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, 2006
[_] 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 (I.R.S Employer Identification No.)
of Incorporation or Organization)
75 South Broadway, Suite 302, White Plains, New York 10601
(Address of Principal Executive Offices) (Zip Code)
(914) 682-0214
(Registrant's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, par value $.10 per share
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes |_| No |X|
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act. Yes |_| No |X|
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 |_|
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check One):
Large accelerated filer |_| Accelerated filer |_| Non-accelerated filer |X|.
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
On February 15, 2007, 22,434,282 shares of registrant's common stock
were outstanding. The aggregate market value of the voting stock held by
non-affiliates as of May 31, 2006 was approximately $5,463,000.
Documents Incorporated by Reference: The definitive proxy statement
relating to the registrant's 2007 Annual Meeting of Stockholders is incorporated
by reference into Part III of this Form 10-K to the extent described therein.
TABLE OF CONTENTS
PART I
Item 1. Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
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, Related Stockholder Matters
and Issuer Purchases of Equity Securities
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
Item 9A. Controls and Procedures
Item 9B. Other Information
PART III
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions, and Director
Independence
Item 14. Principal Accounting Fees and Services
PART IV
Item 15. Exhibits and Financial Statement Schedules
SIGNATURES
The statements contained in this Report that are not historical facts
are "forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 with respect to our financial condition, results
of operations and business, which can be identified by the use of
forward-looking terminology, such as "estimates," "projects," "plans,"
"believes," "expects," "anticipates," "intends," or the negative thereof or
other variations thereon, or by discussions of strategy that involve risks and
uncertainties. Management wishes to caution the reader of the forward-looking
statements that such statements, which are contained in this Report, reflect our
current beliefs with respect to future events and involve known and unknown
risks, uncertainties and other factors, including, but not limited to, economic,
competitive, regulatory, technological, key employee, and general business
factors affecting our operations, markets, growth, services, products, licenses
and other factors discussed in our other filings with the Securities and
Exchange Commission, and that these statements are only estimates or
predictions. No assurances can be given regarding the achievement of future
results, as actual results may differ materially as a result of risks facing us,
and actual events may differ from the assumptions underlying the statements that
have been made regarding anticipated events. Factors that may cause our actual
results, performance or achievements, or industry results, to differ materially
from those contemplated by such forward-looking statements include, without
limitation:
o The availability of additional funds to successfully pursue our
business plan;
o The impact of changes the Federal Communications Commission or State
Public Service Commissions may make to existing telecommunication
laws and regulations, including laws dealing with Internet
telephony;
o The ability to comply with provisions of our financing agreements
(we are currently in default in certain of the covenants contained
therein);
o The highly competitive nature of our industry;
o The acceptance of telephone calls over the Internet by mainstream
consumers;
o Our ability to retain key personnel;
o Our ability to maintain adequate customer care and manage our churn
rate;
o The cooperation of incumbent carriers and industry service partners
that have signed agreements with us;
o Our ability to maintain, attract and integrate internal management,
technical information and management information systems;
o Our ability to market our services to current and new customers and
generate customer demand for our products and services in the
geographical areas in which we operate;
o The availability and maintenance of suitable vendor relationships,
in a timely manner, at reasonable cost;
o Our ability to manage rapid growth while maintaining adequate
controls and procedures;
o The decrease in telecommunications prices to consumers; and
o General economic conditions.
These forward-looking statements are subject to numerous assumptions, risks and
uncertainties that may cause our actual results to be materially different from
any future results expressed or implied by us in those statements. Some of these
risks are described in "Risk Factors" in Item 1A of this Report.
These risk factors should be considered in connection with any subsequent
written or oral forward-looking statements that we or persons acting on our
behalf may issue. All written and oral forward looking statements made in
connection with this Report that are attributable to us or persons acting on our
behalf are expressly qualified in their entirety by these cautionary statements.
Given these uncertainties, we caution investors not to unduly rely on our
forward-looking statements. We do not undertake any obligation to review or
confirm analysts' expectations or estimates or to release publicly any revisions
to any forward-looking statements to reflect events or circumstances after the
date of this document or to reflect the occurrence of unanticipated events.
Further, the information about our intentions contained in this document is a
statement of our intention as of the date of this document and is based upon,
among other things, the existing regulatory environment, industry conditions,
market conditions and prices, the economy in general and our assumptions as of
such date. We may change our intentions, at any time and without notice, based
upon any changes in such factors, in our assumptions or otherwise.
PART I
In this Annual Report on Form 10-K, we will refer to eLEC
Communications Corp., a New York corporation, as "our company," "we," "us," and
"our."
Item 1. - Business
Overview
We are a provider of local, long distance and international voice
telephone services. We provide these services over wirelines, using leased
facilities of other carriers, and over broadband services, using our own
Internet Protocol ("IP") telephony product. IP telephony is the real time
transmission of voice communications in the form of digitized "packets" of
information over the Internet or a private network, which is analogous to the
way in which e-mail and other data is transmitted. We use proprietary softswitch
technology that runs on Cisco and Dell hardware to provide broadband telephone
services to other service providers, such as cable operators, Internet service
providers, WiFi and fixed wireless broadband providers, data integrators,
value-added resellers, and satellite broadband providers. Our technology enables
these carriers to quickly and inexpensively offer premiere broadband telephone
services, complete with order flow management for efficient provisioning,
billing and support services and user interfaces that are easily customized to
reflect the carrier's unique brand.
The worldwide rollout of broadband voice services has allowed consumers
and businesses to communicate at dramatically reduced costs in comparison to
traditional telephony networks. Traditionally, telephone service companies have
built networks based on circuit switching technology, which creates and
maintains a dedicated path for individual telephone calls until the call is
terminated. While circuit-switched networks have provided reliable voice
communications services for more than 100 years, transmission capacity is not
efficiently utilized in a circuit-switched system. Under circuit-switching
technology, when a person makes a telephone call, a circuit is created and
remains dedicated for the entire duration of that call, rendering the circuit
unavailable for the transmission of any other calls. Because of the high cost
and inefficiencies of a circuit-switched network, we have never owned a
circuit-switched network. Instead, we have leased circuit-switched network
elements from other carriers in order to provide wireline services to customers.
Data networks, such as IP networks, utilize packet switching technology
that divides signals into packets and simultaneously routes them over different
channels to a final destination where they are reassembled into the original
order in which they were transmitted. No dedicated circuits are required and a
fixed amount of bandwidth is not needed for the duration of each call. The more
efficient use of network capacity results in the ability to transmit
significantly higher amounts of traffic over a packet-switched network than a
circuit-switched network. Packet-switching technology enables service providers
to converge traditional voice and data networks in an efficient manner by
carrying voice, fax, video and data traffic over the same network. IP networks
are therefore less expensive for carriers to operate, and these cost savings can
be passed on to the consumer in the form of lower costs for local, long distance
and international long distance telephone services.
2
We have created our own proprietary IP platform and have transitioned
into a facilities-based broadband service provider to take advantage of the
network cost savings that are inherent in an IP network. We have signed a
contract to sell our leased lines telephone business to another company, so that
we can focus our resources and our energies on our broadband voice product. In
addition to the cost savings we obtain from the efficient use of network
capacity, we believe our network equipment costs are lower than most other
carriers as our network and technology require significantly less capital
expenditures than a traditional Class 5 telecom switch in a circuit-switched
network, and less equipment costs than our broadband voice competitors that
utilize a packet-switched network. Our proprietary softswitch provides more than
20 of the Class 5 call features, voice mail and enhanced call handling on our
own Session Initiation Protocol ("SIP") server suite. We control all of the
features we offer to broadband voice customers, because instead of a relying on
a software vendor, we write the code for any new features that we desire to
offer our customers. We have no software licensing fees and our other variable
network costs are expected to drop as we increase our network traffic and as we
attract more pure IP telephony users with traffic that does not incur the cost
of originating or terminating on a circuit- switched network.
Our SIP servers are part of a cluster of servers, which we refer to as
a server farm, in which each server performs different network tasks, including
back-up and redundant services. We believe the server farm structure can be
easily and cost-effectively scaled as our broadband voice business grows. In
addition, servers within our server farm can be assigned different tasks as
demand on the network dictates. If an individual server ceases to function, our
server farm is designed in a manner that subscribers should not have a call
interrupted. We support origination and termination using both the G.711 and
G.729 voice codecs. Codecs are the algorithms that enable us to carry analog
voice traffic over digital lines. There are several codecs that vary in
complexity, bandwidth required and voice quality. We primarily use G.711 and
G.729 codecs. G.711 is a standard to represent 8 bit compressed pulse code
modulation samples for signals of voice frequency. It creates a 64 kilobit per
second bitstream, and we find that approximately 90% of the current IP telephony
traffic in the United States uses G.711. We frequently process G.711 traffic
because some of our wholesale customers do not have the ability to handle G.729.
We prefer the G.729 codec, which allows us to utilize the Internet in more cost
effective ways. It allows for compressing more calls in limited bandwidth,
reducing the call to 8 kilobits per second. For all of our retail customers and
our more sophisticated wholesale accounts, we use G.729 to save cost and enhance
the quality of the call.
Development of Business
We were incorporated in the State of New York in 1964 under the name
Sirco Products Co. Inc. and developed a line of high quality handbags, totes,
luggage and sport bags. Between 1995 and 1999, we divested our handbag and
luggage operations, which had experienced several years of operating losses.
We commenced operations in the telecommunications industry in fiscal
1998 by acquiring Essex Communications, Inc. ("Essex"), a newly-formed
Competitive Local Exchange Carrier ("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.
3
In January 2000, we acquired Telecarrier Services, Inc. ("TSI"), a CLEC
that operated primarily in the states of New Jersey and New York provided long
distance service in 13 states. Most of TSI's operations were acquired by Essex
after the acquisition was complete, and TSI maintained its licenses as an
inactive subsidiary. On July 29, 2002, TSI commenced a case under chapter 11 of
the Bankruptcy Code. In February 2004, TSI filed a plan of reorganization
pursuant to which the capital stock of a reorganized TSI would be sold by
competitive bid and the proceeds from the sale of such stock would be used to
make distributions to creditors of TSI. In April 2004, the court accepted our
plan to purchase all the stock of a reorganized TSI for a price of $325,000. The
purchase of TSI and its emergence from bankruptcy was completed in October 2004.
On December 31, 2002, we sold certain assets of Essex to Essex
Acquisition Corp. ("EAC"), a wholly-owned subsidiary of BiznessOnline.com, Inc.
("Biz"). EAC purchased selected assets and assumed certain liabilities in
conjunction with this transaction. The remaining shell of Essex was sold to Glad
Holdings, LLC on September 11, 2003.
In November 2002, we began the operations of New Rochelle Telephone
Corp. ("NRTC") as a start-up CLEC. We built a customer base in NRTC similar to
the one we had sold to EAC. On December 14, 2006, we entered into two separate
definitive purchase agreements ("Agreements") to sell TSI and NRTC to two
wholly-owned subsidiaries of Cyber Digital, Inc. ("Purchaser"), a publicly
traded shell company. The planned sales are subject to the receipt of required
regulatory approvals and other closing conditions.
If the sale of our CLECs is consummated, Purchaser will acquire all the
outstanding shares of the CLECs and either pay or assume $1.3 million of
outstanding debt that we owe to Laurus Master Fund, Ltd. ("Laurus"). In the
Agreements, we have guaranteed maximum levels of negative working capital of the
CLECs and we indemnified the Purchaser against liabilities that would reduce
working capital, as defined in the Agreements, below the agreed upon levels. In
accordance with an amendment to the Agreements, if the closing of the
transaction has not occurred by April 12, 2007, we or the Purchaser may
terminate the Agreements with no penalty to the terminating party, so long as
such delay in closing the transaction is not the result of willful and material
breach by the terminating party of any of its obligations under the Agreements.
On August 4, 2004, we incorporated VoX Communications Corp. ("VoX") as
our wholly-owned IP subsidiary to pursue the deployment of our own IP network
for broadband telephony services. In addition to the general cost advantages of
broadband telephone service noted above, we believe that IP communication
technologies will continue to rapidly advance and will further the potential for
the Internet to become the preferred medium of communication and commerce.
Consequently, in fiscal 2005 and 2006 we expended a vast amount of our resources
on the planning, development and implementation of our IP network. Although we
allow individual users to purchase our broadband voice service on the VoX
website at www.voxcorp.net, we have focused our efforts on becoming a wholesale
provider of broadband voice services. As a wholesaler, we empower broadband
service providers with the ability to sell a broadband voice product to their
existing customers before the broadband voice retail companies, such as Vonage
Holdings Corp. ("Vonage") and SunRocket, Inc. try to sell their broadband voice
product. This wholesale model contains many cost advantages for us, especially
with regard to customer acquisition costs. Companies that sell broadband voice
services on a retail level typically experience significant customer acquisition
costs because of the high marketing expenses and special promotions they use to
attract an end-user who already has broadband service. We do not incur the
expense of retail customer acquisitions, as these costs are borne by our
wholesale customers. Our wholesale customers, however, often can attract retail
customers in a more cost effective manner than we can because the wholesale
customer already has a customer base of end-users who are utilizing broadband
services.
4
Available Information
We maintain a corporate website with the address www.elec.net. We also
maintain a corporate website with the address www.pervasip.com in anticipation
of our shareholders approving a name change of our company from eLEC
Communications Corp. to Pervasip Corp. We have not incorporated by reference
into this Report on Form 10-K the information on any of our websites and you
should not consider any of such information to be a part of this document. Our
website addresses are included in this document for reference only. We make
available free of charge through our corporate website our Annual Reports on
Form 10-K or 10-KSB, Quarterly Reports on Form 10-Q or Form 10-QSB and Current
Reports on Form 8-K, and amendments to these reports, through a link to the
EDGAR database, as soon as reasonably practicable after we electronically file
such material with, or furnish such material to, the Securities and Exchange
Commission.
Our Products and Services
Our broadband voice service offerings are tailored to meet the specific
needs of unique wholesale customers. We focus on marketing to wholesale accounts
that have an existing customer base of residential and small business users. We
believe we provide compelling product offerings to Cable Operators, CLECs,
Internet Service Providers ("ISPs"), and other broadband service providers, as
we enable them to quickly roll out private-labeled broadband voice solutions to
their residential and small business customers. We have identified approximately
3,000 U.S. independent cable companies that can use our product. Many of these
companies are already providing high-speed Internet access to their customers.
As a result, we believe upselling broadband voice services to their broadband
subscribers is a natural fit. Under our private label program, we provide each
reseller with its own customer support web site, allowing them to offer a
transparent user experience for customers without risking their own capital on
expensive switches and custom IP software. Our broadband voice solution offers
each reseller:
o Rapid market entry in U.S. and eventually worldwide
o High-quality, reliable voice services
o Disruptive technology
o Free use of our softswitch and application servers
o Low priced services
o Flexibility to change platform to needs of individual carrier
o Customer service web site
o End user web site
o Automatic sign-up on the Internet
Our retail customers consist of small businesses and residential users.
These customers consist primarily of our landline customers. Our broadband voice
services are available nationwide, while our landline services are limited to
the states of New Jersey, New York and Pennsylvania. We primarily market our
services through two distribution channels. We use third-party telemarketers to
attract small business and residential accounts (typically less than three
telephone lines for each account), and we use agents and direct marketing to
attract small business and residential accounts (typically one to 10 lines in
size for each account). To further help our customers manage their phone
service, and to differentiate
5
ourselves from other service providers, we provide a secure customer web site
with the tools to help our customers to manage their accounts. These tools
include the following:
o Billing management: we provide customers with Web-based access to
billing records, invoices, payment history and individual call records;
o Payment processing: we provide customers with the ability to process or
change secure credit card information over the Web to make payments to
us;
o Account provisioning: we provide customers with Web pages through which
they can order new services, new phone numbers, including virtual
numbers, and advanced features;
o Customer care: we provide customers with first tier customer care to
explain how to use features, to perform simple diagnostic checks and
repairs and to contact us via email.
The pricing and robust nature of our feature packages also help to
differentiate us from our competitors. For landline customers, we offer the same
calling features offered by the Incumbent Local Exchange Carrier ("ILEC") from
which we are buying and reselling services, but we charge less for each of the
features. We also bundle certain key features, such as Caller ID and Call
Waiting, in an unlimited monthly calling plan. For our broadband voice
customers, we offer differentiating features, such as fax lines and toll free
numbers. The following features are offered to our broadband voice customers, at
no extra charge:
o 911 Dialing
o Voicemail
o Caller ID
o Call Waiting
o Call Forwarding
o Three Way Calling
o Free In-Network Calls
o Call Return
o Caller ID Block
o International Call Blocking
o Directory Assistance Blocking
o Do Not Disturb
o Speed Dial
o Online Account Management
For an additional competitive charge, our broadband voice customers can receive
additional premium features, such as:
o 411 Directory Assistance
o Virtual numbers
o Local number portability
Our Network
We operate a sophisticated IP network to deliver our broadband voice
services. We carefully monitor the network as it automatically minimizes the
route taken by packets carrying a voice conversation, and self-regulates traffic
volumes to directly control the quality of service from the origination to the
termination of a call. Calls are connected on our network with minimal post dial
delay
6
and our G.729 compression yields virtually no jitter. When compared to other
broadband voice carriers, or wireline connections, we deliver a high quality
call. Our softswitch utilizes advanced SIP infrastructure on a cluster of SIP
servers and has the ability to scale at a low cost. We believe the collective
thought process of our SIP servers makes us unique, as our servers are capable
of "thinking" about what they are doing and will perform self-healing functions
when necessary to ensure a call is not dropped. Unlike many of our competitors,
we do not rely on Microsoft to power our softswitch. By using our own
open-source software platform, we are able to update the network as needed,
avoid the delays of waiting for software upgrades from Microsoft and avert the
problems associated with having too much reliance on one vendor in order to run
our network.
We consider voice to be an application on an IP transport. Our network
does not use the mainframe technology approach that Sonus Networks, Inc. or
BroadSoft, Inc. promotes. Instead, we have a fully-scalable, redundant,
power-backed stable platform with a server farm that contains no specifically
designed telecom equipment. By not relying on the telecom equipment and related
software of the larger equipment vendors, we are able to own and control our own
proprietary source code and to scale without the limitations and delays
associated with equipment financing, installation, integration and source code
updates that equipment vendors impose on other broadband voice carriers. Our
approach is very similar to the server cluster type of approach that has
provided Google, Inc. substantial computing resources at a relatively low cost.
Business Strategy
Our objective is to build a profitable telephone company on a stable
and scalable platform with minimal network costs. We want to be known for our
high quality of service, robust features and ability to deliver any new product
to a wholesale customer or a web store without delay. We believe that to achieve
our objective we need to have "cradle to grave" automation of our back-office
web and billing systems. We have written our software for maximum automation,
flexibility and changeability.
We know from experience in provisioning complex telecom orders that
back-office automation is a key factor in keeping overhead costs low. Technology
continues to work for 24 hours a day and we believe that the fewer people a
company has in the back office, the more efficiently it can run, which should
drive down the cost per order.
Furthermore, our strategy is to grow rapidly by leveraging the capital,
customer base and marketing strength of our wholesale customers. Many of our
targeted wholesale customers and some of our existing wholesale customers have
ample capital to market a private-labeled broadband voice product to their
existing customer base or to new customers. We believe our strength is our
technology-based platform. By providing our technology to cable companies,
CLECs, ISPs, WiFi and fixed-wireless broadband providers, data integrators,
value-added resellers, and satellite broadband providers and any other entity
that desires to offer a broadband telephony product, we believe we will require
significantly less cash resources than other providers will require to attract a
similar number of subscribers.
By taking a wholesale approach, our goal is to obtain and manage 500
customers that have an average customer base of 1,000 end-users. We believe we
will be more successful and more profitable taking this approach to reaching
500,000 end-users than we would be if we tried to attract and manage 500,000
individual end-users by ourselves.
7
Sales and Marketing
In establishing our broadband voice business, we do not want our
selling price to be the only reason we win a wholesale customer. We do not
intend to be the broadband voice carrier that sells services at the lowest
price. We believe the price savings that broadband voice services offer our
customers, when compared to traditional wireline telephone services, provides a
significant monetary value that will help us attract customers. In addition to
our price advantage over traditional wireline services, we believe we have a
stable, high-quality, feature-rich service that allows us to distinguish
ourselves from lower-priced alternatives. Our extensive pool of local telephone
numbers that we offer broadband carriers in remote areas, coupled with the
customization of our customer web portals, helps to create an attractive
offering for broadband carriers. In addition to our in-house staff of sales
professional, we partner with various resellers, wholesalers and referral
channels to assist in the sale of our services.
