 750 34,250 -- Stock issued to acquire OPC Acquisition Corp. 4,000,000 4,000 429,251 -- Stock issued pursuant to private placements, net 465,000 465 285,835 -- Stock issued to Sirco International Corp. in exchange for 425,000 shares of Sirco International Corp. 3,000,000 3,000 1,497,000 -- Net loss for the year ended October 31, 1997 -- -- -- -- ----------- --------- ----------- --------- Balance, October 1, 1997 10,715,000 10,715 2,243,936 -- Net loss for the year ended October 31, 1998 -- -- -- -- Unrealized loss on investment arising during the period -- -- -- (124,730) Comprehensive income (loss) -- -- -- -- Stock issued to eLEC Communications, Inc. in exchange for 750,000 shares of eLEC Communications, Inc. 700,000 700 1,454,330 -- Stock issued to related parties in satisfaction of loans and accrued interest 846,000 846 422,154 Stock issued to president of The Other Phone Company Inc. for compensation 200,000 200 99,800 Stock issued pursuant to private placements 315,000 315 314,685 -- ----------- --------- ----------- --------- Balance, October 31, 1998 12,776,000 12,776 4,534,905 (124,730) Net loss for the year ended October 31, 1999 -- -- -- -- Other comprehensive income: Unrealized holding gains arising during period -- -- -- 382,440 Plus: reclassification adjustment for losses included in net loss -- -- -- 196,010 Comprehensive income (loss) -- -- -- -- Stock issued to eLEC Communications in exchange for 1,420,000 shares of eLEC Communications, Inc. 1,775,000 1,775 1,824,700 -- Exercise of put with eLEC Communications, Inc. (1,750,000) (1,750) (1,799,000) -- Purchase of outstanding warrants -- -- (520,000) -- Options granted for consulting services -- -- 50,000 -- ----------- --------- ----------- --------- Balance, October 31, 1999 12,801,000 $ 12,801 $ 4,090,605 $ 453,720 ----------- --------- ----------- --------- Accumulated Deficit Total --------- ------- Balance, November 1, 1996 $ -- $ -- Capital contributed -- 100 Stock issued to reimburse Chairman for expenses -- 35,000 Stock issued to acquire OPC Acquisition Corp. -- 433,251 Stock issued pursuant to private placements, net -- 286,300 Stock issued to Sirco International Corp. in exchange for 425,000 shares of Sirco International Corp. -- 1,500,000 Net loss for the year ended October 31, 1997 (158,098) (158,098) ----------- ----------- Balance, October 1, 1997 (158,098) 2,096,553 ----------- Net loss for the year ended October 31, 1998 (4,761,333) (4,761,333) Unrealized loss on investment arising during the period -- (124,730) ----------- Comprehensive income (loss) -- (4,886,063) ----------- Stock issued to eLEC Communications, Inc. in exchange for 750,000 shares of eLEC Communications, Inc. -- 1,455,030 Stock issued to related parties in satisfaction of loans and accrued interest -- 423,000 Stock issued to president of The Other Phone Company Inc. for compensation -- 100,000 Stock issued pursuant to private placements -- 315,000 ---------- ----------- Balance, October 31, 1998 (4,919,431) (496,480) ----------- Net loss for the year ended October 31, 1999 (4,994,124) (4,994,124) Other comprehensive income: Unrealized holding gains arising during period -- 382,440 Plus: reclassification adjustment for losses included in net loss -- 196,010 ----------- Comprehensive income (loss) -- (4,415,674) ----------- Stock issued to eLEC Communications in exchange for 1,420,000 shares of eLEC Communications, Inc. -- 1,826,475 Exercise of put with eLEC Communications, Inc. -- (1,800,750) Purchase of outstanding warrants (520,000) Options granted for consulting services -- 50,000 ----------- ----------- Balance, October 31, 1999 ($9,913,555) ($5,356,429) ----------- ----------- See accompanying notes to consolidated financial statements. F-39 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES STATEMENTS OF CASH FLOWS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 1999 1998 1997 ----------- ----------- ----------- Cash flows from operating activities: Net loss ($4,994,124) ($4,761,333) ($ 158,098) ----------- ----------- ----------- Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 1,008,950 342,897 22,595 Provision for losses on receivables 1,744,945 592,720 16,590 Loss on sale of securities 214,625 1,061,000 -- Stock issued for compensation 100,000 -- Reimbursement of expenses to eLEC Communications 75,000 -- Expenses reimbursed through issuance of common stock -- -- 35,000 Changes in operating assets and liabilities, net of effect of acquisition in 1997: Accounts receivable, less amounts purchased (455,745) (1,262,839) (172,679) Prepaid expenses (955) 5,776 (16,770) Deferred finance costs (46,174) -- -- Deposits (176,140) (376,334) 3,674 Accounts payable 972,781 1,844,500 159,901 Accrued expenses (1,541) 523,087 44,019 ----------- ----------- ----------- Total adjustments 3,260,746 2,905,807 92,330 ----------- ----------- ----------- Net cash used in operating activities (1,733,378) (1,855,526) (65,768) ----------- ----------- ----------- Cash flows from investing activities: Proceeds from sale of securities 85,000 1,373,125 -- Purchase of equipment (120,207 (203,762) (17,969) Purchased customer accounts and accounts receivable (2,105,519) -- -- Repurchase of warrants (520,000) -- -- Acquisition of OPC -- -- (1,000,000) ----------- ----------- ----------- Net cash provided by (used in) investing activities (2,660,726) 1,169,363 (1,017,969) ----------- ----------- ----------- Cash flows from financing activities: Repayment of loan payable, bank -- (250,000) -- Borrowings (repayments), Receivable Funding Corporation, net (1,054,046) 1,054,046 -- Repayment to related parties, net ( 185,000) (239,521) -- Principal payments of long-term debt (408,415) (215,562) (59,822) Proceeds from issuance of long-term debt 6,837,119 -- 502,442 Proceeds from issuance of common stock and contribution to capital -- 315,000 719,651 ----------- ----------- ----------- Net cash provided by financing activities 5,189,658 663,963 1,162,271 ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents 795,554 (22,200) 78,534 Cash and cash equivalents, beginning of year 118,042 140,242 61,708 ----------- ----------- ----------- Cash and cash equivalents, end of year $ 913,596 $ 118,042 $ 140,242 ----------- ----------- ----------- Supplemental disclosure of cash flow information: Cash paid - interest $ 1,018,313 $ 312,869 $ 4,462 ----------- ----------- ----------- Non-cash investing and financing activities (see Notes 3 and 5) See accompanying notes to consolidated financial statements. F-40 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 1. Summary of Significant Accounting Policies Principles of Consolidation The accompanying consolidated financial statements include the accounts of Access One Communications Corp. and its subsidiaries ("the Company"). All significant intercompany balances and transactions have been eliminated. Organizational Background The Company was formerly known as CLEC Holding Corp. ("CLEC"), formerly PRS SUB II ("PRS"), was incorporated under the laws of the State of New Jersey in 1991. The Company emerged from bankruptcy, pursuant to a Bankruptcy Court Order in 1996, and was inactive until September 1997. On September 9, 1997, the Company acquired 95% of the common stock of The Other Phone Company, Inc. ("OPC"), a reseller of local and long-distance telecommunications services to businesses and residential customers in the Southeastern United States, principally in Florida, which began operations in January, 1997. The cost of the acquisition, which was accounted for as a purchase, was $1,927,178 ($1,000,000 paid in cash and the remainder in seller notes (see Note 8), and the entire purchase price of $1,927,178 was allocated to goodwill. The consolidated financial statements include the results of operations of OPC since September 9, 1997. The following unaudited pro forma consolidated results of operations for the year ended October 31, 1997 assumes the OPC acquisition occurred as of November 1, 1996: Net sales $1,723,853 Net loss ($ 561,348) Loss per share ($ .09) Cash and Cash Equivalents The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. F-41 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 1. Summary of Significant Accounting Policies (Continued) Investment Securities Marketable equity securities, all of which have represented common shares of eLEC Communications ("eLEC"), have been categorized as available for sale and as a result, are stated at fair value. Unrealized holding gains and losses are included as a component of stockholders' equity until realized. Realized gains and losses are determined based on the specific identification method. Property and Equipment Property and equipment are stated at cost. Depreciation is being provided by the straight-line method over the estimated useful lives of the assets, generally three to seven years. Leasehold improvements are amortized, using the straight-line method, over the term of the lease or the useful life of the improvements, whichever is shorter. Earnings Per Share For the year ended October 31, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," which replaces the presentation of primary earnings per share ("EPS") and fully diluted EPS with a presentation of basic EPS and diluted EPS. Basic EPS excludes common stock equivalents and is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if common stock equivalents such as stock options and warrants were exercised. The effect of stock options and warrants on the calculation of earnings per common share was anti-dilutive in all years but may be dilutive in the future. Deferred Financing Costs Deferred financing costs are amortized to interest expense over the life