Competition
The communications industry is highly competitive and the market for
enhanced Internet and IP communications services is new and rapidly evolving. We
believe the primary competitive factors that will determine our success in the
Internet and IP communications market are:
o Quality of service
o Responsive customer care services
o Ability to provide customers with a telephone number in their local
calling area
o Pricing levels and policies
o Ability to provide E911 and 911 service
o Bundled service offerings
o Innovative features
o Ease of use
o Accurate billing
o Brand recognition
o Quality of analog telephone adapter ("ATA") supported by us and used by
our customer
Future competition could come from a variety of companies, both in the
Internet and telecommunications industries. This includes major companies that
have been in operation for many years and have greater resources and larger
subscriber bases than we have, as well as companies operating in the growing
market of discount telecommunications services, including calling cards and
prepaid cards. In addition, some Internet service providers have begun to
aggressively enhance their real- time interactive communications, and are
focusing initially on instant messaging, with the intent to progress toward
providing PC-to-Phone services and broadband telephony services.
We anticipate that competition will also come from several traditional
telecommunications companies, including industry leaders, such as AT&T Inc.,
Sprint Nextel Corporation, Deutsche Telekom AG, and Qwest Communications
International, Inc., as well as established broadband services providers, such
as Time Warner Inc., Comcast Corporation and Cablevision Inc. These companies
all have announced their intention to offer enhanced Internet and IP
communications services in both the United States and internationally. All of
these competitors are significantly larger than we are and have:
o substantially greater financial, technical and marketing resources;
o stronger name recognition and customer loyalty;
o well-established relationships with many of our target customers;
o larger networks; and
o large existing user base to cross sell new services.
8
These and other competitors may be able to bundle services and products
that are not offered by us together with enhanced Internet and IP communications
services, which could place us at a significant competitive disadvantage. Many
of our competitors enjoy economies of scale that can result in lower cost
structure for transmission and related costs, which could cause significant
pricing pressures within the industry.
Government Regulation
The FCC has jurisdiction over all U.S. telecommunications common
carriers to the extent they provide interstate or international communications
services, including the use of local networks to originate or terminate such
services. The FCC also has jurisdiction over certain issues relating to
interconnection between providers of local exchange service and the provision of
service via fixed wireless spectrum.
Universal Service - In 1997, the FCC issued an order, referred to as
the Universal Service Order, that requires all telecommunications carriers
providing interstate telecommunications services to periodically contribute to
universal service support programs administered by the FCC (the "Universal
Service Fund"). These periodic contributions are currently assessed based on a
percentage of each contributor's interstate and international end user
telecommunications revenues reported to the FCC. We, and most of our
competitors, pass through these Universal Service Fund contributions in the
price of our services, either as a separate surcharge or as part of the base
rate. In addition to the FCC universal service support mechanisms, state
regulatory agencies also operate parallel universal service support systems. As
a result, we are subject to state, as well as federal, universal service support
contribution requirements, which vary from state to state.
Interconnection and Unbundled Network Elements - The Telecommunications
Act requires ILECs to allow competitors to interconnect with their networks in a
nondiscriminatory manner at any technically feasible point on their networks at
cost-based prices, which are more favorable than past pricing based on the
historic regulated costs of the ILEC. Since the FCC's 1996 "Local Competition
Order," CLECs have enjoyed the right to lease unbundled network elements at
rates determined by state public utility commission employing the FCC's TELRIC
(Total Element Long Run Incremental Cost) forward looking, cost-based pricing
model.
The FCC's rules governing availability of ILEC unbundled network
elements to CLECs have been the subject of on-going litigation and rulemaking
proceedings. In February 2005, the FCC eliminated the availability of unbundled
local switching at TELRIC prices, and thereby eliminated the ability of CLECs to
obtain a full "UNE Platform" that provides all elements of local dial-tone
service at TELRIC prices. The FCC also limited the availability of high-capacity
loops and dedicated transport elements at TELRIC prices; these elements will now
be available only in particular markets that do not meet tests for the presence
of competitive facilities as detailed in the FCC's rules.
The FCC's unbundling rules continue to be the subject of further
litigation and could change in ways we cannot now predict, which could have a
material affect on the cost of telephony services and the business strategy of
carriers that use wirelines that are leased from the ILECs, as is the case with
our subsidiaries, NRTC and TSI.
9
Pursuant to the FCC's rules, we negotiate interconnection arrangements
with each ILEC, generally on a state-by-state basis, which allows us to sell
local telephone service over leased wirelines. While current FCC rules and
regulations require the incumbent provider to provide certain network elements
necessary for us to provision end-user services on an individual and combined
basis, we cannot assure you that the ILECs will provide these components in a
manner and at a price that will support competitive operations. If we sell NRTC
and TSI, as we have planned, we will no longer need interconnection agreements
with the ILECs in order to operate. Our Internet telephony product does not
require an interconnection agreement with the ILECs, as the Internet is our
network.
Internet Telephony - The use of the Internet and private IP networks to
provide a voice communications services is a relatively recent market
development. Although the provision of such services is currently permitted by
United States law and largely unregulated within the United States, several
foreign governments have adopted laws and/or regulations that could restrict or
prohibit the provision of voice communications services over the Internet or
private IP networks. More aggressive regulation of the Internet in general, and
Internet telephony providers and services specifically, may materially and
adversely affect our business.
On March 10, 2004, the FCC initiated a broad rulemaking proceeding
concerning the provision of voice and other services and applications utilizing
IP technology. While the Commission has not released an order in this
proceeding, it has addressed some of the questions raised by the rulemaking in
subsequent proceedings. Although the Commission has not adopted a formal
definition of broadband voice services, we use the term generally to include any
IP-enabled services offering real-time, multidirectional voice functionality,
including, but not limited to, services that mimic traditional telephony.
In June 2005, the FCC adopted rules requiring providers of broadband
voice services to provide 911 emergency access. We believe we are in compliance
with this order. In August 2005, the FCC adopted rules that these providers must
design their systems to facilitate authorized wiretaps pursuant to the
Communications Assistance to Law Enforcement Act. We anticipate that we will
continue to develop technologies as required by governmental regulation that
support emergency access and enhanced services.
In June 2006, the FCC announced that interconnected broadband voice
providers, such as VoX, would be required to contribute to the USF on an interim
basis, beginning October 2006. The Commission permitted interconnected broadband
voice providers to determine their USF contribution according to one of three
different calculation methods. Implementation of the regulatory requirements
compelled by the Commission's action take considerable time and cost, and we
cannot guarantee that we have implemented these requirements fully. If we fail
to report our revenue and remit USF on that revenue accurately, we may be
subject to late fees, penalties or other actions, which could negatively affect
our business.
Recent action by the FCC has also expanded the possibility that our
broadband voice services may become subject to state regulation, which will
likely lead to higher costs and reduce some of the competitive advantage
broadband voice services hold over traditional telecommunications services.
Regulation by state public utility commissions - Our telecommunications
services that originate and terminate within the same state, including both
local service and in-state long distance toll calls, are subject to the
jurisdiction of that state's utility commission. The Telecommunications Act of
1996 generally preempts state statutes and regulations that prevent the
provision of competitive services,
10
but permits state utility commissions to regulate the rates, terms and
conditions of intrastate services, so long as such regulation is not
inconsistent with the requirements of federal law. Our CLECs are certified to
provide facilities-based and/or resold long distance service in the states in
which we operate. In addition to requiring certification, state regulatory
authorities may impose tariff and filing requirements, consumer protection
measures, and obligations to contribute to universal service and other funds.
Rates for intrastate switched access services, which we both pay to local
exchange companies and collect from long-distance companies for originating and
terminating in-state toll calls, are subject to the jurisdiction of the state
commissions. State commissions also have jurisdiction to approve negotiated
rates, or establish rates through arbitration, for interconnection, including
rates for unbundled network elements. Changes in those access charges or rates
for unbundled network elements could have a substantial and material impact on
our business if we do not complete the sale of NRTC and TSI.
Employees
As of February 15, 2007, we employed 35 employees, of whom 34 were
employed on a full-time basis and one was employed on a part-time basis. We are
not subject to any collective bargaining agreement and we believe our
relationship with our employees is good.
Item 1A. Risk Factors
This report contains forward-looking statements that involve risks and
uncertainties, such as statements of our objectives, expectations and
intentions. The cautionary statements made in this report are applicable to all
forward-looking statements wherever they appear in this report. Our actual
results could differ materially from those discussed herein. Risk factors that
could cause or contribute to such differences include those discussed below, as
well as those discussed elsewhere in this report. In addition to the other
information contained in this Form 10-K, the following risk factors should be
considered carefully in evaluating our business. Our business, financial
condition, or results of operations may be materially adversely affected by any
of these risks. Please note that additional risks not presently known to us or
that we currently deem immaterial may also impair our business and operations.
Risks Relating to Our Business
We have incurred operating losses since inception of our telephone business and
we may be unable to achieve profitability or generate positive cash flow.
We have not generated operating profits since fiscal 1996. While we
reported net income of $170,253 and $8,323,211 in fiscal 2004 and 2003,
respectively, we reported losses from our telecommunications operations.
Furthermore, in fiscal 2006 and 2005, we reported net losses of approximately
$2,345,000 and $2,266,000, respectively. In fiscal 2004, net income of $170,253
resulted primarily from the gain of approximately $743,000 resulting from a
settlement with creditors in the bankruptcy proceedings of a subsidiary. In
fiscal 2003, net income of $8,323,211 resulted primarily from the gain on the
disposition of a subsidiary and the disposition of property of approximately
$11,306,000. In fiscal 2006, fiscal 2005 and fiscal 2004, we generated operating
losses of approximately $2,287,000 $2,402,000 and $642,000, respectively, from
our telecommunications operations. We expect to continue to incur operating
losses until we develop our telecommunications operations to a level at which it
generates sufficient revenues to cover operating expenses.
We have an unproven business model and our inability to scale our broadband
voice business could delay or prevent our future profitability.
Our business strategy is unproven and we do not know whether our
business model and strategy will be successful. We intend to sell wholesale
broadband voice services to other carriers, primarily those carriers that
already have broadband customers. We also plan to sell our wireline business by
April 12, 2007, that has generated substantially all of our revenues since
fiscal 2000. We have developed our own proprietary IP platform and for the first
time in our operating history, we are a facilities-based carrier. We believe our
network is robust and efficient, but it has not carried the hundreds of millions
of minutes that we anticipate will eventually use our network. Our inability to
scale our IP network and execute effectively as a broadband voice provider would
significantly diminish our ability to generate
11
sufficient revenue to achieve profitability.
We have a need for additional financing and without such financing we may be
forced to curtail or cease our operations or sell our business, which may cause
the value of your investment to decline.
Due to our recent operating losses and our additional requirements for
working capital to establish and grow our business, over the past several months
we have sold debt and additional shares of capital stock to fund our working
capital needs. We expect that we will continue to sell our capital stock, incur
additional indebtedness or sell other assets we currently own to fund the
anticipated growth of our telecommunications business and implement our business
objectives. There can be no assurance that we will be able to obtain additional
funding when needed, or that such funding, if available, will be available on
terms we find acceptable. If we cannot obtain additional funds when needed, we
may be forced to curtail or cease our activities, or sell our business, which
may result in the loss of all or a substantial portion of your investment.
We depend on other carriers as a key component for our business and any failure
of these carriers to continue service to us could damage our reputation and
cause us to lose customers .
To limit our capital expenditures and support staff, we rely
extensively on third parties. For our CLECs, we lease our local exchange network
and our long distance network. As a result, we depend entirely on incumbent
carriers for the transmission of customer telephone calls for our CLEC
subsidiaries. The risk factors inherent in this approach include, but are not
limited to, the following:
o the inability to negotiate and renew favorable wholesale agreements;
o lack of timeliness of the ILEC in processing our orders for
customers seeking to utilize our services;
o dependence on the effectiveness of internal and external
telemarketing services to attract new customers;
o dependence on third-party contractors to install necessary equipment
and wiring at our customers facilities; and
o dependence on a facilities-based carrier to provide our customers
with repair services and new installation services.
If we are successful in selling our CLECs this year, we will still be
reliant on third party carriers in conjunction with the operations of our IP
network.
We depend on a third-party billing system to bill our wireline customers and we
are exposed to a loss of revenues and customers if we cannot generate timely and
accurate invoices to our customers.
The accurate and prompt billing of our customers is essential to our
operations and future profitability. Our CLECs utilize a third-party system for
billing, tracking and customer service. Our former Chairman, who beneficially
owns stock in our company, is the Chairman and CEO of our billing company, and
we believe that all transactions with this company are at arms-length. The
system is designed to provide us with a high degree of flexibility to handle
custom rate plans that provide consumers discounts from the incumbent local
carriers' rate plans or bundled plans that include various
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features and long distance services. Although we believe the system is very
functional, it is currently set up to support approximately 500,000 local lines
in six states, and its ability to handle substantially more customers is not
fully tested. In addition, the billing company we utilize competes with us as a
CLEC and may terminate its billing services at any time. Furthermore, in the
most recent quarterly financial statements of the billing company we utilize,
the billing company reported a quarterly loss of $932,409 and negative working
capital of $832,760, raising some doubt about its ability to continue as a going
concern. This strategy exposes us to various risks that include, but are not
limited to, the following:
o the inability to adapt the billing system to process the number of
customers we are targeting in our marketing plans;
o the failure of the system to provide all of the billing services
that we require;
o the possibility that the billing company could hinder the
anticipated sale of our CLECs;
o the possibility that we may need to quickly engage a new billing
company to process our invoices to our customers, and devote a large
amount of internal resources at one time to work on this transition.
A portion of our business is dependent upon our ability to resell long distance
services, for which we currently rely on only one third-party carrier, and any
service disruption form this carrier could cause us to lose customers and
revenues.
Our CLECs offer long distance telephone services as part of their
service package. We currently have a wholesale agreement with only one long
distance carrier to provide transmission and termination services for all of our
long distance traffic. Recently, several long distance carriers have encountered
financial difficulties, including the carrier utilized by us. Financial
difficulties encountered by our current carrier or any other carrier with which
we are negotiating could cause disruption to our operations and loss of
customers and revenues.
We could be liable for breaches of security on our web site, fraudulent
activities of our users, or the failure of third-party vendors to deliver credit
card transaction processing services.
A fundamental requirement for operating a customer-friendly CLEC and an
internet-based, worldwide voice service is the secure transmission of
confidential information over public networks. Although we have developed
systems and processes that are designed to protect consumer information and
prevent fraudulent credit card transactions and other security breaches, failure
to mitigate such fraud or breaches may adversely affect our operating results.
The law relating to the liability of providers of online payment services is
currently unsettled. We rely on third party providers to process and guarantee
payments made by our customers up to certain limits, and we may be unable to
prevent our users from fraudulently receiving goods and services. Any costs we
incur as a result of fraudulent transactions could harm our business. In
addition, the functionality of our current billing system relies on certain
third-party vendors delivering services. If these vendors are unable or
unwilling to provide services, we will not be able to charge for our services in
a timely or scalable fashion.
We may face difficulties managing our anticipated rapid expansion, which would
adversely affect our operations.
13
We are attempting to grow our business rapidly in terms of the number
of services we offer, the number of customers we serve and the regions we serve.
In particular, we are expending substantial sums to expand our broadband voice
services, including the utilization of international routes. There can be no
assurance that our marketing initiatives will proceed as expected or that they
will be successful, particularly in light of the legal and regulatory and
competitive uncertainties described elsewhere in this report. Furthermore, there
is no assurance that we will successfully manage our efforts to:
o expand, train, manage and retain our employee base;
o expand and improve our customer service and support systems;
o introduce and market new products and services and new pricing
plans;
o capitalize on new opportunities in the competitive marketplace; or
o control our expenses.
The strains posed by these new demands are magnified by the emerging
nature of our operations. If we cannot manage our growth effectively, our
results of operations could be adversely affected.
The failure of our customers to pay their bills on a timely basis could
adversely affect our cash flow.
Our target customers consist primarily of broadband service providers.
Although we required a deposit for most accounts, we give credit limits in
excess of the deposited amounts and we offer payment terms. We may experience
difficulty in collecting amounts due on a timely basis, especially if
competition on the broadband services market becomes more intense. Our failure
to collect accounts receivable owed to us by our customers on a timely basis
could have a material adverse effect on our business, financial condition,
results of operations and cash flow.
Acquisitions could divert management's time and attention, dilute the voting
power of existing shareholders and have a material adverse effect on our
business.
As part of our growth strategy, we may continue to acquire
complementary businesses and assets. Acquisitions that we may make in the future
could result in the diversion of time and personnel from our business. We also
may issue shares of common stock or other securities in connection with
acquisitions, which could result in the dilution of the voting power of existing
shareholders and could dilute earnings per share. Any acquisitions would be
accompanied by other risks commonly encountered in such transactions, including
the following:
o difficulties integrating the operations and personnel of acquired
companies;
o the additional financial resources required to fund the operations
of acquired companies;
o the potential disruption of our business;
o our ability to maximize our financial and strategic position by the
incorporation of acquired technology or businesses with our product
and service offerings;
o the difficulty of maintaining uniform standards, controls,
procedures and policies;
14
o the potential loss of key employees of acquired companies;
o the impairment of employee and customer relationships as a result of
changes in management; and
o significant expenditures to consummate acquisitions.
As a part of our acquisition strategy, we may engage in discussions
with various businesses respecting their potential acquisition. In connection
with these discussions, we and each potential acquired business may exchange
confidential operational and financial information, conduct due diligence
inquiries, and consider the structure, terms and conditions of the potential
acquisition. In certain cases, the prospective acquired business may agree not
to discuss a potential acquisition with any other party for a specific period of
time, may grant us certain rights in the event the acquisition is not completed,
and may agree to take other actions designed to enhance the possibility of the
acquisition. Potential acquisition discussions may take place over a long period
of time, may involve difficult business integration and other issues, and may
require solutions for numerous family relationship, management succession and
related matters. As a result of these and other factors, potential acquisitions
that from time to time appear likely to occur may not result in binding legal
agreements and may not be consummated. Our acquisition agreements may contain
purchase price adjustments, rights of set-off and other remedies in the event
that certain unforeseen liabilities or issues arise in connection with an
acquisition. These remedies, however, may not be sufficient to compensate us in
the event that any unforeseen liabilities or other issues arise.
We need to retain key management personnel and hire additional qualified
personnel. We are dependent on the efforts of our executive officers and senior
management and on our ability to hire and retain qualified management personnel.
A small number of key management and operating employees and
consultants manage our telecommunications business. Our loss of such employees
or consultants or their failure to work effectively as a team could materially
adversely impact our telecommunications business. Competition for qualified
executives in the telecommunications and data communication industries is
intense and there are a limited number of persons with applicable experience. We
believe that our future success in the telecommunications business significantly
depends on our ability to attract and retain highly skilled and qualified
telecommunications personnel. We have not entered into employment agreements
with any of our senior officers. The loss of any of Paul H. Riss, our Chief
Executive Officer, or Mark Richards, our Chief Information Officer and the
President of our Vox Communications subsidiary, or the loss of one or more
programmers or engineers employed by Vox could adversely affect our business.
We may be unable to adapt to rapid technology trends and evolving industry
standards, which would limit our growth.
The communications industry is subject to rapid and significant changes
due to technology innovation, evolving industry standards, and frequent new
service and product introductions. New services and products based on new
technologies or new industry standards expose us to risks of technical or
product obsolescence. We will need to use technologies effectively, continue to
develop our technical expertise and enhance our existing products and services
in a timely manner to compete successfully and grow our business. We may not be
successful in using new technologies effectively, developing new products or
enhancing existing products and services in a timely manner or that any new
technologies or enhancements used by us or offered to our customers will achieve
market acceptance.
15
The telecommunications industry is highly regulated and amendments to or repeals
of existing regulations or the adoption of new regulations could adversely
affect our business, financial condition or results of operations.
Federal, state and local regulation may affect our telecommunications
business. Since regulation of the telecommunications industry is frequently
changing, we cannot predict whether, when and to what extent new regulations
will affect us. The following factors, among others, may adversely affect our
business, financial condition and results of operations:
o delays in obtaining required regulatory approvals;
o new court decisions;
o the enactment of new adverse regulations; and
o the establishment of strict regulatory requirements.
The communications services industry is highly competitive and we may be unable
to compete effectively, which could delay or prevent our future profitability.
The communications industry, including Internet and data services, is
highly competitive, rapidly evolving and subject to constant technological
change and intense marketing by providers with similar products and services. We
expect that new competitors are likely to join existing competitors in the
communications industry, including the market for broadband voice, Internet and
data services. Many of our current competitors are significantly larger and have
substantially greater market presence, as well as greater financial, technical,
operational, marketing and other resources and experience, than we do. In the
event that such a competitor expends significant sales and marketing resources
in one or several markets, we may not be able to compete successfully in such
markets. We believe that competition will continue to increase, placing downward
pressure on prices. Such pressure could adversely affect our gross margins if we
are not able to reduce our costs commensurate with such price reductions. In
addition, the pace of technological change makes it impossible for us to predict
whether we will face new competitors using different technologies to provide the
same or similar services offered or proposed to be offered by us. If our
competitors were to provide better and more cost effective services than ours,
our business initiatives could be materially and adversely affected.
Industry consolidation could make it more difficult for us to compete and limit
our growth.
Companies offering Internet, data and communications services are, in
some circumstances, consolidating. We may not be able to compete successfully
with businesses that have combined, or will combine, to produce companies with
substantially greater financial, sales and marketing resources, larger client
bases, extended networks and infra-structures and more established relationships
with vendors, distributors and partners than we have. With these heightened
competitive pressures, there is a risk that our financial performance could be
adversely impacted and the value of our common stock could decline.
Our inability to adjust to new product developments and rapid technological
changes would negatively impact our ability to grow our broadband voice
business.
IP telephony is an emerging market that is characterized by rapid
changes in customer requirements, frequent introductions of new and enhanced
products, and continuing and rapid
16
technological advancement. To compete successfully in this emerging market, we
must continue to design, develop and sell new and enhanced software products and
services that provide increasingly higher levels of performance and reliability
at lower cost. These new and enhanced products must take advantage of
technological advancements and changes, and respond to new customer
requirements. Our success in designing, developing and selling such products and
services will depend on a variety of factors, including:
o the identification of market demand for new products;
o the scalability of our IP telephony software products;
o product and feature selection;
o timely implementation of product design and development;
o product performance;
o cost-effectiveness of products under development;
o effective distribution processes; and
o success of promotional efforts.
Additionally, we may also be required to collaborate with third parties
to develop our products and may not be able to do so on a timely and
cost-effective basis, if at all. We have in the past experienced delays in the
development of new products and the enhancement of existing products, and such
delays will likely occur in the future. If we are unable, due to resource
constraints or technological or other reasons, to develop and introduce new or
enhanced products in a timely manner, if such new or enhanced products do not
achieve sufficient market acceptance, or if such new product introductions
decrease demand for existing products, our operating results would decline and
our business would not grow.
If broadband voice technology fails to gain acceptance among mainstream
consumers, our ability to grow our business will be limited.
If the market for IP-based communications and the related services that
we will make available does not grow at the rate we anticipate or at all, we
will not be able to realize our anticipated revenues with respect to our
broadband phone service. To be successful, IP-based communications require
validation as an effective means of communication and as a viable alternative to
traditional phone service. Demand and market acceptance for newly introduced
services are subject to a high level of uncertainty. The Internet may not prove
to be a viable alternative to traditional phone service for reasons including:
o inconsistent quality or speed of service;
o traffic congestion on the Internet;
o potentially inadequate development of the necessary infrastructure;
o lack of acceptable security technologies;
17
o lack of timely development and commercialization of performance
improvements; and
o unavailability of cost-effective, high-speed access to the Internet.
Future legislation or regulation of the Internet and/or broadband voice services
could restrict our business, prevent us from offering service or increase our
cost of doing business.
At present there are few laws, regulations or rulings that specifically
address access to or commerce on the Internet, including broadband voice
services. We are unable to predict the impact, if any, that future legislation,
legal decisions or regulations concerning the Internet may have on our business,
financial condition or results of operations. Regulation may be targeted toward,
among other things, assessing access or settlement charges, imposing taxes
related to Internet communications, imposing tariffs or regulations based on
encryption concerns or the characteristics and quality of products and services,
imposing additional regulations and requirements related to the handling of
emergency 911 services, any of which could restrict our business or increase our
cost of doing business. The increasing growth of the broadband voice services
market and popularity of a variety of new wireless IP products and services
heighten the risk that governments or other legislative bodies will seek to
further regulate IP telephony and the Internet. In addition, large, established
telecommunication companies may devote substantial lobbying efforts to influence
the regulation of the broadband IP telephony market, which may be contrary to
our interests.
Many regulatory actions are underway or are being contemplated by
federal and state authorities, including the FCC and other state regulatory
agencies. There is risk that a regulatory agency may require us to conform to
rules that are unsuitable for broadband voice communications technologies or
rules that cannot be complied with due to the nature and efficiencies of IP
routing, or are unnecessary or unreasonable in light of the manner in which we
offer service to our customers. It is not possible to separate the Internet, or
any service offered over it, into intrastate and interstate components. While
suitable alternatives may be developed in the future, the current IP network
does not enable us to identify the geographic nature of the traffic traversing
the Internet.
Our emergency calling services are different from those offered by traditional
wireline telephone companies and may expose us to significant liability.
Our 911 calling service is more limited, in certain areas, than the
emergency calling services offered by traditional wireline telephone companies.
In each case, those differences may cause significant delays, or even failure,
in a caller's receipt of the emergency assistance he or she needs.
Traditional wireline telephone companies route emergency calls over a
dedicated infrastructure directly to an emergency services dispatcher at the
public safety answering point, or PSAP, in the caller's area. Generally, the
dispatcher automatically receives the caller's phone number and actual location
information. While our 911 service being deployed in the United States is
designed to route calls in a fashion similar to traditional wireline services,
our 911 capabilities may not reach the intended PSAP, although we do have
procedures in place to ensure that a dispatcher somewhere is reached. In
addition, the only location information that our E911 service can transmit to a
dispatcher at a PSAP is the information that our customers have registered with
us. A customer's registered location may be different from the customer's actual
location at the time of the call because customers can use their enabled ATA
device to make calls almost anywhere a broadband connection is available. In
such cases, as described below, we offer customers alternative access to
emergency services.
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We are also providing E911 service that is comparable to the emergency
calling services obtained by customers of traditional wireline telephone
companies in the same area. For those customers, emergency calls are routed,
subject to the limitations discussed below, directly to an emergency services
dispatcher at the PSAP in the area of the customer's registered location. The
dispatcher will have automatic access to the customer's telephone number and
registered location information. However, if a customer places an emergency call
using the customer's enabled ATA device and the device is in a location
different from the one registered with us, the E911 system will still route the
call to a dispatcher in the registered location, not the customer's actual
location at the time of the call. Every time a customer moves his or her enabled
ATA device to a new location, the customer's registered location information
must be updated and verified. Until that takes place, the customer will have to
verbally advise the emergency dispatcher of his or her actual location at the
time of the call and wait for the call to be transferred, if possible, to the
appropriate local emergency response center before emergency assistance can be
dispatched.
In some cases, even under our E911 service, emergency calls may be
routed to a local PSAP, designated statewide default answering point or
appropriate local emergency authority that is not capable of receiving our
transmission of the caller's registered location information and, in some cases,
the caller's phone number. Where the emergency call center is unable to process
the information, the caller is provided a service that is similar to the basic
911 services offered to some wireline telephone customers. In these instances,
the emergency caller may be required to verbally advise the operator of his or
her location at the time of the call and, in some cases, a call back number so
that the call can be handled or forwarded to an appropriate emergency
dispatcher. We are continuing our efforts to deploy our E911 service such that
all relevant information is displayed and will be routed to the appropriate PSAP
in the first instance.
Customers who are located in areas in which we are currently unable to
provide either E911 or the basic 911 described above, as well as WiFi telephone
and SoftPhone users, are supported by a national call center that is run by a
third-party provider and operates 24 hours a day, seven days a week. When
reaching the call center, a caller must provide his or her physical location and
call back number, after which an operator will coordinate connecting the caller
to the appropriate PSAP or emergency services provider.
Our softswitching platform and back office systems are technologically
advanced and the essential service delivery of providing emergency call handling
is of paramount importance to us. We have developed a web portal where
subscribers can maintain the flexibility of providing us with a currently
correct physical location should they take the ATA device away from the
registered location. We cannot guarantee they will actually remember to enter
this information in the web portal when they move their ATA device, and if they
do not make this update, the emergency call will be routed to the address that
was previously notified. This flexibility, along with the ability to call into
our customer support call center to update the address, is compliant with the
current requirements of the FCC regarding emergency calling.
If one of our customers experiences a broadband or power outage, or if
a network failure were to occur, the customer will not be able to reach an
emergency services provider.
Delays our customers encounter when making E911 or basic 911 calls and
any inability of the answering point to automatically recognize the caller's
location or telephone number can have devastating consequences. Customers may in
the future attempt to hold us responsible for any loss, damage, personal injury
or death suffered as a result. Some traditional telephone companies also may be
19
unable to provide the precise location or the caller's telephone number when
their customers place emergency calls. However, while we are not covered by
legislation exempting us from liability for failures of our emergency calling
services, traditional telephone companies are covered. This liability could be
significant. In addition, we have lost, and may in the future lose, existing and
prospective customers because of the limitations inherent in our emergency
calling services. Any of these factors could cause us to lose revenues, incur
greater expenses or cause our reputation or financial results to suffer.
The success of our planned expansion is dependent upon market developments and
usage patterns which are needed in order for us to efficiently utilize our
network equipment.
Our purchase of network equipment and placement of our IP telephony
software will be based in part on our expectations concerning future revenue
growth and market developments. As we expand our network, we will be required to
make capital expenditures, in addition to making financial commitments for DS-3
circuits and colocation space, and to add additional employees. If our traffic
volume were to decrease, or fail to increase to the extent expected or necessary
to make efficient use of our network, our costs as a percentage of revenues
would increase significantly, which would have a materially adverse effect on
our financial condition and results of operations.
Regulation of VoIP services is developing and therefore uncertain, and future
legislative, regulatory or judicial actions could adversely impact our business
and expose us to liability.
To date, the FCC has treated Internet service providers as information
service providers. Information service providers are currently exempt from
federal and state regulations governing common carriers, including the
obligation to pay access charges. The FCC is currently examining the status of
Internet service providers and the services they provide. If the FCC were to
determine that Internet service providers, or the services they provide, are
subject to FCC regulation, including the payment of access charges or other
fees, it could have a material adverse effect on our business, financial
condition and operating results.
If our network is unable to handle a large number of simultaneous calls, our
growth will be limited.
We expect the volume of simultaneous calls to increase significantly as
our broadband voice subscriber base grows. Our network hardware and software may
not be able to accommodate this additional volume. If we fail to maintain an
appropriate level of operating performance, or if our broadband voice service is
disrupted, our reputation could be hurt and we could lose customers, which could
have a material adverse effect on our business, financial condition and results
of operations.
Our growth in our broadband voice business is dependent upon our ability to
build new relationships with a wide range of other carriers and to bring on new
customers.
Our ability to grow through quick and cost effective deployment of our
broadband voice services is due, in part, to our ability to create new
agreements with other carriers that can provide us with telephone numbers and
termination service. We also will need to sign contracts with new customers,
and, in many cases, to enter into joint venture or strategic agreements with
local partners, as well as to satisfy newly enacted regulatory requirements to
operate in emerging markets. While we pursue several opportunities
simultaneously, we might not be able to create the necessary partnerships and
interconnections, expand our customer base, deploy networks and generate
profitable traffic over these networks within the time frame envisioned.
20
We are pursuing new business lines that require specialized skill sets. Our
ability to effectuate our business plan is due, in part, to the roll out of new
services.
Our ability to deploy new products and services may be hampered by
technical and operational issues that could delay our ability to derive
profitable revenue from these service offerings. These issues include our
ability to competitively price such products and services. In addition, certain
broadband voice service offerings are relatively new in our industry and their
market potential is relatively untested. Additionally, our ability to market
these products and service offerings may prove difficult. To date, our customers
use only approximately 3,000,000 minutes per month on our IP network. As a
result we have derived limited revenue from our broadband voice service
offerings, and there can be no assurance that we will increase our current focus
and/or derive significant revenue from such offerings.
We rely on third party equipment suppliers and the failure of such equipment
could cause interruptions of our service, damage our reputation, cause us to
lose customers and limit our growth.
We are dependent on third party equipment suppliers for equipment, IP
phones and adapter devices, including companies such as UTStarcom Inc., and
Cisco Systems, Inc. If these suppliers fail to continue product development or
research and development or fail to deliver quality products or support services
on a timely basis, or we are unable to develop alternative sources, if and as
required, our financial condition or results of operations could be materially
adversely impacted.
We may not be able to maintain adequate customer care during periods of growth
or in connection with our addition of new and complex IP devices, which could
adversely affect our ability to grow and cause our financial results to be
negatively impacted.
Good customer care is important to acquiring and retaining customers.
As we continue to grow our broadband voice business, we will need to expand our
customer care operations quickly enough to meet the needs of our increased
customer base. We may face additional challenges in training our customer care
staff. If we are unable to hire, train and retain sufficient personnel to
provide adequate customer care, we may experience slower growth, increased costs
and higher churn levels, which would cause our financial results to be
negatively impacted.
If we are unable to improve our process for local number portability
provisioning, our growth may be negatively impacted.
We support local number portability for our customers, which allow our
customers to retain their existing telephone numbers when subscribing to our
services. Transferring numbers is a manual process that in the past could have
taken us 20 business days or longer, although we have taken steps to automate
this process to reduce the delay. A new VoX customer must maintain both VoX
service and the customer's existing telephone service during the transferring
process. By comparison, transferring wireless telephone numbers among wireless
service providers generally takes several hours, and transferring wireline
telephone numbers among traditional wireline service providers generally takes a
few days. The additional delay that we experience is due to our reliance on the
telephone company from which the customer is transferring and to the lack of
full automation in our process. Further, because VoX is not a regulated
telecommunications provider, it must rely on the telephone companies, over whom
we have no control, to transfer numbers. Local number portability is considered
an important feature by many potential customers, and if we fail to reduce
related delays, we may experience increased difficulty in acquiring new
customers.
21
Our failure to adequately protect our proprietary rights may adversely affect
our business, increase our costs and limit our sales growth.
We rely on unpatented trade secrets and know-how to maintain our
competitive position. Our inability to protect these secrets and know-how could
have a material adverse effect on our business and prospects. We protect our
proprietary information by entering into confidentiality agreements with
employees and consultants and business partners. These agreements may be
breached or terminated. In addition, third parties, including our competitors,
may assert infringement claims against us. Any of such claims could result in
costly litigation, divert management's attention and resources, and require us
to pay damages and/or to enter into license or similar agreements under which we
could be required to pay license fees or royalties.
Flaws in our technology and systems could cause delays or interruptions of
service, damage our reputation, cause us to lose customers and limit our growth.
Our operations depend upon our ability to support a highly complex
network infrastructure and avoid damage from fires, earthquakes, floods, power
losses, excessive sustained or peak user demand, telecommunications failures,
network software flaws, computer worms and viruses, transmission cable cuts and
similar events. The occurrence of a natural disaster or other unanticipated
interruption of service at our facilities could cause interruptions in our
services. In addition, failure of a traditional telephone company, competitive
telecommunications company or other service provider to provide communications
capacity or other services that we require, as a result of a natural disaster or
other unanticipated interruptions, operational disruption or any other reason,
could cause interruptions in our services. Any damage or failure that causes
sustained interruptions in our operations could have a material adverse effect
on our business.
A breach of our network security could result in liability to us and deter
customers from using our services
Our network may be vulnerable to unauthorized access, computer viruses
and other disruptive problems. Any of the foregoing problems could result in
liability to us and deter customers from using our service. Unauthorized access
could jeopardize the security of confidential information stored in the computer
systems of our customers. Eliminating computer viruses and alleviating other
security problems may require interruptions, delays or cessation of service to
our customers, cause us to incur significant costs to remedy the problem, and
divert management's attention. We can provide no assurance that the security
measures we have implemented will not be circumvented or that any failure of
these measures will not have a material adverse effect on our ability to obtain
and retain customers. Any of these factors could have a material adverse effect
on our business and prospects.
We may not be able to obtain sufficient or cost-effective termination capacity
to particular destinations, causing us to lose customers and limit our growth.
Most of our telecommunications traffic is terminated through
third-party providers. In order to support our minutes-of-use demands and
geographic expansion, we may need to obtain additional termination capacity or
destinations. We may not be able to obtain sufficient termination capacity from
high-quality carriers to particular destinations or may have to pay significant
amounts to obtain such capacity. This could result in our not being able to
support our minutes-of-use demands or in a higher cost-per-minute to particular
destinations, which could adversely affect our revenues and margins.
We are subject to acts of God, war, sabotage and terrorism risk.
Acts of God, war, sabotage and terrorist attacks or any similar risk
may affect our operations in unpredictable ways, including disruptions of the
behavior of our customers, changes in the insurance markets and disruptions of
markets. Acts of God, war and risk of war also have an adverse effect on the
economy. Instability in the financial markets as a result of war, sabotage or
terrorism could adversely affect our ability to raise capital, as well as
adversely affect the industries in which we do business and restrict their
future growth.
22
Risks Relating to Our Common Stock
Disappointing quarterly revenue or operating results could cause the price of
our common stock to fall.
Our quarterly revenue and operating results are difficult to predict
and may fluctuate significantly from quarter to quarter. If our quarterly
revenue or operating results fall below the expectations of investors or
security analysts, the price of our common stock could fall substantially. Our
quarterly revenue and operating results may fluctuate as a result of a variety
of factors, many of which are outside our control, including:
o the amount and timing of expenditures relating to the rollout of
our service offerings;
o our ability to obtain, and the timing of, necessary regulatory
approvals;
o the rate at which we are able to attract customers within our
target markets and our ability to retain these customers at
sufficient aggregate revenue levels;
o our ability to deploy our network on a timely basis;
o the availability of financing to continue our expansion;
o technical difficulties or network downtime;
o the timing of the implementation of additional points of presence
for our IP services; and
o the introduction of new services or technologies by our
competitors and resulting pressures on the pricing of our
service.
We do not intend to pay dividends on our common stock in the foreseeable future,
which could cause the market price of our common stock and the value of your
investment to decline.
We expect to retain earnings, if any, to finance the expansion and
development of our business. Our Board of Directors will decide whether to make
future cash dividend payments. Such decision will depend on, among other things,
the following factors:
o our earnings;
o our capital requirements;
o our operating condition;
o our financial condition; and
23
o our compliance with various financing covenants to which we are
or may become a party. Our agreement with our primary lender
currently precludes the payment of dividends.
The market for our common stock is thinly traded, which could result in
fluctuations in the value of our common stock.
Although there is a public market for our common stock, the market for
our common stock is thinly traded. The trading prices of our common stock could
be subject to wide fluctuations in response to, among other events and factors,
the following:
o variations in our operating results;
o sales of a large number of shares by our existing shareholders;
o announcements by us or others;
o developments affecting us or our competitors; and
o extreme price and volume fluctuations in the stock market.
Our common stock price is likely to be highly volatile, which could cause the
value of your investment to decline.
The market price of our common stock is likely to be highly volatile as
the stock market in general, and the market for small cap and micro cap
technology companies in particular, has been highly volatile. For example,
during the last 12 months our common stock has traded at prices ranging from
$0.16 to $0.50 per share. Investors may not be able to resell their shares of
our common stock following periods of volatility because of the market's adverse
reaction to volatility. We cannot assure you that our common stock will trade at
the same levels of our stocks in our industry or that our industry stocks in
general will sustain their current market prices. Factors that could cause such
volatility may include, among other things:
o actual or anticipated fluctuations in our quarterly operating
results;
o large purchases or sales or our common stock;
o announcements of technological innovations;
o changes in financial estimates by securities analysts;
o investor perception of our business prospects;
o conditions or trends in the telecommunications industry;
o changes in the market valuations of other industry-related
companies;
24
o the acceptance of market makers and institutional investors of
our business model and our common stock; and
o worldwide economic or financial conditions.