of the relating financing. Purchased Customer Accounts Purchased customer accounts are amortized over three years on a straight-line basis or the termination of the customer account, whichever is shorter. F-42 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 1. Summary of Significant Accounting Policies (Continued) Goodwill The excess of the cost of subsidiaries over the equity in underlying net assets at the dates of acquisition (goodwill) is being amortized over 7 years. Impairment of Long-Lived Assets The Company reviews its intangible assets and other long-lived assets for impairment at each balance sheet date or whenever events or changes in circumstances indicate that the carrying amount of an asset should be assessed. Management evaluates the intangible assets related to each acquisition individually to determine whether an impairment has occurred. An impairment is recognized when the discounted future cash flows estimated to be generated by the acquired business is insufficient to recover the current unamortized balance of the intangible asset, with the amount of any such deficiency charged to income in the current year. Estimates of future cash flows are based on many factors, including (i) current operating results of the applicable business, (ii) projected future operating results of the applicable business, (iii) the occurrence of any significant regulatory changes which may have an impact on the continuity of the business, and (iv) any other material factors that affect the continuity of the applicable business. Revenue Recognition Revenues are recognized in the period services are provided to customers and consist primarily of charges for use of local and long-distance services. Income Taxes The Company provides for income taxes in accordance with Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes." Under the asset and 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. Deferred tax expense is the result of changes in deferred tax assets and liabilities. The principal type of differences between assets and liabilities for financial statement and tax return purposes are allowances for doubtful accounts, depreciation and amortization, and net operating losses. F-43 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 1. Summary of Significant Accounting Policies (Continued) Advertising Costs The Company expenses advertising costs in the period incurred. Advertising expense was $30,170, $2,267 and $-0- for the years ended October 31, 1999, 1998 and 1997. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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. Actual results could differ from those estimates. Fair Value of Financial Instruments The Company's principal financial instruments consist of cash and cash equivalents, investment securities, and loans and notes payable. The Company believes that the carrying amount of such instruments approximates fair value. Recently Issued Accounting Standards In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 requires companies to classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings, and is effective for financial statements issued for fiscal years beginning after December 15, 1997. The Company has adopted SFAS No. 130 as reflected in the accompanying consolidated financial statements. 2. Description of Business and Concentrations The Company provides local and long-distance telecommunications services to business and residential c, principally in Florida. The Company's business is highly competitive and is subject to various Federal, State and local regulations, including the Federal Communications Commission and various state public service commissions. F-44 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 2. Description of Business and Concentrations (Continued) Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of trade receivables. The Company's trade receivables are geographically concentrated with businesses and residential customers primarily located in the Southeastern United States. The Company continually evaluates the creditworthiness of its customers; however, it generally does not require collateral. The Company's allowance for doubtful accounts is based on historical trends, current market conditions and other relevant factors. During the years ended October 31, 1999, 1998 and 1997, the Company purchased in excess of 90% of its telephone services under a resale agreement with one supplier, BellSouth. BellSouth is one of only a few potential suppliers for the Company's local telephone resale business and, therefore, the loss of the Company's relationship with BellSouth could adversely affect the Company's ability to continue in business. 