Effect of certain charter provisions could cause the value of your investment to
decline.
Authority of Board of Directors to Issue Preferred Stock. Pursuant to
the terms of our charter, our Board of Directors has the authority to issue up
to 1,000,000 shares of preferred stock in one or more series. Our Board of
Directors may also determine the prices, rights, preferences, privileges and
restrictions, including voting rights, of the shares within each series without
any further shareholder vote or action. The rights of the holders of our
preferred stock may adversely affect the rights of the holders of common stock.
While the issuance of such preferred stock could facilitate possible
acquisitions and other corporate activities, it could also impede a third
party's ability to acquire control of our company.
Limitation of Liability of Directors. Pursuant to the terms of our
charter and to the extent New York law permits, we and our shareholders may not
hold our directors personally liable for monetary damages in the event of a
breach of fiduciary duty.
Provisions of New York law may discourage a takeover attempt even if doing so
may be beneficial to our shareholders.
Certain anti-takeover provisions of New York law could delay or hinder
a change of control of our company. While such provisions generally facilitate
our Board of Directors' ability to maximize shareholder value, they may
discourage takeovers that could be in the best interest of certain shareholders.
Such provisions could adversely affect the market value of our stock in the
future.
We are exposed to potential risks from recent legislation requiring companies to
evaluate internal controls under Section 404 of the Sarbanes Oxley Act of 2002
which could adversely affect our financial results and cause or stock price to
decline.
We are evaluating and documenting our internal controls systems so that
when we are required to do so, our management will be able to report on, and our
independent auditors to attest to, our internal controls, as required by this
legislation. We will be performing the system and process evaluation and testing
(and any necessary remediation) required in an effort to comply with the
management certification and auditor attestation requirements of Section 404 of
the Sarbanes Oxley Act. As a result, we expect to incur additional expenses and
diversion of management's time. We have reported material weaknesses and
significant deficiencies in our disclosure controls and procedures and our
internal control over financial reporting because of a deficiency in the number
of qualified personnel in our accounting department. While we anticipate being
able to rectify this weakness and to fully implement the requirements relating
to internal controls and all other aspects of Section 404 in a timely fashion,
we cannot be certain as to the timing of completion of our evaluation, testing
and remediation actions or the impact of the same on our operations. If we are
not able to implement the requirements of Section 404 in a timely manner or with
adequate compliance, we might be subject to sanctions or investigation by
regulatory authorities, such as the Securities and Exchange Commission. Any such
action could adversely affect our financial results and could cause our stock
price to decline.
Item 1B. Unresolved Staff Comments
25
None.
Item 2. - Properties
The following table sets forth pertinent facts concerning our office
leases at February 15, 2006.
Location Use Approximate Square Feet Annual Rent
-------- --- ----------------------- -----------
75 South Broadway Office 4,000 $79,000
White Plains, NY 10601
118 Celebration Avenue Office 2,000 $54,000
Celebration, FL 34747
The lease for our office space in White Plains, New York is a five-year
lease that began on December 1, 2003 and our lease for our office space in
Celebration, Florida is a three-year lease that began on February 1, 2005. We
also lease colocation space in two locations in Orlando that are subject to
written agreements that are renewable each year. We believe we will need to
lease additional office space of between 6,000 and 10,000 square feet to meet
our operating needs in fiscal 2007. We have been considering leases in Orlando,
Florida with annual rentals between approximately $100,000 and $150,000.
Item 3. - Legal Proceedings
We are subject to legal proceedings and claims that arise in the
ordinary course of business. In the opinion of management, the amount of
ultimate liability, if any, is not likely to have a material effect on our
financial condition, results of operations or liquidity. However, as the outcome
of litigation or legal claims is difficult to predict, significant changes in
exposures could occur.
Item 4. - Submission of Matters to a Vote of Security Holders
None.
26
PART II
Item 5. - Market for Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
Our common stock currently trades on The OTC Bulletin Board(R)
("OTCBB") under the symbol ELEC. The high and low closing price for each
quarterly period of our last two fiscal years are listed below:
High Low
---- ---
Fiscal 2005
-----------
1st Quarter $0.74 $0.28
2nd Quarter 0.69 0.35
3rd Quarter 0.58 0.36
4th Quarter 0.53 0.35
Fiscal 2006
-----------
1st Quarter $0.48 $0.37
2nd Quarter 0.50 0.35
3rd Quarter 0.40 0.25
4th Quarter 0.27 0.17
The quotations set forth in the table above reflect inter-dealer
prices, without retail mark-up, mark-down or commission, and may not necessarily
represent actual transactions. As of February 15, 2007, there were 190 holders
of record of our common stock and approximately 3,000 beneficial holders.
We have never paid dividends on our common stock and do not expect to
do so in the foreseeable future. Our loan agreements with Laurus do not allow us
to directly or indirectly declare or pay any dividends so long as certain
amounts of our secured convertible term notes to Laurus remain outstanding.
27
The following table provides information as of November 30, 2006 with
respect to shares of our common stock that are issuable under equity
compensation plans.
Number of Securities
remaining available to
Number of securities Weighted-average future issuance under
to be issued upon exercise price of equity compensation
exercise of outstanding plans (excluding
outstanding options, options, warrants securities reflected in
warrants and rights and rights column (a))
Plan Category (a) (b) (c)
-------------------------------------------------------------------------------------------------------------
Equity compensation plans approved
by security holders:
1995 Stock Option Plan(1) 810,500 $0.28 -
-----------
1996 Restricted Stock Plan(2) - 400,000
----------- -----------
Subtotal 810,500 400,000
----------- -----------
Equity compensation plans not
approved by security holders:
Employee stock options 1,900,000 0.24 -
2004 Equity Incentive Plan(3) 708,000 0.39 292,000
Laurus Master Fund, Ltd.(4) 5,837,434 0.20 -
Source Capital Group, Inc.(4) 1,347,234 0.36 -
Institutional Marketing Services,
Inc. (5) 100,000 0.63 -
Capital TT, LLC(6) 150,000 0.63 -
----------- -----------
Subtotal 10,042,668 292,000
----------- -----------
Total 10,853,168 692,000
=========== ===========
---------------------------
(1) Options are no longer issuable under our 1995 Stock Option Plan.
(2) Our Restricted Stock Plan provides for the issuance of restricted share
grants to officers and non-officer employees.
(3) Our 2004 Equity Incentive Plan allows for the granting of share options to
members of our board of directors, officers, non-officer employees and
consultants.
(4) Warrants were issued in conjunction with financings provided by Laurus
Master Fund, Ltd.
(5) Warrants were granted for investor relation services.
(6) Warrants were issued for consulting services.
28
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,
(In thousands, except per share amounts)
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
Selected Income Statement Data
Net Sales $ 8,357 $ 15,881 $ 9,558 $ 5,568 $ 14,242
Gross Profit 3,227 7,279 4,820 2,802 5,266
Earnings (Loss) (2,345) (2,266) 170 8,323 (3,319)
Earnings (Loss) per Common Share:
Basic (0.14) (0.14) 0.01 0.53 (0.21)
Diluted (0.14) (0.14) 0.01 0.53 (0.21)
Cash Dividends -- -- -- -- --
Selected Balance Sheet Data
Working Capital Deficiency $ (5,087) $ (974) $ (1,939) $ (1,938) $(11,214)
Property, Plant and Equipment 903 594 192 25 1,827
Total Assets 4,188 4,385 1,904 1,637 4,885
Long-Term Debt (Less Current Maturities) 215 2,722 -- -- 1,145
Stockholders' Equity Deficiency (4,249) (2,364) (1,696) (1,864) (10,162)
29
Item 7. - Management's Discussion and Analysis of Financial Condition and
Results of Operation
Certain statements set forth below under this caption constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Please refer to page 1 of this Report for
additional factors relating to such statements.
Overview
We have operated as a telephone service provider since 1998. We built
our telephony business by leasing lines from incumbent local exchange carriers
and reselling their services, while maintaining the vision of becoming a carrier
that provides voice services over the Internet. We have succeeded in our efforts
to transition to a facilities-based broadband voice provider, and we currently
offer telephony services over the Internet or over a wireline. We offer our
Internet services throughout the United States and in many foreign countries,
whereas our wireline services are offered only in the States of Pennsylvania,
New Jersey and New York. Our IP technology enables voice communications over the
Internet through the conversion of voice signals into data packets. In order to
use our broadband voice service, customers must have access to a high-speed
Internet connection. We believe broadband voice services utilize a technology
that is so invasive, that we have entered into a definitive purchase agreement
to sell our wireline business.
The roll-out of our broadband voice product has taken significantly
longer than we anticipated. A key reason for the delay was the extensive effort
required for us to become a customized wholesale service provider. Because of
the intense competition on the retail level and the high marketing costs that
broadband voice providers have incurred to acquire a subscriber, we decided that
we should not compete in the retail arena. Our goal is to obtain 500 customers
that will private label and resell our broadband voice services to their
customer base. We target cable operators that already are providing broadband
Internet services, Internet service providers, WiFi and fixed wireless broadband
providers, data integrators, value-added resellers, and satellite broadband
providers. We anticipate that our wholesale customers will be able to obtain an
average of at least 1,000 broadband voice end-users. We believe our approach, in
which we are seeking 500 customers that we will manage, and a total of at least
500,000 end users, which our customers will manage, will provide us with the
quickest and least expensive way of leveraging our technology. Under our
approach, we will avoid the expensive customer acquisition costs that other
broadband voice carriers are experiencing as they try to find a broadband
end-user to try their product. Instead of us incurring this cost, our customer,
who should be able to incur a reduced marketing expense because it has an
imbedded customer base already buying broadband service, incurs it. We believe
we can empower small and medium-sized broadband providers with the ability to
take customers away from the traditional telephone companies.
Through February 15, 2007, we have signed agreements with 59 wholesale
customers. We categorize them as 22 resellers, 14 agents, seven CLECs, five
cable operators, four ISPs, four data integrators and three ASPs. The resellers
include other broadband voice carriers that use our platform and the agents
include CompUSA, which is selling our product in its stores in Puerto Rico. We
do not anticipate large volumes of traffic from the CLECs, at least not
initially, because they are the least likely to market our product to their
existing customer bases. If a CLEC sells broadband voice services to an existing
telephone customer, it will reduce the sales dollars and gross margin dollars
that its existing customer is generating. We find that CLECs try to market the
broadband voice services to end-users who are not existing customers, and thus
they incur significantly higher marketing costs, similar to the way Vonage has
to incur these costs, in order to sign up a new subscriber that had no prior
relationship with the company. In general, we anticipate that our customers who
are cable operators, resellers and ISPs
30
will be more successful in generating sales of our broadband voice product
without overspending to complete the sale.
Some of our wholesale accounts experience delays before they develop
and execute their marketing plans. We provide the technology and the technical
assistance they need to offer a broadband voice product. We also give them
suggested marketing information and customer service training to encourage them
to begin selling the broadband voice product immediately, but we cannot control
the marketing budget, the personnel resources or the timing of the launch of
their broadband voice services. As of February 15, 2007, we have billed 31 of
our 59 accounts. 28 accounts had not yet turned up our service. We anticipate
that some of our wholesale customers will never actually sell our service. We
are optimistic that our broadband voice services are beginning to generate the
rapid sales growth we have been anticipating, as we have one account that is
sending us orders for approximately 20 new lines a day and we have similar
accounts testing our services. We have completed a successful trial agreement in
which a restaurant chain with 11,000 locations used our broadband voice service,
and we are negotiating to add them as a customer. We are also attracting
customers who do not require an ATA, but are using our services for minutes
only, which we can provide at competitive rates for certain routes. Furthermore,
we recently secured a wholesale customer who sells broadband over power lines.
Revenues
Revenues consist of telephony services revenue and customer equipment
revenue.
Telephony services revenue. Substantially all of our operating revenues
are telephony services revenue. We offer several bundled plans, unlimited plans
and basic plans for residential and business customers. Each of our unlimited
plans offers unlimited domestic calling, subject to certain restrictions, and
each of our basic plans offers a limited number of calling minutes per month.
Under our basic plans, we charge on a per minute basis when the number of
calling minutes included in the plan is exceeded for a particular month. For all
of our U.S. plans, we charge on a per minute basis for international calls to
destinations other than Canada. These per minute fees are not included in our
monthly subscription fees. Any plan we offer to individual end-users is also
available to our wholesale customers at a reduced rate.
We derive most of our telephony services revenue from monthly
subscription fees we charge our customers under our service plans. We also offer
a fax service over broadband, virtual phone numbers, toll free numbers and other
services, for each of which we may charge an additional monthly fee. We
automatically charge service fees monthly in advance to the credit cards of all
of our broadband voice retail customers and approximately 10% of our wireline
customers. We automatically charge the per minute fees not included in our
monthly subscription fees to our customers' credit cards monthly in arrears
unless they exceed a certain dollar threshold, in which case they are charged
immediately.
By collecting monthly subscription fees in advance and certain other
charges immediately after they are incurred, we are able to reduce the amount of
accounts receivable we have outstanding, which lowers our working capital
requirements. Collecting fees and charges in this manner also helps us mitigate
bad debt exposure and is one of the industry-accepted practices for broadband
voice services. Approximately 90% of our leased wireline customers do not pay by
credit card and are mailed an invoice that is due within 25 days. We have
experienced growth periods with significant bad debts from wireline customers.
We do not anticipate the same level of bad debt exposure in our broadband voice
service offerings, as our wholesale customers are required to place a one-month
deposit and our retail customers are required to pay by credit card. If a
customer's credit card is declined, we generally suspend international calling
capabilities as well as the customer's ability to incur domestic usage charges
in excess of its plan minutes. Historically, in most cases, we are able to
correct the problem with the
31
customer within the current monthly billing cycle. If a customer's credit card
cannot be successfully processed during the current month's billing cycle, we
generally terminate the account.
We also generate revenue by charging a fee for activating service.
Further, we generally charge a disconnect fee to customers who do not return
their ATA to us upon termination of service, if the length of time between
activation and termination is less than one year. Disconnect fees are recorded
as revenue and are recognized at the time the customer terminates service. These
revenues were nominal in fiscal 2006.
Telephony services revenue is offset by the cost of certain customer
acquisition activities, such as rebates and promotions.
Customer equipment revenue. Customer equipment revenue consists of
revenue from sales of customer equipment to our wholesalers or directly to
customers. In addition, customer equipment revenue includes the fees we charge
our customers for shipping any equipment to them. These revenues were nominal in
fiscal 2006.
Cost of Revenues
Direct cost of telephony services. Direct cost of telephony services
primarily consists of fees that we pay to third parties on an ongoing basis in
order to provide our services. These fees include:
o Usage charges and line and port costs from reselling wireline service
of incumbent carriers.
o Access charges we pay to other telephone companies to terminate
broadband voice calls on the public switched telephone network ("PSTN"). When a
VoX subscriber calls another VoX subscriber, we do not pay an access charge, as
the call routes through our network without touching the PSTN.
o The cost of leasing interconnections to route calls over the Internet
and transfer calls between the Internet and the PSTN of various long distance
carriers.
o The cost of leasing from other telephone companies the telephone
numbers we provide to our customers. We lease these telephone numbers on a
monthly basis.
o The cost of co-locating our connection point equipment in third-party
facilities owned by other telephone companies.
o The cost of providing local number portability, which allows
customers to move their existing telephone numbers from another provider to our
service. Only regulated telecommunications providers have access to the
centralized number databases that facilitate this process. Because VoX is not a
regulated telecommunications provider, we must pay other telecommunications
providers to process our local number portability requests.
o The cost of complying with the new FCC regulations regarding
emergency services, which require us to provide enhanced emergency dialing
capabilities to transmit 911 calls for all of our customers. This cost may
increase in future periods.
o Taxes we pay on our purchases of telecommunications services from our
suppliers.
32
Direct cost of customer equipment and shipping. Direct cost of goods
sold primarily consists of costs we incur when a customer first subscribes to
our service. These costs include:
o The cost of the equipment we provide to customers who subscribe to
our service through our direct sales channel, in each case in excess of
activation fees.
o The cost of shipping and handling for customer equipment, together
with the installation manual, we ship to customers.
Results of Operations
Fiscal Year 2006 Compared to Fiscal Year 2005
Our revenues for fiscal 2006 decreased by approximately $7,524,000, or
approximately 47%, to approximately $8,357,000 as compared to approximately
$15,881,000 reported for fiscal 2005. The decrease in revenues was directly
related to the cessation of our marketing program for new wireline customers, as
we did not have new wireline customers to replace the normal monthly churn of
our existing wireline customers. In conjunction with our decision to become a
wholesale broadband voice provider, almost all of our marketing efforts are
focused on attracting broadband voice customers. We anticipate we will be able
to sell our wireline business, as planned, in April 2007. Thereafter, all of our
revenue will come from IP telephony services. As noted above, we are beginning
to experience more rapid month-to-month sales growth in this area. We do not
control, however, the marketing dollars of our wholesale customers or the timing
of their marketing efforts. Consequently, we are unable to model or predict the
future sales growth in our broadband telephony business.
Our gross profit for fiscal 2006 decreased by approximately $4,052,000
to approximately $3,227,000 from approximately $7,279,000 reported in fiscal
2005, while our gross profit percentage of 38.6% in fiscal 2006, as compared to
45.8% in fiscal 2005, decreased by 7.2 percentage points primarily due to the
higher fees we were charged for leasing lines and ports from Verizon Services
Corp. ("Verizon"). The decrease in our dollars of gross profit resulted from the
decrease in our customer base in fiscal 2006 over fiscal 2005. Our gross profit
percentage of approximately 38.6% included fixed network costs for our IP
telephony network that we were not able to recover based upon the limited sales
dollars we achieved for broadband voice services in fiscal 2006. If we are
successful in selling our wireline business in fiscal 2007, we anticipate that
our gross margins will be significantly lower because we employ a wholesale
model for our broadband voice business. As a wholesaler, we will not be able to
enjoy the same mark-up that a retail seller can achieve. However, on an
operating basis, the lower margin should be offset by significantly lower
customer service and customer acquisition costs.
Selling, general and administrative expenses ("SG&A") decreased by
approximately $1,079,000, or approximately 18.4%, to approximately $4,794,000
for fiscal 2006 from approximately $5,873,000 reported in the prior year fiscal
period. Of this decrease, approximately $935,000 was for marketing expense,
approximately $339,000 was for billing costs, offset by increased personnel
costs of approximately $117,000. Bad debt expense decreased by approximately
$3,440,000, or approximately 95%, to approximately $172,000 in fiscal 2006 from
approximately $3,612,000 in fiscal 2005. From January 2005 until mid-April 2005,
our CLECs attracted an unusually high number of residential consumers that did
not pay our invoices, and for which we subsequently terminated services, even
though such customers had qualifying credit scores. We discontinued most of our
marketing efforts for new CLEC customers and concentrated on attracting
broadband voice customers in fiscal 2006. With our existing CLEC customer base
and with our broadband voice customers, we anticipate minimal bad debt expense,
as our CLEC customers are an embedded customer base that has historically paid
its bills, and
33
our broadband voice customers are primarily wholesale accounts, which are credit
checked and required to pay us a deposit for future services.
Depreciation and amortization expense increased by approximately
$351,000 to approximately $547,000 for fiscal 2006 as compared to approximately
$196,000 for the prior fiscal year. Approximately $241,000 of the increase was
for deferred financing costs related to the Laurus financings we completed in
November 2005 and May 2006 (See Note 8) and approximately $102,000 related to an
increase in depreciation of our IP platform.
Interest expense increased by approximately $474,000 to approximately
$1,156,000 for the year ended November 30, 2006 as compared to approximately
$682,000 for the prior fiscal year, primarily as a result of increased
borrowings under our financing agreements (See Note 8).
Other income amounted to approximately $108,000 for the year ended
November 30, 2006 as compared to $66,000 for the prior fiscal year. In both
years, other income resulted primarily from commission income. For fiscal 2006,
other income also included approximately $36,000 for the reduction of a
liability previously accrued and $13,000 of miscellaneous refunds.
For the year ended November 30, 2006, we recorded income of
approximately $990,000, an increase of approximately $813,000 over fiscal 2005
amounts of approximately $177,000, which resulted from the change in the market
value of the warrants issued to Laurus as part of the Laurus financing (See Note
8). The increase in income in fiscal 2006 was a direct result of a larger
decrease in the market value of our common stock at the end of fiscal 2006, as
compared to the decrease in fiscal 2005.
For the fiscal year ended November 30, 2005, we recorded a gain on the
sale of investment securities and other investments of approximately $378,000.
No gains were recorded in fiscal 2006. In fiscal 2005, the gain resulted from
the sale of shares of Cordia Corporation of approximately $160,000 and Talk
America Holding, Inc. warrants of approximately $218,000.
In fiscal 2005, we reversed liabilities related to our discontinued
luggage business in the amount of approximately $198,000. No such adjustment was
made in fiscal 2006.
Fiscal Year 2005 Compared to Fiscal Year 2004
Our revenues for fiscal 2005 increased by approximately $6,323,000, or
approximately 66%, to approximately $15,881,000 as compared to approximately
$9,558,000 reported for fiscal 2004. The growth in revenues was directly related
to the increased number of leased local access lines we served in fiscal 2005.
The bulk of our marketing dollars in fiscal 2005 were expended to generate new
customers for our wireline telephony business.
Our gross profit for fiscal 2005 increased by approximately $2,459,000
to approximately $7,279,000 from approximately $4,820,000 reported in fiscal
2004, while our gross profit percentage of 45.8% in fiscal 2005, as compared to
50.4% in fiscal 2004, decreased by 4.6 percentage points primarily due to the
higher fees we were charged for leasing lines and ports from Verizon. The
increase in our dollars of gross profit resulted from the increase in our
customer base in fiscal 2005 over fiscal 2004. Our gross profit percentage of
approximately 45.8% reflected our sales strategy of selling only in those states
in which we believe we will be able to achieve a gross margin of over 40%.
34
SG&A increased by approximately $1,474,000, or approximately 33.5%, to
approximately $5,873,000 for fiscal 2005 from approximately $4,399,000 reported
in the prior year fiscal period. Of this increase, approximately $816,000 was
for increased personnel costs, of which approximately $403,000 was related to
VoX, approximately $230,000 was for billing costs, approximately $144,000 was
for non-employee option costs and approximately $187,000 was for other VoX
operating costs. Bad debt expense increased by approximately $2,563,000, or
approximately 244%, to approximately $3,613,000 for fiscal 2005 from
approximately $1,049,000 reported in the prior year fiscal period. From January
2005 until mid-April 2005, our CLECs attracted an unusually high number of
residential consumers that did not pay our invoices and for which we
subsequently terminated services, even though such customers had qualifying
credit scores.
Depreciation and amortization expense increased by approximately
$182,000 to approximately $196,000 for fiscal 2005 as compared to approximately
$14,000 for the prior fiscal year. Approximately $143,000 of the increase was
for deferred financing costs related to the Laurus financing we completed in
February 2005 (See Note 8) and approximately $40,000 related to our IP telephony
platform.
Interest expense increased by approximately $679,000 to approximately
$682,000 for the year ended November 30, 2005 as compared to approximately
$3,000 for the prior fiscal year, as a result of increased borrowings under our
financing agreements (See Note 8).
Other income amounted to approximately $66,000 for the year ended
November 30, 2005 as compared to $46,000 for the prior fiscal year. For fiscal
2005, other income of approximately $66,000 resulted primarily from commission
income. For fiscal 2004, other income of approximately $46,000 resulted
primarily from commission income of approximately $91,000, which was partially
offset by approximately $45,000 in additional costs associated with the sale of
our headquarters building in the fourth quarter of fiscal 2003.
For the year ended November 30, 2005, we recorded income of
approximately $177,000, which resulted from the change in the market value of
the warrants issued to Laurus as part of the Laurus financing (See Note 8). No
such income was recorded in fiscal 2004.
For the fiscal years ended November 30, 2005 and 2004, we recorded gain
on the sale of investment securities and other investments of approximately
$378,000 and $1,000, respectively. In fiscal 2005, the gain resulted from the
sale of shares of Cordia Corporation of approximately $160,000 and Talk America
Holding, Inc. warrants of approximately $218,000.
In fiscal 2005 we reversed liabilities related to our discontinued
luggage business in the amount of approximately $198,000. No such adjustment was
made in fiscal 2004.
For the fiscal year ended November 30, 2004, we reported a gain on
settlement with creditors of approximately $904,000, which was offset in part by
approximately $161,000 in professional fees. No such gain was recorded in the
fiscal year ended November 30, 2005 (See Note 10).
For the fiscal year ended November 30, 2004, we recorded a tax benefit
of $26,000 that resulted from the reduction of an estimated accrual of corporate
tax expense for fiscal 2003. No such benefit was recorded in the fiscal year
ended November 30, 2005.
Liquidity and Capital Resources
35
At November 30, 2006, we had cash and cash equivalents of approximately
$1,338,000 and negative working capital of approximately $5,087,000 (including
deferred finance costs in current assets of approximately $1,013,000) as
compared to cash and cash equivalents of approximately $206,000 and negative
working capital of approximately $974,000 at November 30, 2005.
Net cash used in operating activities aggregated approximately
$1,511,000 $1,741,000 and $80,000 in fiscal 2006, 2005 and 2004, respectively.
The principal use of cash from operating activities in fiscal 2006 and 2005 was
the loss for the year of approximately $2,345,000 and $2,266,000, respectively.
The principal use of cash from operating activities in fiscal 2004 was the
increase in accounts receivable of approximately $1,590,000, which was offset by
a non-cash item, an increase in the provision for doubtful accounts of
approximately $1,049,000.
Net cash used in investing activities aggregated approximately
$263,000, $12,000 and $186,000 in fiscal 2006, 2005 and 2004, respectively. The
principal use of cash from investing activities in fiscal 2006 was the purchase
of property and equipment of approximately $259,000. The principal use of cash
from investing activities in fiscal 2005 was the net proceeds of approximately
$385,000 received from sale of investment securities and other investments,
which was offset by the purchase of property and equipment of approximately
$390,000. The principal use of cash from investing activities in fiscal 2004 was
the purchase of property and equipment of approximately $182,000.
Net cash provided by (used in) financing activities aggregated
approximately $2,905,000, $1,587,000 and ($31,000) in fiscal 2006, 2005 and
2004, respectively. The principal source of cash from financing activities in
fiscal 2006 was the proceeds from a private equity placement, net of fees of
$490,000 and net proceeds from secured term notes of approximately $3,379,000.
These amounts were partially offset by repayment of loan principal of
approximately $593,000. The principal source of cash from financing activities
in fiscal 2005 was the net proceeds from short-term borrowings of approximately
$274,000 and net proceeds from a secured convertible note of approximately
$1,744,000. In fiscal 2004, net cash used in financing activities resulted from
the repayment of debt.
In fiscal 2006 and 2005, we spent approximately $472,000 and $390,000
on capital expenditures, primarily for software, servers and routers related to
our IP network. We intend to continue additional software development in fiscal
2007. We believe we also will make capital expenditures for our IP platform and
that capital additions will be flexible depending upon the number of customers
that we are able to attract to our network.
We did not make the principal payments to Laurus in the aggregate
amount of approximately $93,000 that were due on October 1, 2006 under the terms
of our promissory notes payable to Laurus. Laurus issued us a waiver for
non-payment and changed the due date of the $93,000 to the final maturity date
of the notes. We have not made any principal payments to Laurus that were due on
and after December 1, 2006. We have negotiated a principal deferral of nine
months for one of our notes and we anticipate paying off another note to Laurus
if we close on the purchase agreement we signed on December 14, 2006 to sell our
CLEC subsidiaries. We have not executed a signed document with Laurus regarding
this deferral. We are also in default with Laurus for other items, such as late
payment of taxes. We plan to remedy the defaults in conjunction with the sale of
our CLEC subsidiaries. Because of the default on the Laurus debt, the debt can
be called immediately and the entire amount including the warrant liability has
been classified as a current liability. We would not be able to make payments to
Laurus if they called our debt to them.
The report of our independent registered accounting firm on our 2006
financial statements indicates there is substantial doubt about our ability to
continue as a going concern. We have sustained
36
net losses from operations during the last three years, as we have worked to
build our customer base since the sale of almost all of our customers on
December 31, 2002, and subsequently worked to build the software and back-office
systems required to provide broadband telephony services. Our operating losses
have been funded through the sale of non-operating assets, the issuance of
equity securities and borrowings. We believe that we will need to make some
capital changes to our business, including the potential sale of our CLEC
subsidiaries and the injection of money from individual investors into our
company, in order to have the resources required to finance our operations
through the next twelve months. We continually evaluate our cash needs and
growth opportunities and we believe we require additional equity or debt
financing in order to achieve our overall business objectives. There can be no
assurance that such financing will be available, or, if available, that such
financing will be at a price that will be acceptable to us. Failure to generate
sufficient revenues, raise additional capital, or renegotiate payment terms of
our debt would have an adverse impact on our ability to achieve our longer-term
business objectives, and would adversely affect our ability to continue
operating as a going concern.
New Accounting Standards
The new accounting pronouncements in Note 1 to our consolidated
financial statements, which are included in this Report, are herein
incorporated.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles ("GAAP") in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities and disclosures of contingent assets and liabilities at the
date of the financial statements and reported amounts of revenues and expenses
during the reporting period. The most significant estimates include:
* revenue recognition and estimating allowance for doubtful
accounts;
* valuation of long-lived assets;
* income tax valuation allowance; and
* valuation of debt discount.
We continually evaluate our accounting policies and the estimates we
use to prepare our consolidated financial statements. In general, the estimates
are based on historical experience, on information from third party
professionals and on various other sources and assumptions that are believed to
be reasonable under the facts and circumstances at the time such estimates are
made. Management considers an accounting estimate to be critical if:
* it requires assumptions to be made that were uncertain at the
time the estimate was made; and
* changes in the estimate, or the use of different estimating
methods, could have a material impact on our consolidated results
of operations or financial condition.
Actual results could differ from those estimates. Significant
accounting policies are described in Note 1 to our consolidated financial
statements, which are included in this Report. In many cases, the accounting
treatment of a particular transaction is specifically dictated by GAAP. There
are also areas in which management's judgment in selecting any available
alternative would not produce a materially different result.
37
Certain of our accounting policies are deemed "critical", as they
require management's highest degree of judgment, estimates and assumptions. The
following critical accounting policies are not intended to be a comprehensive
list of all of our accounting policies or estimates:
Revenue Recognition
We apply the provisions of Staff Accounting Bulletins relating to
revenue recognition. We recognize revenue from telecommunication services in the
period that the service is provided. We estimate amounts earned for carrier
interconnection and access fees based on usage.
Allowance for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses that
result from the inability or unwillingness of our customers to make required
payments. We base our allowances on our determination of the likelihood of
recoverability of trade accounts receivable based on past experience and current
collection trends that are expected to continue. In addition, we perform ongoing
credit evaluations of our significant customers and we require most of our
wholesale customers to post a deposit, typically an amount between $2,500 and
$5,000, which may be refunded after several months of prompt payments.
Impairment of Long-Lived Assets
We follow the provisions of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement requires that
certain assets be reviewed for impairment and, if impaired, remeasured at fair
value whenever events or changes in circumstances indicate that the carrying
amount of the asset may not be recoverable. Impairment loss estimates are
primarily based upon management's analysis and review of the carrying value of
long-lived assets at each balance sheet date, utilizing an undiscounted future
cash flow calculation. During fiscal years 2006, 2005 and 2004, there were no
impairment losses.
Income Taxes
We estimate the degree to which tax assets and loss carryforwards will
result in a benefit based on expected profitability by tax jurisdiction. A
valuation allowance for such tax assets and loss carryforwards is provided when
it is determined that such assets will more likely than not go unused. If it
becomes more likely than not that a tax asset or loss carryforward will be used,
the related valuation allowance on such assets is reversed. If actual future
taxable income by tax jurisdiction varies from estimates, additional allowances
or reversals of reserves may be necessary.
Item 7A. - Quantitative and Qualitative Disclosure About Market Risk
Our debt is primarily under three borrowing arrangements with one
lender and such borrowings are at a base rate of 2% over the prime rate. We
currently do not use interest rate derivative instruments to manage our exposure
to interest rate changes. As a result of warrants and lender discounts, the
effective rate of interest on our lender agreements as modified has been
calculated at rates of approximately 38% on our February 2005 financing, 47% on
our November 2005 financing and 185% on the $650,000 portion of our May 2006
financing.
Item 8. - Financial Statements and Supplementary Data
The following consolidated financial statements, notes thereto,
supplemental schedule, and the report of the independent registered public
accounting firm contained on page F-1 to our consolidated financial statements
are herein incorporated:
Report of the independent registered public accounting firm
Consolidated balance sheets - November 30, 2006 and 2005
Consolidated statements of operations - Years ended November 30, 2006, 2005
and 2004
Consolidated statements of stockholders' equity deficiency - Years ended
November 30, 2006, 2005 and 2004
Consolidated statements of cash flows - Years ended November 30, 2006, 2005
and 2004
Notes to consolidated financial statements - Years ended November 30, 2006,
2005 and 2004
Schedule II, Valuation and Qualifying Accounts
All other schedules have been omitted as not required or not applicable or
because the information required to be presented is included in the
consolidated financial statements and related notes. For more information,
see Part IV, Item 15, Exhibits, below.
38
Item 9. - Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 9A. Controls and Procedures.
(a) Disclosure Controls and Procedures. Our management, with the
participation of our chief executive officer/chief financial officer, has
evaluated the effectiveness of our disclosure controls and procedures (as such
term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange
Act of 1934, as amended (the "Exchange Act")) as of the end of the period
covered by this Report. Based on such evaluation, our chief executive
officer/chief financial officer has concluded that, as of the end of such
period, for the reasons set forth below, our disclosure controls and procedures
were not effective. We are presently taking the necessary steps to improve the
effectiveness of such disclosure controls and procedures.
(b) Internal Control Over Financial Reporting. There have not been any
changes in our internal control over financial reporting (as such term is
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the
fourth quarter of 2006 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting. In
connection with our year-end November 30, 2006 audit, our management became
aware of an inadequately designed accounting system as it pertains to our VoX
subsidiary. We expect to address this issue in the second quarter of fiscal
2007. As reported in fiscal 2005, we also have a lack of staffing within our
accounting department, both in terms of the small number of employees performing
our financial and accounting functions and their lack of experience to account
for complex financial transactions. This lack of staffing continued throughout
fiscal 2006 and at the time this report is issued. Management believes the lack
of qualified personnel, in the aggregate and the inadequate accounting system
for VoX amounts to a material weakness in our internal control over financial
reporting. We will continue to evaluate the employees involved, the need to
engage outside consultants with technical and accounting related expertise to
assist us in accounting for complex financial transactions and the hiring of
additional accounting staff with complex financing experience.
39
We are also evaluating our internal controls systems so that when we
are required to do so, our management will be able to report on, and our
independent auditors to attest to, our internal controls, as required by Section
404 of the Sarbanes-Oxley Act of 2002. We will be performing the system and
process evaluation and testing (and any necessary remediation) required in an
effort to comply with the management certification and auditor attestation
requirements of Section 404 of the Sarbanes-Oxley Act. In connection with our
year-end November 30, 2006 and 2005 audits, we have identified the following
control deficiencies and issues with our internal controls over financial
reporting that we believe amount in the aggregate to a significant deficiency in
our internal controls over financial reporting:
Due to the voluminous nature of state and local telecom taxes
and the small quantity of taxes payable to certain municipalities, we
do not remit all our telecom taxes in a timely manner. Certain taxes
that we should be remitting on a monthly basis, we remit quarterly or
semi-annually because many of the checks and returns that we are
processing are for insignificant amounts. We are aware of other
telephone companies that follow this process. We continue to monitor
the responses, if any, we receive from the tax authorities regarding
late filings and we intend to remit such taxes in a timely manner in
the future.
Due to the complex nature and changing regulations regarding
telecom taxes, we do not always calculate and remit the appropriate
amount of taxes due. We are challenging taxes that one state claims are
owed to them. At least some of the taxes are due because of improper
calculation of taxes that should have been billed to and collected from
our wireline telephone customers in one particular state.
Item 9B. Other Information
None.
40
PART III
Item 10. - Directors, Executive Officers and Corporate Governance.
The information required by this Item will be contained in the
Company's Proxy Statement for its Annual Stockholders Meeting, which will be
filed with the Securities and Exchange Commission, is incorporated by reference
herein.
Item 11. - Executive Compensation.
The information required by this Item will be contained in the
Company's Proxy Statement for its Annual Stockholders Meeting, which will be
filed with the Securities and Exchange Commission, is incorporated by reference
herein.
Item 12. - Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
The information required by this Item will be contained in the
Company's Proxy Statement for its Annual Stockholders Meeting, which will be
filed with the Securities and Exchange Commission, is incorporated by reference
herein.
Item 13. - Certain Relationships and Related Transactions, and Director
Independence.
The information required by this Item will be contained in the
Company's Proxy Statement for its Annual Stockholders Meeting, which will be
filed with the Securities and Exchange Commission, is incorporated by reference
herein.
Item 14. Principal Accounting Fees and Services.
The information required by this Item will be contained in the
Company's Proxy Statement for its Annual Stockholders Meeting, which will be
filed with the Securities and Exchange Commission, is incorporated by reference
herein.
PART IV
Item 15. - Exhibits and Financial Statement Schedules.
(a)(1) Financial Statements. Reference is made to the financial
statements listed in Section 1 of the Index to Consolidated Financial
Statements and Schedules in this Report.
(a)(2) Financial Statement Schedule. Reference is made to the financial
statement schedule listed in Section 2 of the Index to Consolidated
Financial Statements and Schedules in this Report. All other schedules
have been omitted as not required, not applicable or because the
information required to be presented is included in the financial
statements and related notes.
41
(2) Schedules for the years ended November 30, 2006, 2005 and 2004
Schedule II - Valuation and Qualifying Accounts.
(b) Exhibits
(3) Articles of Incorporation and By-laws
(a) Certificate of Incorporation, as amended, incorporated by reference
to our Registration Statement on Form S-1 filed with the Securities
and Exchange Commission on August 27, 1969 under Registration Number
2-34436.
(b) Certificate of Amendment of the Certificate of Incorporation,
incorporated by reference to our definitive proxy statement filed
with the Securities and Exchange Commission in connection with our
Annual Meeting of Shareholders held in May 1984.
(c) Certificate of Amendment to the Certificate of Incorporation,
incorporated by reference to Exhibit 3(b) to our Annual Report on
Form 10-K for the year ended November 30, 1988.
(d) Certificate of Amendment to the Certificate of Incorporation,
incorporated by reference to Exhibit 3(e) to our Annual Report on
Form 10-K for the year ended November 30, 1994, as amended.
(e) Certificate of Amendment of the Certificate of Incorporation,
incorporated by reference to Exhibit 3 to our Quarterly Report on
Form 10-Q for the quarter ended August 30, 1995.
(f) Certificate of Amendment of the Certificate of Incorporation,
incorporated by reference to Exhibit 3(f) to our Annual Report on
Form 10-K for the year ended November 30, 1998.
(g) Certificate of Amendment of the Certificate of Incorporation,
incorporated by reference to Exhibit 3.2 to our Quarterly Report on
Form 10-Q for the quarter ended August 31, 1998.
(h) Certificate of Amendment of the Certificate of Incorporation,
incorporated by reference to Exhibit 3(1) to our Current Report on
Form 8-K dated November 16, 1999.
(i) By-laws, amended and restated as of December 1996, incorporated by
reference to Exhibit 3(e) to our Annual Report on Form 10-K for the
year ended November 30, 1996.
(10) Material Contracts
(a) 1995 Stock Option Plan, incorporated by reference to Exhibit 10(I)
to our Annual Report on Form 10-K for the year ended November 30,
1995, as amended.
(b) 1996 Restricted Stock Award Plan, incorporated by reference to
Exhibit A to our Proxy Statement dated October 24, 1996.