3. Investment Securities On October 22, 1997, the Company exchanged 3,000,000 shares of its common stock for 375,000 shares of unregistered eLEC Communications, Inc. ("eLEC") common stock, subject to certain price protection adjustments, which required eLEC to issue an additional 50,000 shares of common stock to the Company. The Company valued the entire 425,000 shares at $1,500,000 at the exchange date and on October 31, 1997, which represented its estimate of the fair value of the aforementioned eLEC shares. During fiscal 1998, the aforementioned 425,000 shares were sold for proceeds of $687,500, resulting in a realized loss of $812,500. During fiscal 1998, there were two additional exchanges of shares with eLEC. The first exchange occurred on April 23, 1998 when the Company exchanged 300,000 of its common stock for 350,000 shares of eLEC common stock. This exchange was valued at $1,233,750. Of this first exchange, 265,000 shares were sold for proceeds of $685,625, resulting in a realized loss of $248,500. The second exchange occurred on September 10, 1998 when the Company exchanged 400,000 shares of its common stock for 400,000 shares of eLEC common stock. This exchange was valued at $221,280. F-45 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 3. Investment Securities (Continued) In March 1999, the Company issued to eLEC 1,775,000 shares of common stock in consideration for the issuance by eLEC to the Company of 1,420,000 shares of its common stock. In connection with such transaction, the Company was granted an option to put to eLEC for repurchase at any time on or before December 1, 1999 at the original purchase price, all or a portion of the shares of common stock the Company purchased in March 1999. In connection with any such exercise of its put option, in whole or in part, the Company was required to issue to eLEC warrants to purchase 500,000 shares of the Company common stock at a purchase price of $1.00 per share. Prior to October 31, 1999, the Company notified eLEC of its intention to exercise the option and, on December 1, 1999, exercised its option with respect to 1,750,000 shares of the Company's common stock which has been reflected in the accompanying financial statements as of October 31, 1999. As of October 31, 1999 and 1998, the Company owned 400,000 and 485,000 shares of eLEC's common stock, which represents approximately 4% and 8% of eLEC's common stock, respectively. As of October 31, 1999 and 1998, eLEC owned approximately 31% of the Company's common stock. During fiscal 1999, the Company sold 85,000 shares of eLEC's common stock for $85,000, resulting in a realized loss of $214,675. The Company's investment in eLEC shares are summarized as follows: Holding Cost Fair Value Gain (Loss) ------------ ------------ ----------- October 31, 1999 $221,280 $675,000 $453,720 October 31, 1998 $520,905 $396,175 ($124,730) 4. Property and Equipment 1999 1998 --------- --------- Furniture and fixtures $ 81,687 $ 63,916 Office equipment 101,846 101,846 Computer equipment 202,062 152,126 Billing software 72,675 20,175 Leasehold improvements 4,268 4,268 --------- --------- 462,538 342,331 Less accumulated depreciation and amortization (162,332) (88,271) --------- --------- $ 300,206 $ 254,060 --------- --------- F-46 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 5. Customer Base Acquisition During the fiscal year ended October 31, 1999, in two transactions with a competitor, the Company purchased a customer base of approximately 17,500 local access lines and the associated accounts receivable from the competitor for an aggregate purchase price of approximately $3,600,000. Approximately $2,300,000 of the purchase price represented accounts receivable, and the remainder, $1,300,000 was allocated to the customer base (intangible asset). Approximately $2,100,000 of the purchase price was paid in cash, and promissory notes aggregating approximately $1,500,000 were executed for the balance of the purchase price. Principal and interest (interest at 10.625%) are payable in equal monthly installments through June 30, 2000. As of October 31, 1999, the principal balance of the note was $850,811, which reflects adjustments pursuant to the agreement which reduced the amount outstanding. 6. Loans Payable, Receivable Funding Corporation The Company had a receivable financing and a senior secured promissory note with Receivables Funding Corporation ("RFC"). As of October 31, 1998, the Company had outstanding $1,054,046 under the agreements with an interest rate of approximately 5.5% above the prime rate and had collateralized it with a security interest in the accounts receivable and certain shares of eLEC stock. In connection with the agreement, the Company granted RFC warrants to purchase 300,000 shares of the Company's stock at $1.00 per share. The receivables financing was to have expired December 26, 1999 and the note was to have been paid over 48 months from the date of draw. On June 30, 1999, the agreement with RFC was terminated as new financing was obtained from MCG Finance Corporation ("MCG") as described in Note 8. As consideration for early termination, the Company paid RFC a termination fee of $180,000 which was charged to expense. Additionally, the warrants were repurchased for $520,000. 