(c) Non-Employee Director Stock Option Plan, dated March 30, 2001,
incorporated by reference to Exhibit 10(c) to our Annual Report on
Form 10-KSB for the year ended November 30, 2003.
(d) Lease Agreement between South Broadway WP, LLC, Landlord, and New
Rochelle Telephone Corp., Tenant, dated August 2003, incorporated by
reference to Exhibit 10(d) to our Annual Report on Form 10-KSB for
the year ended November 30, 2003.
(e) Office Lease between Lexin Celebration, LLC, as Landlord, and Vox
Communications Corp., as Tenant, dated January 25, 2005,
incorporated by reference to Exhibit 10(e) to our Annual Report on
Form 10-KSB for the year ended November 30, 2005.
(f) Securities Purchase Agreement, dated as of February 8, 2005, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.1 to our Current Report on Form 8-K dated
February 8, 2005.
(g) Master Security Agreement, dated as of February 8, 2005, among us,
New Rochelle Telephone Corp., Telecarrier Services, Inc., Vox
Communications Corp., Line One, Inc., AVI Holding Corp. and
TelcoSoftware.com Corp. in favor of Laurus Master Fund, Ltd.,
incorporated by reference to Exhibit 10.3 to our Current Report on
Form 8-K dated February 8, 2005.
42
(h) Stock Pledge Agreement, dated as of February 8, 2005, executed by
eLEC Communications Corp. in favor of Laurus Master Fund, Ltd.,
incorporated by reference to Exhibit 10.4 to our Current Report on
Form 8-K dated February 8, 2005.
(i) Subsidiary Guaranty, dated as of February 8, 2005, executed by New
Rochelle Telephone Corp., Telecarrier Services, Inc., Vox
Communications Corp., Line One, Inc., AVI Holding Corp. and
TelcoSoftware.com Corp., incorporated by reference to Exhibit 10.5
to our Current Report on Form 8-K dated February 8, 2005.
(j) Registration Rights Agreement, dated as of February 8, 2005, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.6 to our Current Report on Form 8-K dated
February 8, 2005.
(k) Common Stock Purchase Warrant, dated as of February 8, 2005, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.7 to our Current Report on Form 8-K dated
February 8, 2005.
(l) Form of Common Stock Purchase Warrant, dated as of February 8, 2005,
issued by eLEC Communications Corp. to or on the order of Source
Capital Group, Inc., incorporated by reference to Exhibit 10.8 to
our Current Report on Form 8-K dated February 8, 2005.
(m) Securities Purchase Agreement, dated as of November 30, 2005,
between eLEC Communications Corp. and Laurus Master Fund, Ltd.,
incorporated by reference to Exhibit 10.1 to our Current Report on
Form 8-K dated November 30, 2005.
(n) Reaffirmation and Ratification Agreement, dated as of November 30,
2005, executed by eLEC Communications Corp., New Rochelle Telephone
Corp., Telecarrier Services, Inc., Vox Communications Corp., Line
One, Inc., AVI Holding Corp. and TelcoSoftware.com Corp.
incorporated by reference to Exhibit 10.3 to our Current Report on
Form 8-K dated November 30, 2005.
(o) Registration Rights Agreement, dated as of November 30, 2005,
between eLEC Communications Corp. and Laurus Master Fund, Ltd.,
incorporated by reference to Exhibit 10.4 to our Current Report on
Form 8-K dated November 30, 2005.
(p) Common Stock Purchase Warrant, dated as of November 30, 2005,
between eLEC Communications Corp. and Laurus Master Fund, Ltd.,
incorporated by reference to Exhibit 10.5 to our Current Report on
Form 8-K dated November 30, 2005.
(q) Form of Common Stock Purchase Warrant, dated as of November 30,
2005, issued by eLEC Communications Corp. to or on the order of
Source Capital Group, Inc., incorporated by reference to Exhibit
10.6 to our Current Report on Form 8-K dated November 30, 2005.
(r) Securities Purchase Agreement, dated as of May 31, 2006, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.1 to our Current Report on Form 8-K dated
May31, 2006.
(s) Secured Term Note, dated as of May 31, 2006, between eLEC
Communications Corp. and Laurus Master Fund, Ltd., incorporated by
reference to Exhibit 10.2 to our Current Report on Form 8-K dated
May 31, 2006.
(t) Reaffirmation and Ratification Agreement, dated as of May 31, 2006,
executed by eLEC Communications Corp., New Rochelle Telephone Corp.,
Telecarrier Services, Inc., Vox Communications Corp., Line One,
Inc., AVI Holding Corp. and TelcoSoftware.com Corp. incorporated by
reference to Exhibit 10.3 to our Current Report on Form 8-K dated
May 31, 2006.
(u) Funds Escrow Agreement, dated as of May 31, 2006, between eLEC
Communications Corp. and Laurus Master Fund, Ltd., incorporated by
reference to Exhibit 10.4 to our Current Report on Form 8-K dated
May 31, 2006.
43
(v) Restricted Account Agreement, dated as of May 31, 2006, between eLEC
Communications Corp. and Laurus Master Fund, Ltd., incorporated by
reference to Exhibit 10.5 to our Current Report on Form 8-K dated
May 31, 2006.
(w) Common Stock Purchase Warrant, dated as of May 31, 2006, between
eLEC Communications Corp. and Laurus Master Fund, Ltd., incorporated
by reference to Exhibit 10.7 to our Current Report on Form 8-K dated
May 31, 2006.
(x) Form of Common Stock Purchase Warrant, dated as of May 31, 2006,
issued by eLEC Communications Corp. to or on the order of Source
Capital Group, Inc., incorporated by reference to Exhibit 10.8 to
our Current Report on Form 8-K dated May 31, 2006.
(y) Amended and Restated Secured Term Note, dated as of May 31, 2006,
between eLEC Communications Corp. and Laurus Master Fund, Ltd.,
incorporated by reference to Exhibit 10.9 to our Current Report on
Form 8-K dated May 31, 2006.
(z) Amended and Restated Secured Term Note, dated as of May 31, 2006,
between eLEC Communications Corp. and Laurus Master Fund, Ltd.,
incorporated by reference to Exhibit 10.10 to our Current Report on
Form 8-K dated May 31, 2006.
(aa) Stock Purchase Agreement dated as of December 14, 2006 by and among
eLEC Communications Corp., CYBD Acquisition, Inc. and Cyber Digital,
Inc., with respect to the capital stock of New Rochelle Telephone
Corp., incorporated by reference to Exhibit 10.1 to our Current
Report on Form 8-K dated December 14, 2006.
(bb) Stock Purchase Agreement dated as of December 14, 2006 by and among
eLEC Communications Corp., CYBD Acquisition II, Inc. and Cyber
Digital, Inc., with respect to the capital stock of Telecarrier
Services, Inc., incorporated by reference to Exhibit 10.2 to our
Current Report on Form 8-K dated December 14, 2006.
(cc) Amendment No.1 to Stock Purchase Agreement dated as of February 27,
2007 by and among eLEC Communications Corp., CYBD Acquisition, Inc.
and Cyber Digital, Inc., with respect to the capital stock of New
Rochelle Telephone Corp.
(dd) Amendment No.1 to Stock Purchase Agreement dated as of February 27,
2007 by and among eLEC Communications Corp., CYBD Acquisition II,
Inc. and Cyber Digital, Inc., with respect to the capital stock of
Telecarrier Services, Inc.
(22) Subsidiaries - The significant wholly-owned subsidiaries are as
follows:
Name Jurisdiction of Organization
---- ----------------------------
New Rochelle Telephone Corp. New York
Telecarrier Services, Inc. Delaware
VoX Communications Corp. Delaware
(23) Consent of Nussbaum Yates & Wolpow, P.C.
(31.1) Certification of our Chief Executive Officer and Chief Financial
Officer, Paul H. Riss, pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
(32.1) Certification of our Chief Executive Officer and Chief Financial
Officer, Paul H. Riss, pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, we have duly caused this Report to be signed on our behalf
by the undersigned, thereunto duly authorized on the 8th day of March 2007.
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 Chairman of the Board of Directors March 8, 2007
------------------------- Chief Executive Officer
Paul H. Riss Chief Financial Officer
(Principal Accounting Officer)
/s/ Greg M. Cooper Director March 8, 2007
-------------------------
Greg M Cooper
/s/ Gayle Greer Director March 8, 2007
-------------------------
Gayle Greer
/s/ Michael Khalilian Director March 8, 2007
-------------------------
Michael Khalilian
45
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
Page
Number
------
1. Financial Statements
Report of Independent Registered Public Accounting Firm F-1
Consolidated Financial Statements
Balance Sheets F-2
Statements of Operations F-3
Statements of Stockholders' Equity Deficiency F-4
Statements of Cash Flows F-5
Notes to Financial Statements F-7
2. Financial Statement Schedule
Schedule II S-1
Report of Independent Registered Public Accounting Firm
-------------------------------------------------------
The Board of Directors
eLEC Communications Corp.
White Plains, New York
We have audited the consolidated balance sheets of eLEC Communications Corp. and
subsidiaries as of November 30, 2006 and 2005, and the related consolidated
statements of operations, stockholders' equity deficiency, and cash flows for
the years ended November 30, 2006, 2005 and 2004. Our audits also included the
financial statement schedule on page S-1. These financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on the financial statements and
schedule based on our audits.
We conducted our audits in accordance with the Standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of eLEC
Communications Corp. and subsidiaries as of November 30, 2006 and 2005, and the
consolidated results of their operations and cash flows for the years ended
November 30, 2006, 2005 and 2004, in conformity with U.S. generally accepted
accounting principles. Also, in our opinion, such financial statement schedule,
when considered in relation to the basic consolidated financial statements taken
as a whole, present fairly, in all material respects, the information set forth
therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As further discussed in Note
2 to the financial statements, the Company has suffered recurring losses from
operations and is in default of its financing agreements with its principal
lender which raises substantial doubt about the Company's ability to continue as
a going concern. Management's plans in regard to these matters are also
described in Note 2. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ NUSSBAUM YATES & WOLPOW, P.C.
Melville, New York
February 9, 2007
F-1
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
NOVEMBER 30, 2006 AND 2005
ASSETS
2006 2005
------------ ------------
Current assets:
Cash and cash equivalents $ 1,337,525 $ 205,998
Loan proceeds receivable -- 1,753,500
Accounts receivable, net of allowance of
$230,009 and $258,336 in 2006 and 2005 630,197 989,887
Prepaid expenses and other current assets 154,749 103,193
Deferred finance costs, net 1,012,941 --
------------ ------------
Total current assets 3,135,412 3,052,578
Property and equipment, net 903,281 593,811
Deferred finance costs, net -- 542,893
Other assets 149,525 195,809
------------ ------------
Total assets $ 4,188,218 $ 4,385,091
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY DEFICIENCY
Current liabilities:
Short-term borrowings $ -- $ 326,103
Current portion of long-term debt and capital
lease obligations 3,347,707 43,891
Warrant liability 1,251,182 --
Accounts payable and accrued expenses 2,897,495 2,746,360
Taxes payable 559,617 632,147
Deferred revenues 166,100 278,200
------------ ------------
Total current liabilities 8,222,101 4,026,701
Long-term debt and capital lease obligations, less
current maturities 214,907 1,654,591
Warrant liability -- 1,067,526
------------ ------------
Total liabilities 8,437,008 6,748,818
------------ ------------
Stockholders' equity deficiency:
Preferred stock, $.10 par value; 1,000,000 shares
authorized, none issued and outstanding -- --
Common stock, $.10 par value; 50,000,000 shares
authorized; 22,434,282 and 16,839,282 shares
issued and outstanding in 2006 and 2005 2,243,428 1,683,928
Capital in excess of par value 27,071,584 27,169,409
Deficit (33,554,700) (31,209,645)
Accumulated other comprehensive loss, unrealized
loss on securities (9,102) (7,419)
------------ ------------
Total stockholders' equity deficiency (4,248,790) (2,363,727)
------------ ------------
Total liabilities and stockholders'
equity deficiency $ 4,188,218 $ 4,385,091
------------ ------------
See accompanying notes to consolidated financial statements.
F-2
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
2006 2005 2004
------------ ------------ ------------
Revenues $ 8,356,595 $ 15,880,803 $ 9,557,600
------------ ------------ ------------
Cost and expenses:
Costs of services 5,129,971 8,601,525 4,738,038
Selling, general and administrative 4,793,920 5,872,848 4,398,673
Provision for bad debts 172,268 3,612,005 1,048,559
Depreciation and amortization 546,978 196,377 14,480
------------ ------------ ------------
Total costs and expenses 10,643,137 18,282,755 10,199,750
------------ ------------ ------------
Loss from operations (2,286,542) (2,401,952) (642,150)
------------ ------------ ------------
Other income (expense):
Interest expense (1,156,427) (682,266) (3,126)
Other income, net 107,807 65,521 45,795
Indebtedness adjustment -- 198,059 --
Mark to market adjustment in warrant carrying amount
990,107 176,657 --
Gain on sale of investment securities
and other investments -- 378,186 770
------------ ------------ ------------
Total other income (expense) (58,513) 136,157 43,439
------------ ------------ ------------
Loss before bankruptcy reorganization items
and income tax benefit (2,345,055) (2,265,795) (598,711)
------------ ------------ ------------
Reorganization items:
Gain on settlement with creditors -- -- 904,027
Professional fees -- -- (161,000)
------------ ------------ ------------
-- -- 743,027
------------ ------------ ------------
Income (loss) before income tax benefit (2,345,055) (2,265,795) 144,316
Income tax benefit -- -- (25,937)
------------ ------------ ------------
Net income (loss) $ (2,345,055) $ (2,265,795) $ 170,253
------------ ------------ ------------
Basic earnings (loss) per share $ (.14) $ (.14) $ .01
------------ ------------ ------------
Diluted earnings (loss) per share $ (.14) $ (.14) $ .01
------------ ------------ ------------
Weighted average number of common shares outstanding:
Basic 17,338,268 16,770,789 16,254,282
------------ ------------ ------------
Diluted 17,338,268 16,770,789 16,715,808
------------ ------------ ------------
See accompanying notes to consolidated financial statements.
F-3
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY DEFICIENCY
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
Accumulated Stockholders'
Common Stock Capital Other Stockholders' Total
------------------------ in Excess of Treasury Comprehensive Equity
Shares Amount Par Value Deficit Stock Loss Deficiency
---------- ------------ ------------ ------------ -------- ----------- ------------
Balance, December 31, 2003 16,265,282 $ 1,626,528 $ 25,650,634 $(29,114,103) $(27,500) $ -- $ (1,864,441)
------------
Net income 170,253 170,253
Unrealized holding loss (2,251) (2,251)
------------
Comprehensive income 168,002
Retirement of treasury stock (11,000) (1,100) (26,400) 27,500 --
---------- ------------ ------------ ------------ -------- ----------- ------------
Balance, November 30, 2004 16,254,282 1,625,428 25,624,234 (28,943,850) -- (2,251) (1,696,439)
------------
Net loss (2,265,795) (2,265,795)
Unrealized holding loss (5,168) (5,168)
------------
Comprehensive loss (2,270,963)
Exercise of common stock
options 425,000 42,500 18,000 60,500
Stock issued for debt issue
costs 160,000 16,000 16,000 32,000
Beneficial conversion feature of
convertible notes payable 973,545 973,545
Options and warrants granted for
services 537,630 537,630
---------- ------------ ------------ ------------ -------- ----------- ------------
Balance, November 30, 2005 16,839,282 1,683,928 27,169,409 (31,209,645) (7,419) (2,363,727)
------------
Net loss (2,345,055) (2,345,055)
Unrealized holding loss (1,683) (1,683)
------------
Comprehensive loss (2,346,738)
Exercise of common stock options
390,000 39,000 60,800 99,800
Issuance of common stock 5,180,000 518,000 (28,240) 489,760
Employee stock based
compensation 188,595 188,595
Cancellation of beneficial
conversion feature of
convertible notes payable (534,676) (534,676)
Stock, options and warrants
granted for services 25,000 2,500 215,696 218,196
---------- ------------ ------------ ------------ -------- ----------- ------------
Balance, November 30, 2006 22,434,282 $ 2,243,428 $ 27,071,584 $(33,554,700) $ -- $ (9,102) $ (4,248,790)
---------- ------------ ------------ ------------ -------- ----------- ------------
See accompanying notes to consolidated financial statements.
F-4
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
2006 2005 2004
----------- ----------- -----------
Operating activities:
Net income (loss) $(2,345,055) $(2,265,795) $ 170,253
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 546,978 196,377 14,480
Gain on sale of investment securities and
other investments -- (378,186) --
Gain on settlement with creditors -- -- (904,027)
Non-cash stock based compensation 188,595 -- --
Common stock, options and warrants granted for services 75,358 143,162 --
Provision for bad debts 172,268 3,612,005 1,048,559
Amortization of debt discount 751,890 454,990 --
Non-cash mark to market adjustment (990,107) (176,657) --
Indebtedness adjustment -- (198,059) --
Changes in assets and liabilities:
Accounts receivable 187,422 (3,354,829) (1,590,973)
Prepaid expenses and other current assets (51,556) (61,014) 140,251
Distribution to bankruptcy creditors -- -- (301,170)
Other assets (12,818) (49,837) --
Accounts payable and accrued expenses 151,135 489,088 807,020
Taxes payable (72,530) (88,961) 315,011
Deferred revenues (112,100) (63,502) 220,564
----------- ----------- -----------
Net cash used in operating activities (1,510,520) (1,741,218) (80,032)
----------- ----------- -----------
Investing activities:
Purchase of property and equipment (258,687) (389,758) (181,502)
Proceeds from sale of investment securities -- 385,192 --
Purchase of investment securities (4,001) (7,006) (4,546)
----------- ----------- -----------
Net cash used in investing activities (262,688) (11,572) (186,048)
----------- ----------- -----------
(Continued)
See accompanying notes to consolidated financial statements.
F-5
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
2006 2005 2004
----------- ----------- -----------
Financing activities:
Net proceeds from short-term borrowing $ -- $ 273,686 $ --
Repayment of short-term borrowings (326,103) -- --
Proceeds of issuance of common stock, net of fees 489,760 -- --
Proceeds from exercise of stock options 99,800 60,500 --
Net proceeds from secured term note 3,379,000 1,744,500 --
Debt issuance costs paid (145,047) (65,977) --
Payments of long-term debt (592,675) (425,773) (7,260)
Principal payments on pre-petition bank debt
in bankruptcy proceedings -- -- (23,830)
----------- ----------- -----------
Net cash provided by (used in) financing activities
2,904,735 1,586,936 (31,090)
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents
1,131,527 (165,854) (297,170)
Cash and cash equivalents at beginning of year 205,998 371,852 669,022
----------- ----------- -----------
Cash and cash equivalents at end of year $ 1,337,525 $ 205,998 $ 371,852
----------- ----------- -----------
Cash paid during the year for:
Interest $ 421,038 $ 551,667 $ 3,126
----------- ----------- -----------
Taxes $ -- $ -- $ 27,593
----------- ----------- -----------
Supplemental disclosure of non-cash investing and financing activities:
See Notes 5, 6, 7, 8 and 12 for non-cash investing and financing activities.
See accompanying notes to consolidated financial statements.
F-6
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
1. Description of Business and Summary of Accounting Principles
------------------------------------------------------------
Description of Business and Concentrations
eLEC Communications Corp. ("eLEC" or the "Company") is a full-service
telecommunications company that focuses on developing integrated
telephone service in the competitive local exchange carrier ("CLEC")
industry (wireline telecommunication) services and by utilizing
high-speed internet connections to provide broadband voice telephony
(IP telecommunication services). The Company offers small and
medium-sized businesses and residential customers an integrated set of
telecommunications products and services, including local exchange,
local access, and domestic and international long distance telephone.
The principal focus of the Company, as a communications provider, is to
resell and provide low-cost alternative telecommunication services and
other bundled services, focusing on small business users and
residential customers. With the development of the IP
telecommunications services business, the Company is shifting its focus
towards providing broadband telephone services to other service
providers.
Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries after elimination of
significant intercompany balances and transactions. Investments in less
than 20% owned companies that do not have readily determinable fair
values were carried at cost prior to their disposition.
Investment Securities
The Company follows Statement of Financial Accounting Standards No.
115, "Accounting for Certain Investments in Debt and Equity
Securities", which requires that investment securities be classified as
trading, held-to-maturity or available-for-sale. Investment securities
at November 30, 2006 and 2005 consisted of equity securities classified
as available-for-sale and are carried at fair value with unrealized
gains or losses reported in a separate component of shareholders'
equity.
Property, Plant and Equipment and Depreciation
Property, plant and equipment are recorded at cost. Depreciation is
computed primarily by use of accelerated and straight-line methods over
the estimated useful lives of the assets. The estimated useful lives
are three to five years for computer equipment and software, five to
ten years for machinery and equipment, and five years for furniture and
fixtures.
Computer Software Development Costs
Direct development costs associated with internal-use computer software
are accounted for under Statement of Position 98-1 "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use" and
are capitalized. Costs incurred during the preliminary project stage,
as well as for maintenance and training, are expensed as incurred.
Amortization is provided on a straight-line basis over the shorter of
five years or the estimated useful life of the software.
F-7
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
1. Description of Business and Summary of Accounting Principles
-----------------------------------------------------------------------
(Continued)
-----------
Computer software developed or obtained for internal use were included
in property and equipment at November 30, 2006 and 2005 and were
carried at $705,220 and $508,000, respectively, net of accumulated
depreciation of $158,917 and $39,275, respectively, at November 30,
2006 and 2005. Amortization expense was $119,642, $39,275 and $0,
respectively, for the years ended November 30, 2006, 2005 and 2004.
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 No. 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 that will
be in effect when these differences reverse, and the effect of net
operating loss carryforwards. Deferred tax expense is the result of
changes in deferred tax assets and liabilities. A valuation allowance
has been established to eliminate the deferred tax assets as it is more
likely than not that such deferred tax assets will not be realized.
Revenue Recognition
Revenues from voice, data and other telecommunications-related services
are recognized in the period in which subscribers use the related
services. Revenues for carrier interconnection and access are
recognized in the period in which the service is provided. Deferred
revenue represents the unearned portion of telephone service plans that
are billed a month in advance.
Collectibility of Accounts Receivable
Trade receivables potentially subject the Company to credit risk. The
Company extends credit to its customers and generally does not require
collateral. During fiscal years ended November 30, 2006, 2005 and 2004,
the Company accepted most new customers and extended initial credit
based upon credit scored lists and payment history of telephone bills,
when available. Once a customer is billed for services, the Company
actively manages the accounts receivable to minimize credit risk.
Approximately $46,000 and $93,000 as of November 30, 2006 and 2005
represented net amounts due (after allowance for doubtful collection)
from entities in the telecommunications industry related to carrier
interconnection and access.
F-8
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
1. Description of Business and Summary of Accounting Principles
-----------------------------------------------------------------------
(Continued)
-----------
Collectibility of Accounts Receivable (Continued)
In order to record the Company's accounts receivable at their net
realizable value, the Company must assess their collectibility. A
considerable amount of judgment is required in order to make this
assessment, including an analysis of historical bad debts and other
adjustments, a review of the aging of the Company's receivables, and
the current creditworthiness of the Company's customers. Generally,
when a customer account reaches a certain level of delinquency, the
Company disconnects the customer's service and provides an allowance
for the related amount receivable from the customer. The Company has
recorded allowances for receivables that it considered uncollectible,
including amounts for the resolution of potential credit and other
collection issues, such as disputed invoices, customer satisfaction
claims and pricing discrepancies. However, depending on how such
potential issues are resolved, or if the financial condition of any of
the Company's customers was to deteriorate and its ability to make
required payments became impaired, increases in these allowances may be
required. The Company writes off the accounts receivable balance from a
customer and the related allowance established when it believes it has
exhausted all reasonable collection efforts. As of November 30, 2006
and 2005, the Company had no individual customer that constituted more
than 10% of its accounts receivable. For the years ended November 30,
2006, 2005 and 2004, no individual customer accounted for more than 10%
of the Company's revenues.
Deferred Finance Costs
Deferred finance costs represent fees paid to third parties that
provided services in connection with securing financing and are
amortized over the loan term. Management believes they will be
successful in obtaining a waiver with its lender to sustain the
long-term nature of its debt (see Note 8), and has determined that the
associated deferred finance charges should not be written off.
Accordingly, since the entire amount of the debt is classified as
current, the related deferred finance costs are classified as a current
asset.
Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing net income
(loss) by the weighted-average number of shares outstanding. To the
extent that stock option warrants and convertible securities are
anti-dilutive, they are excluded from the calculation of diluted
earnings (loss) per share. Diluted earnings per share includes the
dilutive effect of stock options and warrants. Approximately 1,130,000
of the Company's stock options and warrants were excluded from the 2004
calculation of the diluted earnings per share because the exercise
price of the stock options and warrants were greater than the average
price of the common shares, and, therefore, their inclusion would have
been anti-dilutive. For 2006 and 2005, the Company excluded from its
loss per share calculations all dilutive securities because their
effect on loss per share was anti-dilutive.
F-9
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
1. Description of Business and Summary of Accounting Principles
-----------------------------------------------------------------------
(Continued)
-----------
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with
original maturities of three months or less to be cash equivalents.
Impairment of Long-Lived Assets
The Company reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to future
forecasted net undiscounted cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to
be recognized is measured by the amount by which the carrying amount of
the assets exceeds the fair values. For the year ended November 30,
2006, the Company's IP telecommunications services business incurred
significant operating and cash flow losses. Combined with a previous
history of such losses, as of November 30, 2006, the Company evaluated
whether the carrying amount of the long-lived assets of this business
were recoverable. The Company had recently received an offer for this
business from a third party for an amount substantially in excess of
the carrying value of the long-lived assets, and accordingly, the
Company determined that such assets were not impaired. In addition, the
Company had entered into a contract to sell its wireline
telecommunications business (see Note 20). The contract selling price
would result in a book gain, if the sale is consummated, and
accordingly, the Company has determined that such assets were not
impaired.
Use of Estimates
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
the disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses
during the reporting period. Significant estimates relate to the
allowance for doubtful accounts receivable, income tax valuation
allowance, and conclusions regarding the impairment of long-lived
assets. On a continual basis, management reviews its estimates,
utilizing currently available information, changes in facts and
circumstances, historical experience and reasonable assumptions. After
such reviews, and if deemed appropriate, those estimates are adjusted
accordingly. Actual results could differ from those estimates.
Advertising
Advertising costs are expensed as incurred. Such costs were not
significant in any of the years presented herein.
F-10
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
1. Description of Business and Summary of Accounting Principles
-----------------------------------------------------------------------
(Continued)
-----------
Accounting for Derivative Instruments
The Company accounts for derivative instruments in accordance with SFAS
No. 133 "Accounting for Derivative Instruments and Hedging Activities,"
as amended, which establishes accounting and reporting standards for
derivative instruments and hedging activities, including certain
derivative instruments imbedded in other financial instruments or
contracts and requires recognition of all derivatives on the balance
sheet at fair value, regardless of the hedging relationship
designation. Accounting for the changes in the fair value of the
derivative instruments depends on whether the derivatives qualify as
hedge relationships and the types of the relationships designated are
based on the exposures hedged. Changes in the fair value of derivatives
designated as fair value hedges are recognized in earnings along with
fair value changes of the hedged item. Changes in the fair value of
derivatives designated as cash flow hedges are recorded in other
comprehensive income (loss) and are recognized in earnings when the
hedged item affects earnings. Changes in the fair value of derivative
instruments which are not designated as hedges are recognized in
earnings as other income (loss). At November 30, 2006 and 2005, the
Company did not have any derivative instruments that were designated as
hedges.
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair
value of each class of significant financial instruments:
o Cash and Cash Equivalents
The carrying amount approximates fair value because of the
short maturity of those instruments.
o Investment Securities
The fair value of the Company's investment in marketable
equity securities is based upon the quoted market price.
o Short-Term Borrowings and Capital Lease Obligations
The fair value of the Company's capital lessee obligations are
estimated based on current rates offered to the Company for
debt of the same remaining maturities and approximates the
carrying amount.
F-11
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
1. Description of Business and Summary of Accounting Principles
-----------------------------------------------------------------------
(Continued)
-----------
o Derivative Instruments
The Company has issued debt and/or equity instruments, some of
which have required a determination of their fair value and/or
the fair value of certain related derivatives, where quoted
market prices were not published or readily available. The
Company bases its fair value determinations using the
Black-Scholes method, which requires judgments and estimates
including, the volatility of the Company's common stock,
expected dividends on the Company's common stock, interest
rate assumptions and expected length of the related
instruments.
The Company has no instruments with significant off-balance-sheet risk.
Stock Compensation Plan
The Company issues stock options to its employees, outside directors
and consultants pursuant to stockholder approved and non-approved stock
option programs.
In December 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 123R, "Share-Based Payment." SFAS 123R is a revision of
SFAS 123, and supersedes APB 25. Among other items, SFAS 123R
eliminates the use of APB 25 and the intrinsic value method of
accounting, and requires companies to recognize in their financial
statements the cost of employee services received in exchange for
awards of equity instruments, based on the grand date fair value of
those awards. SFAS 123R permits companies to adopt its requirements
using either a "modified prospective" method or a "modified
retrospective" method. Under the "modified prospective" method,
compensation cost is recognized in the financial statements beginning
with the effective date, based on the requirements of SFAS 123R for all
share-based payments granted after that date, and based on the
requirements of SFAS 123 for all unvested awards granted prior to the
effective date of SFAS 123R. Under the "modified retrospective" method,
the requirements are the same as under the "modified prospective"
method, but this method also permits entities to restate financial
statements of previous periods based on proforma disclosures made in
accordance with SFAS 123. Beginning in fiscal 2006, the Company
accounts for stock-based compensation in accordance with the provisions
of SFAS 123R and have elected the "modified prospective" method and
have not restated prior financial statements. For the year ended
November 30, 2006, the Company recorded approximately $189,000 in
employee stock-based compensation expense, which is included in our
selling, general and administrative expenses. As of November 30, 2006,
there was approximately $227,000 of unrecognized stock-compensation
expense for previously granted unvested options that will be recognized
over a two-year period.
F-12
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
1. Description of Business and Summary of Accounting Principles
-----------------------------------------------------------------------
(Continued)
-----------
Prior to fiscal 2006, the Company accounted for its stock option awards
under the intrinsic value based method of accounting prescribed by APB
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations, including Financial Accounting Standards Board
("FASB") Interpretation No. 44, "Accounting for Certain Transactions
Including Stock Compensation," an interpretation of APB Opinion No. 25.
Under the intrinsic value based method, compensation cost is the
excess, if any, of the quoted market price of the stock at grant date
or other measurement date over the amount an employee must pay to
acquire the stock. The Company makes pro forma disclosures for the
years ended November 30, 2005 and 2004 of net income and earnings per
share as if the fair value based method of accounting had been applied
as required by SFAS No. 123, "Accounting for Stock-Based Compensation"
and SFAS 148 "Accounting for Stock-Based Compensation-Transition and
Disclosure-an Amendment of SFAS 123."
The Company's 1995 Stock Option Plan (the "1995 Plan") provides for the
grant of up to 3,400,000 incentive stock options, non-qualified stock
options, tandem stock appreciation rights, and stock appreciation
rights of shares of common stock. Under the Plan, incentive stock
options may be granted at no less than the fair market value of the
Company's stock on the date of grant, and in the case of an optionee
who owns directly or indirectly more than 10% of the outstanding voting
stock ("an Affilitate"), 110% of the market price on the date of grant.
As of November 30, 2006, approximately 440,000 option shares were
unissued and will not be available for future issuance, as the plan can
no longer be used for option grants.
The Company's 2004 Equity Incentive Plan (the "Incentive Plan")
provides for the grant of up to 1,000,000 incentive stock options,
non-qualified stock options, tandem stock appreciation rights, and
stock appreciation rights of shares of common stock. Under the
Incentive Plan, incentive stock options may be granted at no less than
the fair market value of the Company's stock on the date of grant, and
in the case of an optionee who owns directly or indirectly more than
10% of the outstanding voting stock ("an Affiliate"), 110% of the
market price on the date of grant. As of November 30, 2006,
approximately 292,000 option shares remain unissued and are available
for future issuance.
The Company's Non-employee Director Stock Option Plan provides for the
grant of options to purchase 10,000 shares of the Company's common
stock to each non-employee director on the first business day following
each annual meeting of the shareholders of the Company. Under this
Plan, options may be granted at no less than the fair market value of
the Company's common stock on the date of grant.
For disclosure purposes, the fair value of each stock option grant is
estimated on the date of grant using the Black Scholes option-pricing
model with the following weighted average assumptions used for stock
options granted in 2005 and 2004, respectively: annual dividends of
$-0- for both years, expected volatility of 152% and 158%, risk-free
interest rate of 4.3% and 3.1%, and expected life of five years for all
grants. The weighted-average fair value of stock options granted in
2005 and 2004 was $.31 and $.21, respectively.
F-13
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
1. Description of Business and Summary of Accounting Principles
-----------------------------------------------------------------------
(Continued)
-----------
Stock Compensation Plan (Continued)
Under the above model, the total value of stock options granted in 2005
and 2004 was approximately $503,000 and $466,000, respectively, which
would be amortized ratably on a pro forma basis over the related
vesting periods, which range from immediate vesting to five years. Had
compensation cost been determined based upon the fair value of the
stock options at grant date for all awards, the Company's net income
(loss) and earnings (loss) per share would have been changed to the pro
forma amounts indicated below:
2005 2004
----------- ----------
Net income (loss):
As reported $(2,265,795) $ 170,253
Stock-based compensation cost, net of
related tax effects, that would have been
included in the determination of net
income in the fair value based method
has been applied to all awards 356,533 279,145
----------- ----------
Pro forma net income (loss) $(2,622,328) $ (108,892)
----------- ----------
Basic earnings (loss) per share:
As reported $ (.14) $ .01
Pro forma $ (.16) $ (.01)
Diluted earnings (loss) per share:
As reported $ (.14) $ .01
Pro forma $ (.16) $ (.01)
Stock-based employee compensation cost, net of
related tax effects, included in the
determination of net income as reported $ -- $ --
----------- ----------
Segment Reporting
The Company has utilized the management approach as defined by
Statement of Financial Accounting Standards No. 131 Disclosures about
Segments of an Enterprise and Related Information ("SFAS 131") to
determine if the Company has reportable operating segments. Based on
this evaluation, the Company is organized into two operating segments:
1) Wireline Telecommunication Services and 2) IP Telecommunication
Services. Each segment is organized and managed separately to make key
decisions such as sales/marketing and product development. Ultimately,
the chief operating decision maker evaluates and makes decisions based
on the financial information available about these two segments. The
chief operating decision maker for the Company is the chief executive
officer.
Reclassifications and Corrections
Certain 2005 and 2004 items have been reclassified to conform to the
2006 presentation. The statement of cash flows for the year ended
November 30, 2005 has been corrected for the classification of
amortization of debt discounts in the amount of $424,242. Such
amortization was originally classified in financing activities instead
of in operating activities. The effect was that previously reported
cash flows used by operating activities of $(2,165,460) has been
corrected to reflect cash flows used by operating activities of
$(1,741,218) and previously reported cash flows provided by financing
activities of $2,011,178 has been corrected to reflect cash flows
provided by financing activities of $1,586,936. There was no effect on
net loss or on loss per share.
Recent Accounting Pronouncements
In December 2006, the FASB issued FASB Staff Position EITF 00-19-2
"Accounting for Registration Payment Arrangements." The guidance in
this staff position addresses an issuer's accounting for registration
payment arrangements and shall be effective for
F-14
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
1. Description of Business and Summary of Accounting Principles
-----------------------------------------------------------------------
(Continued)
-----------
Recent Accounting Pronouncements (Continued)
financial statements issued for fiscal years beginning after December
15, 2006, and interim periods with those fiscal years. Management is
assessing the impact on the Company's financial condition and results
of operations.
In September 2006, the FASB issued SFAS No. 158 "Employers' Accounting
for Defined Benefit Pension and Other Postretirement Plans," which
amends SFAS No. 87 "Employers' Accounting for Pensions" (SFAS No. 87),
SFAS No. 88 "Employers' Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and for Termination Benefits" (SFAS No.
88), SFAS No. 106 "Employers' Accounting for Postretirement Benefits
Other Than Pensions" (SFAS No. 106), and SFAS No. 132R "Employers'
Disclosures About Pensions and Other Postretirement Benefits (revised
2003"" (SFAS No. 132R). This Statement requires companies to recognize
as asset or liability for the overfunded or underfunded status of their
benefit plans in their financial statements. SFAS No. 158 also requires
the measurement date for plan assets and liabilities to coincide with
the sponsor's year end. The standard provides two transition
alternatives related to the change in measurement date provisions. The
recognition of an asset and liability related to the change in
measurement date provisions. The recognition of an asset and liability
related to the funded status provision is effective for fiscal year
ending after December 15, 2006 and the change in measurement date
provisions is effective for fiscal years ended after December 15, 2008.
Management is assessing the impact on the Company's financial condition
and results of operations.
In September 2006, the SEC issued Staff Accounting Bulletin 108("SAB
108"), which expresses the Staff's views regarding the process of
quantifying financial statement misstatements. The bulletin was
effective at fiscal year end 2006. The implementation of this bulletin
had no impact on the Company's results of operations, cash flows or
financial position.
In September 2006, the FASB issued Statement No. 157, Fair Value
Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a
framework for measuring fair value in generally accepted accounting
principles (GAAP), and expands disclosures about fair value
measurements. SFAS 157 will be applied prospectively and will be
effective for periods beginning after November 15, 2007. The Company is
currently evaluating the effect, if any, of SFAS 157 on the Company's
consolidated financial statements.
In June 2006, the FASB issued Interpretation ("FIN") No. 48,
"Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement ("SFAS") No. 109." This Interpretation clarifies the
accounting for uncertainty in income taxes recognized in an entity's
financial statements in accordance with SFAS No. 109, "Accounting for
Income Taxes." The interpretation describes a recognition threshold and
measurement attribute for the financial statement disclosure of tax
positions taken or expected to be taken. It also provides for guidance
on derecognition, classification, interest and penalties, accounting in
interim periods, disclosures and transition. FIN No. 48 is effective
for fiscal years beginning after December 15, 2006. The Company is
still evaluating the effect of adopting FIN 48 and does not expect it
to have a material effect of the Company's consolidated financial
statements.
In June 2006, the Emerging Issues Task Force ("EITF") ratified EITF
Issue 06-3, "How Taxes Collected From Customers and Remitted to
Governmental Authorities Should Be Presented in the Income Statement
(That Is, Gross versus Net Presentation)." A consensus was reached that
entities may adopt a policy of presenting taxes in the income statement
on either a gross or net basis. An entity should disclose its policy of
presenting taxes and the amount of any taxes presented on a gross basis
should be disclosed, if significant. The guidance is effective for
periods beginning after December 15, 2006. We present revenues net of
taxes. EITF 06-3 will not impact the method for recording these sales
taxes in our consolidated financial statements.
F-15
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
1. Description of Business and Summary of Accounting Principles
-----------------------------------------------------------------------
(Continued)
-----------
Recent Accounting Pronouncements (Continued)
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections" ("SFAS 154"), which replaces APB Opinion No. 20,
"Accounting Changes," and FASB Statement No. 3, "Reporting Accounting
Changes in Interim Financial Statements." APB Opinion No. 20 had
required that changes in accounting principles be recognized by
including the cumulative effect of the change in the period in which
the new accounting principle was adopted. SFAS 154 requires
retrospective application of the change to prior periods' financial
statements, unless it is impracticable to determine the period-specific
effects of the change. The FASB identified the reason for the issuance
of SFAS 154 to be part of a broader attempt to eliminate differences
with the International Accounting Standards Board ("IASB"). The
Statement is effective for fiscal years beginning after December 15,
2005. The Company does not anticipate that the adoption of SFAS 154
will have a significant impact on the Company' consolidated financial
position or results of operations.
2. Going Concern Matters and Realization of Assets
-----------------------------------------------
The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the ordinary course of business.
However, the Company has sustained substantial losses from its
continuing operations in recent years and has negative working capital
and a stockholders' equity deficiency. In addition, the Company is
experiencing difficulty in generating sufficient cash flow to meet its
obligations and sustain its operations and is currently in default of
its financing agreement with its principal lender (Note 8). The Company
expects its operating losses and cash deficits from operations to
continue through fiscal 2007.