7. Due To Related Parties Note payable to Chairman of the Company, payable on demand, interest at 12% $ 20,000 Note payable to eLEC, payable on demand, non-interest bearing 75,000 Note payable to a subsidiary of eLEC, payable on demand, interest at 8% 90,000 --------- $ 185,000 ========== The above amounts were repaid during fiscal 1999. F-47 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 8. Long-Term Debt Borrowings Under MCG Credit Facility Agreement On June 30, 1999, the Company entered into a Credit Facility Agreement ("the Facility") with MCG Finance Corporation ("MCG") and other lenders that may subsequently be added to the agreement, collectively referred to as "the Lenders." Under the terms of the Facility, the Company may request periodic advances from June 30, 1999 through November 30, 1999, a maximum of $7.5 million. The maturity date of the Facility is June 30, 2002. The Company is required to pay an origination fee of $250,000, of which $125,000 is due June 2000 and the balance due June 2001. On November 30, 1999, the maximum amount that the Company may borrow under the Facility was increased to $15,000,000 to be requested through November 2000. The maximum amount of credit available under the Facility, however, shall not exceed a multiple of a portion of the Company's collections, as defined in the Facility. For purposes of determining interest, the Company may designate and subdivide the outstanding principal balance under the Facility into a maximum of three portions. The outstanding balance under each such portion will bear interest fluctuating at two alternative rate indexes, the prime rate plus 11% or, at the three-month London Interbank Offered Rate ("LIBOR") plus 9%. The applicable rate index for each portion may be changed by the Company periodically, as defined in the Facility. Interest payable under the Facility is subdivided into two components, current interest, and deferred interest. Current interest on each principal portion is due and payable monthly at the prime rate plus 8%, or at the LIBOR rate plus 6%, depending on the rate assigned to the related portion of the loan. Deferred interest, accrues, calculated at 3%, and shall be due and payable in full in one lump sum, (at the election of the Lenders) upon the occurrence of any of the following events: (a) June 30, 2002, (b) the date that all obligations under the Facility are paid in full and the related loan documents are terminated, or (c) the occurrence of any event of default, as defined. Upon such occurrence, the Lenders may accept actual cash payment of such deferred interest, or may retain the right to exercise certain rights it has under the option under the terms set forth in an Option and Warrant Agreement. If the Lenders exercise the option in accordance with the Option and Warrant Agreement, then the Lenders shall not be entitled to receive payment of such accrued deferred interest, but may, at their election, treat such accrued deferred interest as the exercise price paid for the warrant shares if and when such warrants are exercised. The option to acquire warrants will allow MCG to purchase shares of the Company representing 10% of the issued and outstanding shares of capital stock and voting rights of the Company on a fully diluted basis. The option is exercisable immediately and may be exercised by MCG at any time prior to the earlier of the following (1) June 30, 2009 and (2) the date on which MCG accepts payment of the deferred interest. F-48 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 8. Long-Term Debt (Continued) Borrowings Under MCG Credit Facility Agreement (Continued) As of October 31, 1999, the interest rate on the loan was 16.3%, including the deferred interest portion. In connection with the November 30, 1999 amendment, MCG was granted warrants to purchase 400,000 shares of common stock at $1.55 per share, exercisable immediately through November 30, 2009. As collateral, The Company has granted the Lender a security interest in substantially all assets of the Company. As additional collateral for the Facility, certain shareholders gave a security interest in all of their equity ownership interests in the Company. The Facility contains various covenants and ratios. Among others, the Company must maintain (1) an escalating minimum number of access lines, (2) an escalating minimum gross profit margin percentage, (3) a minimum operating cash flow (as defined), (4) an escalating amount of minimum revenue, (5) a leverage ratio of funded debt (as defined) to qualifying collections (as defined) of 4.5 to 1 through December 31, 1999 and 4.25 to 1.0 thereafter, and (5) an attrition rate (as defined) of not more than 5% from September 30, 1999 through December 31, 1999 and 4% thereafter. In addition, the Company (1) has an annual limitation on capital expenditures of $250,000, (2) cannot create borrowings, indebtedness, guarantees, liens, other than as defined in the Facility, and (3), cannot merge with another entity or declare or make any payment or distribution with respect to, or incur any liability for the purchase acquisition, redemption or retirement of, any of its equity interests or as a dividend, return of capital or other payment or distribution of any kind to any holder of any such equity. Other Long-term debt outstanding on October 31, 1998 consisted of notes payable to John Murray related to the purchase of 95% of OPC. The note was paid in full during fiscal 1999. F-49 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 9. Income Taxes At October 31, 1999, the Company has an operating loss carryforward of approximately $7,000,000 which is available to offset future taxable income. A valuation allowance has been recognized to offset the full amount of the deferred tax asset of approximately $2,800,000 and $1,200,000 at October 31, 1999 and 1998 due to the uncertainty of realizing the benefit of the loss carryforwards. The loss carryforwards will expire in March 2019. The valuation allowance at October 31, 1997 was $30,000. The Company's effective income tax rate differs from the federal statutory rates as follows: 1999 1998 1997 ---- ---- ---- Federal statutory rate 34.0% 34.0% 34.0% Utilization of net operating loss carryforwards (34.0) (34.0) (34.0) ----- ----- ----- -- -- -- ----- ----- ----- 10. Commitments and Contingencies Leases On October 21, 1999, the Company executed a noncancelable lease for a new facility to commence in December 1999. The commencement date of the lease is later. The lease expires five years after the commencement date. The Company will be responsible for a pro rate share of operating expenses for the building. With the exception of real estate taxes, insurance and utilities, Landlord shall cap increases in operating expenses at five percent (5%) per annum. The Company also leases other office facilities and certain equipment under operating leases that expire through 2004. The leases require minimum annual rental and certain other expenses including maintenance and taxes. Rent expense for the years ended October 31, 1999, 1998 and 1997 was approximately $107,000, $86,000 and $7,000. F-50 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 10. Commitments and Contingencies (Continued) Leases (Continued) As of October 31, 1999, the Company's future minimum rental commitments are as follows: 2000 $213,238 2001 185,386 2002 196,076 2003 198,966 2004 142,434 -------- $936,100 ======== 11. Stockholders' Equity Stock Issued for Compensation On December 1, 1997, pursuant to an employment agreement, the Company issued 200,000 shares of unregistered common stock to the new President of OPC. Compensation expense of $100,000 was recorded in fiscal 1998 for these shares. Stock Options On October 22, 1997, the Company, pursuant to the eLEC Stock Purchase Agreement, granted to eLEC's nominee to the Board of Directors options to purchase up to 100,000 shares of common stock for up to three years at an exercise price of $1.00 per share. On December 1, 1997, the Company granted options to the President of OPC to purchase 800,000 shares of common stock for up to three years at an exercise price of $.50 per share. In December 1997, January 1998 and February 1998, the Company granted options to employees to purchase 200,000 shares of common stock at an exercise price of $1.00 per share. These options were issued to four officers of OPC. Options to purchase 50% of the shares of common stock will vest at the one-year anniversary of grant, 25% at the two-year anniversary of grant and the balance of 25% at the three-year anniversary of grant. These options will expire in five years. In June 1999, the Company adopted the 1999 Stock Option Plan. Under the Plan, the Company may grant options to its employees, directors and consultants for up to 1,600,000 shares of its common stock, subject to adjustment. 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, 110% of the market price on the date of the grant. The maximum term of an option is ten years. F-51 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 12. Stockholders' Equity (Continued) Stock Options (Continued) Also, in June 1999, the Company granted options to employees to purchase 351,000 shares of common stock and options to a consultant to purchase 100,000 shares of common stock at an exercise price ranging from $1.50 to $1.65. Options to purchase the shares vest equally over three years. These options will expire in ten years. The Company recorded expense of $50,000 in connection with the options granted the consultant who is also a shareholder. No options were exercised during the years ended October 31, 1999, 1998 and 1997. The following is a summary of outstanding options: Weighted- Average Number Exercise Price Exercise of Shares Per Share Price --------- --------- ----- Outstanding, November 1, 1996 -- $ -- $ -- Granted during the year ended October 31, 1997 100,000 $ 1.00 $ 1.00 --------- Outstanding October 31, 1997 100,000 $ 1.00 $ 1.00 Granted during the year ended October 31, 1998 1,000,000 $.50 - $1.00 $ .60 Canceled during the year ended October 31, 1998 (50,000) $ 1.00 $ 1.00 --------- Outstanding October 31, 1998 1,050,000 $.50 - $1.00 $ .62 Granted during the year ended October 31, 1999 451,000 $1.50 - $1.65 $ 1.53 --------- Outstanding October 31, 1999 1,501,000 $.50 - $1.65 $ .89 --------- Options exercisable, October 31, 1998 900,000 $.50 - $1.00 $ .56 --------- Options exercisable, October 31, 1999 975,000 $.50 - $1.00 $ .59 --------- F-52 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 11. Stockholders' Equity (Continued) The following table summarizes information about the options outstanding at October 31, 1999: Options Outstanding Options Exercisable ------------------------------------------------- --------------------- Weighted- Average Weighted- Weighted- Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life (Years) Price Outstandin Price ------ ----------- ------------ ----- ---------- ----- $ .50 800,000 3.08 $ .50 800,000 $ .50 $1.00 250,000 3.10 $1.00 175,000 $1.00 $1.50 - $1.65 451,000 9.62 $1.53 - - SFAS No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123"), established a fair value method of accounting for employee stock options and similar equity instruments. The fair value method requires compensation cost to be measured at the grant date, based on the value of the award, and recognized over the service period. SFAS No. 123 allows companies to either account for stock-based compensation under the provision of SFAS No. 123 or under the provisions of APB No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"). The Company has elected to account for its stock-based compensation in accordance with the provisions of APB No. 25 and has provided pro forma disclosures of net loss as if the fair value method has been adopted. 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: annual dividends of $0.00 for all years, expected volatility of 0% for all years, risk-free interest rate of 5.80% for fiscal 1999, 5.96% for fiscal 1998 and 6.33% for fiscal 1997, and expected life of ten years for options granted during fiscal 1999 and five years for all other grants. The weighted-average fair value of stock options granted in fiscal 1999, 1998 and 1997 was $.63, $.15 and $.27, respectively. Under the above model, the total value of stock options granted in fiscal 1999, 1998 and 1997 was $220,803, $139,569 and $26,772, respectively, which would be amortized ratably on a pro forma basis over the related vesting periods, which range from immediate vesting to three years. Had the Company determined compensation cost for these plans in accordance with SFAS No. 123, the Company's pro forma net loss would have been ($5,071,314) in fiscal 1999, ($4,876,001) in fiscal 1998 and ($184,870) in fiscal 1997, the Company's pro forma loss per share would be ($.40) for fiscal 1999, ($.42) for fiscal 1998 and $.06 for fiscal 1997. F-53 ACCESS ONE COMMUNICATIONS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED OCTOBER 31, 1999, 1998 AND 1997 11. Stockholders' Equity (Continued) Stock Warrants On September 9, 1997, in connection with borrowings from related parties, the Company granted warrants to such related parties to purchase 500,000 shares of common stock. The exercise price is $1.20 for a period of three years. On December 25, 1997, the Company granted warrants to purchase 25,000 shares of common stock to an individual. The exercise price is $1.20 for a period of three years. The Company has determined that the warrants did not have any significant value at the date of issuance and, accordingly, no portion of the proceeds of the related debt was allocated to the warrants. None of the warrants were exercised during the years ended October 31, 1999, 1998 and 1997. 12. Subsequent Events On November 29, 1999, the Company acquired OmniCall, Inc. ("OmniCall"), a competitive local exchange carrier located in South Carolina. The acquisition will be accounted for as a purchase and was effectuated by the Company issuing 6,493,776 of its common stock for all the issued and outstanding shares of OmniCall. The purchase price will be allocated to the assets acquired and the liabilities assumed based upon their estimated fair values F-54