Based on its current business plans, the Company believes that its
existing cash resources will only be sufficient to fund its operating
losses, capital expenditures, lease and debt payments and working
capital requirements through a portion of the second quarter of fiscal
2007. As a result, the Company will need to raise additional cash
through some combination of borrowings, sale of equity or debt
securities or sale of assets to enable it to meet its cash
requirements.
The Company may not be able to raise sufficient additional debt, equity
or other cash on acceptable terms, if at all. Failure to generate
sufficient revenues, achieve certain other business plan objectives or
raise additional funds could have a material adverse effect on the
Company's results of operations, cash flows and financial position,
including its ability to continue as a going concern, and may require
it to significantly reduce, reorganize, discontinue or shut down its
operations.
In view of the matters described above, recoverability of a major
portion of the recorded asset amounts shown in the accompanying balance
sheet is dependent upon continued operations of the Company which, in
turn, is dependent upon the Company's ability to meet its financing
requirements on a continuing basis, and to succeed in its future
operations. The financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset
amounts or amounts and classification of liabilities that might be
necessary should the Company be unable to continue in its existence.
F-16
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
2. Going Concern Matters and Realization of Assets (Continued)
-----------------------------------------------------------
Management's plans include (1) evaluating offers to sell part or all of
its wireline subscriber base and plans to use the proceeds to reduce
its debt payments, (2) seeking additional financing to purchase target
businesses that are generating positive cash flow, and (3) seeking
additional financing to continue operations as a broadband voice
carrier and increasing its sales channels and sales staff so its
broadband voice facilities are more fully utilized.
There can be no assurance that the Company will be able to achieve its
business plan objectives or that it will achieve or maintain cash flow
positive operating results. If the Company is unable to generate
adequate funds from its operations or raise additional funds, it may
not be able to repay its existing debt, continue to operate its
network, respond to competitive pressures or fund its operations. As a
result, the Company may be required to significantly reduce,
reorganize, discontinue or shut down its operations. The Company's
financial statements do not include any adjustments that might result
from this uncertainty.
3. Investment and Other Securities
--------------------------------
Fair Unrealized
Cost Value Holding Loss
------------ ------------ ------------
At November 30, 2006:
Equity securities, included in
other assets $ 13,470 $ 4,368 ($ 9,102)
------------ ------------ ------------
At November 30, 2005
Equity securities, included in
other assets $ 9,469 $ 2,050 ($ 7,419)
------------ ------------ ------------
The Company exercised its warrant, which was not publicly traded, to
purchase 95,238 shares of Talk America Holding, Inc. ("Talk") at $6.30
per share, in August 2005, the Company sold the warrant, recognizing a
gain of approximately $218,000. As of November 30, 2005, the gain is
included in the Consolidated Statements of Operations under the
caption, "Gain on sale of investment securities and other investments."
4. Other Investments
-----------------
The Company held shares in Cordia Corporation ("Cordia"), a
publicly-held company whose shares were quoted in the over-the-counter
market. Due to the thinly-traded nature of the Cordia shares, such
shares had not been accounted for as a marketable equity security in
accordance with Statement of Financial Accounting Standards No. 115,
but instead were carried at cost.
During the years ended November 30, 2005 and 2004, the Company sold
82,080 and 2,000 shares of Cordia stock, resulting in gains of $159,776
and $770. At November 30, 2006 and 2005, the Company held 100 and
81,180 shares of Cordia.
F-17
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
5. Property, Plant and Equipment
-----------------------------
2006 2005
---------- ----------
Machinery and equipment $ 447,612 $ 82,605
Computer equipment and software 1,010,276 903,532
Furniture and fixtures 90,452 90,452
---------- ----------
1,548,340 1,076,589
Less accumulated depreciation and
amortization 645,059 482,778
---------- ----------
$ 903,281 $ 593,811
---------- ----------
6. Deferred Finance Costs
----------------------
2006 2005
---------- ----------
Gross asset $1,494,775 $ 676,342
Less accumulated amortization 481,834 133,449
---------- ----------
$1,012,941 $ 542,893
---------- ----------
Amortization expense of deferred finance costs for the years ended
November 30, 2006, 2005 and 2004 was $384,697, $133,448 and $0.
Future amortization of deferred finance costs are as follows:
Years ended November 30,
------------------------
2007 $ 638,016
2008 338,660
2009 36,265
----------
$1,012,941
----------
7. Short-Term Borrowings
---------------------
On December 17, 2004, the Company sold a promissory note (the "Note")
in the principal amount of $328,767 and issued 160,000 shares of
restricted common stock to an unaffiliated party for $273,686, net of
related financing costs. $32,000 of the proceeds has been allocated to
the common stock. The Note was payable on December 17, 2005 and was
unsecured. On December 16, 2005, the Company paid $328,767 to the
holder of the Note in full settlement of the obligation. The Note
required the Company to spend the proceeds of the Note on sales and
marketing efforts. The Company incurred costs of $36,314 in connection
with the issuance of the Note, which was amortized over the term of the
Note. Amortization of these costs for the year ended November 30, 2005
was $34,722, and is included in depreciation and amortization expense.
Amortization of the $32,000 debt discount for the year ended November
30, 2005 was $30,597 and was included in interest expense. On November
30, 2005, $326,103 was due the holder of the Note. The effective
interest rate on the Note was 22.7%.
F-18
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
8. Long-Term Debt and Capital Lease Obligations
--------------------------------------------
The following table summarizes components of long-term debt and capital
lease obligations as of November 30, 2006 and 2005:
November 30
-----------------------
2006 2005
---------- ----------
Term note dated February 8, 2005 $1,006,799 $ 695,651
Term note dated November 30, 2005 1,205,408 907,266
Term note dated May 31, 2006 1,057,618
Capital lease obligations 292,789 95,565
---------- ----------
Total 3,562,614 1,698,482
Less current portion 3,347,707 43,891
---------- ----------
Long-term debt and capital lease obligations $ 214,907 $1,654,591
---------- ----------
Payments of long-term debt and capital lease obligations are scheduled
as follows:
Term Capital Lease
Notes Obligations Total
2007 $2,114,616 $ 120,702 $2,235,318
2008 2,855,846 80,013 2,935,859
2009 437,846 77,808 515,654
2010 -- 66,198 66,198
2011 -- 51,187 51,187
---------- ---------- ----------
5,408,308 395,908 5,804,216
Less amount representing
interest 2,138,483 103,119 2,241,602
---------- ---------- ----------
Principal portion of future
payments 3,269,825 292,789 3,562,614
Less current portion 3,269,825 77,882 3,347,707
---------- ---------- ----------
Long-term portion $ -- $ 214,907 $ 214,907
---------- ---------- ----------
On February 8, 2005, the Company entered into a secured financing
arrangement with a lender. The financing consisted of a $2 million
secured convertible term note (the "February 2005 Financing") that, as
modified, matures on February 8, 2008. The note was amended on May 31,
2006 and is no longer convertible (see below).
F-19
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
8. Long-Term Debt and Capital Lease Obligations (Continued)
--------------------------------------------------------
In connection with this financing, the Company issued the lender
warrants to purchase up to 793,650 shares of common stock. The warrants
are exercisable through February 8, 2012 as follows: 264,550 shares at
$0.72 per share; 264,550 shares at $0.79 per share; and the balance at
$0.95 per share. The underlying contracts provide for a potential cash
settlement and accordingly, the warrants were classified as debt. The
Company initially recorded discounts aggregating approximately
$1,316,000, of which, approximately $504,000 represented the value of
the warrants using the Black-Scholes method with an interest rate of
3.1%, volatility of 158%, zero dividends and expected term of seven
years; approximately $706,000 represented the beneficial conversion
feature inherent in the instrument; and approximately $106,000
represented debt issue costs paid to the lender. Such discounts are
being amortized using the effective interest method over the term of
the related debt. Although the stated interest rate of the convertible
note was the prime rate plus 3%, as a result of the aforementioned
discounts, the effective interest rate of the note, as modified,
approximated 38% per annum. The Company incurred fees to third parties
in connection with this financing aggregating approximately $367,000,
including warrants to purchase up to 253,968 shares of common stock.
These warrants were valued at $150,000 using the Black-Scholes method
using the same assumptions described above and are included in equity.
These warrants are exercisable through February 8, 2009 at $.63 per
share.
On November 30, 2005, the Company entered into a second financing
arrangement with the lender (the "November 2005 Financing"). This
financing consisted of a $2 million secured convertible term note that
matures on November 30, 2008. The note was amended on May 31, 2006 and
is no longer convertible (see below). The proceeds of the financing
were held in escrow, and received by the Company on December 1, 2005.
In connection with this financing, the Company issued the lender
warrants to purchase up to 1,683,928 shares of the Company's common
stock. The warrants are exercisable at $.10 per share through November
30, 2020. The underlying contracts provide for a potential cash
settlement, and accordingly, the warrants have been classified as debt.
The Company initially recorded discounts aggregating approximately
$1,093,000, of which, approximately $740,000 represented the value of
the warrants using the Black-Scholes method with an interest rate of
4.3%, volatility of 152%, zero dividends and expected term of fifteen
years; approximately $268,000 represented the beneficial conversion
feature inherent in the instrument; and approximately $85,000
represented debt issue costs paid to the lender. Such discounts are
being amortized using the effective interest method over the term of
the related debt. Although the stated interest rate of the convertible
note is the prime rate plus 2%, as a result of the aforementioned
discounts, the effective interest rate of the note amounted to
approximately 47% per annum. The Company incurred fees to third parties
in connection with this financing aggregating approximately $273,000,
including warrants to purchase up to 262,296 shares of common stock.
These warrants were valued at approximately $99,000 using the
Black-Scholes method using the same assumptions described above and are
included in equity. These warrants are exercisable through November 30,
2009 at $.61 per share. The warrant liability will be adjusted at each
future reporting date to fair market value (see discussion of the
amendment to this Note below).
F-20
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
8. Long-Term Debt and Capital Lease Obligations (Continued)
--------------------------------------------------------
On May 31, 2006, the Company entered into a third financing arrangement
with the lender (the "May 2006 Financing"). This financing consisted of
a secured term note up to a maximum principal amount of $1,700,000 (the
"Note"), an amended and restated secured term note that amended and
restated the February 2005 Financing ("Amended Note 1"), an amended and
restated secured term note that amended and restated the November 30,
2005 Financing ("Amended Note 2") and a common stock purchase warrant
(the "Warrant") that entitles Laurus to purchase up to 3,359,856 shares
of the Company's common stock, par value $.10 per share. The Warrant
grants the lender the right to purchase for cash up to 3,359,856 shares
of common stock at an exercise price of $0.10 per share. The Warrant
expires on May 31, 2020. If the Company repays the Note in full prior
to May 31, 2007 plus an additional amount of $100,000, the number of
shares originally issuable upon exercise of the Warrant will be reduced
by 1,175,950 shares, and the maximum number of shares that may be
purchased upon exercise of the Warrant is reduced to 2,183,906 shares.
The Warrant does not contain registration rights and requires the
lender to limit the sale on any trading day of any shares of common
stock issued upon the exercise of the Warrant to a maximum of ten
percent (10%) of the aggregate number of shares of common stock traded
on such trading day. The value of the Warrant was $1,173,762 determined
using the Black-Scholes method with an interest rate of 4.8%,
volatility of 152%, zero dividends and expected term of fourteen years,
and the cost has been allocated as described below. The Warrant
provides for a potential cash settlement, and accordingly, is
classified as debt.
The warrant liability for all of the above warrants which have been
classified as debt are adjusted to fair market value at each reporting
date.
F-21
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
8. Long-Term Debt and Capital Lease Obligations (Continued)
--------------------------------------------------------
The Company received $650,000 of the principal amount of the Note on
June 2, 2006 and $1,050,000 on November 14, 2006, after certain
operating milestones were met. Had the Company not met the operating
milestones, the Company could not have access to the funds and such
funds were kept in a restricted account not controlled by the Company.
Accordingly, the Company did not record an obligation until November
14, 2006. The Note requires interest payments at prime plus 2% on the
first day of each month during the term of the Note, except that the
Company was not required to make interest payments on the $1,050,000
portion of the Note until the principal proceeds were received on
November 14, 2006. At such time an interest payment was made of
$49,423, and the Company received interest income of $23,501, which
represented the interest income earned on the $1,050,000 balance that
was deposited in a restricted cash account from the time period of June
2, 2006 to November 14, 2006. Principal payments of $60,954 are due on
a monthly basis beginning June 1, 2007 until May 31, 2009, when a final
payment of $237,097 is due.
The Company has accounted for this as two separate borrowings, one for
$650,000 borrowing and one for the $1,050,000 borrowing. The value of
the Warrant allocated to the May 2006 Financing ($650,000 principal
component) amounted to $586,881 and is accounted for as a debt
discount. Debt issue costs paid to the lender amounted to $59,400.
These discounts are being amortized using the effective interest method
over the term of the related debt. Although the stated interest rate of
the $650,000 component of the note is the prime rate plus 2%, as a
result of the aforementioned discounts, the effective interest rate of
the $650,000 note is approximately 185% per annum. The Company incurred
fees to third parties in connection with this financing aggregating
approximately $244,000, including warrants to purchase up to 548,571
shares of common stock. These warrants were valued at approximately
$108,000 using the Black-Scholes method using the same assumptions
described above and are included in equity. 148,571 of the shares can
be purchased at $.35, until May 31, 2010, and 400,000 shares can be
purchased at $.21 until November 15, 2010. The $1,050,000 borrowing is
at prime plus 2%. The prime rate was 8 1/4% at November 30, 2006.
The principal amendments to the February 8, 2005 note effected in
Amended Note 1 on May 31, 2006 were the elimination of the conversion
features that permitted the conversion of unpaid principal and interest
on the February 8, 2005 note into shares of Company common stock and
the reduction in the interest rate payable on the outstanding principal
amount of the February 8, 2005 note from the "prime rate" plus three
percent (3%) to the "prime rate" plus two percent (2%). The remaining
principal and interest payments on this note, in monthly amounts of
$60,606 plus interest, are no longer convertible. Any unpaid principal
balance at the maturity date of February 8, 2008 is payable at that
time.
F-22
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
8. Long-Term Debt and Capital Lease Obligations (Continued)
--------------------------------------------------------
The principal amendment to the November 30, 2005 note effected in
Amended Note 2 on May 31, 2006 was the elimination of the conversion
features that permitted the conversion of unpaid principal and interest
on the November 30, 2005 note into shares of Company common stock. The
remaining principal and interest payments on this note, monthly amounts
of $33,333 plus interest, are no longer convertible. The interest rate
is the "prime rate" plus two percent (2%). Any unpaid principal balance
at the maturity date of November 30, 2008 is payable at that time.
The amendments to Amended Note 1 and Amended Note 2 (the "Amendments")
were accounted for as modifications of debt instruments. Consequently,
the unamortized beneficial conversion features (approximately $535,000
at May 31, 2006) arising from the original issuance of the February
2005 Financing and the November 2005 Financing were reversed to paid-in
capital on May 31, 2006. The value of the Warrant allocated to the
Amendments was $586,881 and the Company recorded a deferred finance
cost for such amount. The deferred finance cost is being amortized over
the life of the related indebtedness.
The Company did not make the scheduled monthly principal payments to
the lender under the terms of Amended Note 1 and Amended Note 2 of
approximately $93,000 that were due on October 1, 2006. The lender
issued a waiver for non-payment and changed the due date of the $93,000
to the final maturity date of the notes. The Company has not made
principal payments due to the lender for Amended Note 1 due on or after
December 1, 2006 or for Amended Note 2 that were due on and after
November 1, 2006. The Company is in the process of negotiating a
principal deferral of nine months for Amended Note 2 and a principal
deferral for payments on Amended Note 1 until the time that the Company
sells its CLEC operations in accordance with the agreement it signed on
December 14, 2006 (see Note 19). The Company has not executed a signed
document with the lender regarding this deferral. The Company remains
in default with its lender for late principal payments and for other
items, such as late payment of taxes, and has recorded default interest
of $42,733 in accordance with its lending agreement. The Company plans
to cure the default and negotiate a waiver with its lender in
conjunction with the sale of its CLEC subsidiaries, although there can
be no assurance that this will be consummated. Because of the existence
of a default, the debt may become callable and it is classified as a
current liability as of November 30, 2006.
F-23
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
8. Long-Term Debt and Capital Lease Obligations (Continued)
--------------------------------------------------------
The Company determined, in accordance with SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities," that the warrants
issued to the lender in the February 2005, November 2005 and May 2006
Financings represented derivatives. Accordingly, the Company recorded
the fair value of these derivatives as a debt discount and a liability
on its consolidated balance sheet. The discounts are being amortized to
interest expense using the "Effective Interest Method" of amortization
over the term of the related indebtedness. At November 30, 2006, the
value of the derivatives was decreased by $990,107 to the then current
fair value of $1,251,182 with a corresponding credit to other income.
At November 30, 2005, the value of the derivatives was decreased by
$176,657 to the then current fair value of $1,067,526, with a
corresponding credit to other income. The Company will continue to mark
these derivatives to market.
In connection with the financings, the Company has agreed, so long as
25% of the principal amount of the financings are outstanding, to
certain restrictive covenants, including, among others, that the
Company will not declare or pay any dividends, issue any preferred
stock that is subject to mandatory redemption prior to the one year
anniversary of the maturity date as defined in the agreement, redeem
any of its preferred stock or other equity interests, dissolve,
liquidate or merge with any other party unless, in the case of a
merger, the Company is the surviving entity, materially alter or change
the scope of the Company's business incur any indebtedness except as
defined in the agreement, or assume, guarantee, endorse or otherwise
become directly or contingently liable in connection with any other
party's obligations.
To secure the payment of all obligations to the lender, including
warrants, the Company entered into a Master Security Agreement that
assigns and grants to the lender a continuing security interest and
first lien on all of the assets of the Company and its subsidiaries. In
the event the Company or any of its subsidiaries wishes to finance an
acquisition in the ordinary course of business of any
hereafter-acquired equipment and has obtained a commitment from a
financing source to finance such equipment from an unrelated third
party, the lender has agreed to release its security interest on such
hereafter-acquired equipment so financed by such third party financing
source.
9. Income Taxes
------------
At November 30, 2005, the Company had net operating loss carryforwards
for Federal income tax purposes of approximately $25,400,000 expiring
in the years 2008 through 2026. There is an annual limitation of
approximately $187,000 on the utilization of approximately $2,200,000
of such net operating loss carryfowards under the provisions of
Internal Revenue Code Section 382.
F-24
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
9. Income Taxes (Continued)
------------------------
At November 30, 2006, the Company's net operating loss carryforwards
are scheduled to expire as follows:
Year ended November 30
----------------------
2008 $ 1,110,000
2009 1,050,000
2010 1,000,000
2012 3,100,000
2018 2,710,000
2019 2,510,000
2020 2,350,000
2021 5,850,000
2022 770,000
2024 450,000
2025 2,100,000
2026 2,400,000
-----------
$25,400,000
-----------
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, 2006 and 2005 were as follows:
2006 2005
----------- -----------
Deferred tax assets:
Net operating loss carryforwards $ 8,636,000 $ 7,820,000
Allowance for doubtful accounts 80,000 80,000
Stock based compensation 64,000 --
Other 76,000 --
----------- -----------
8,856,000 7,900,000
Valuation allowance (8,856,000) (7,900,000)
----------- -----------
Net deferred assets $ -- $ --
----------- -----------
F-25
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
9. Income Taxes (Continued)
------------------------
The following is a reconciliation of the tax provisions for the three
years ended November 30, 2006, 2005 and 2004 with the statutory Federal
income tax rates:
Percentage of Pre-Tax Income
----------------------------
2006 2005 2004
------ ------ ------
Statutory Federal income tax rate (34.0)% (34.0)% 34.0%
Income (loss) generating no tax benefit or
expense 36.1 28.8 (34.0)
State taxes net of Federal effect -- -- 15.3
Reversal of accrual for prior year items -- -- (33.3)
Permanent differences (2.1) 5.2 --
------ ------ ------
-- -- (18.0)%
------ ------ ------
For the year ended November 30, 2004, the Company recorded a tax
benefit of approximately $48,000 which resulted from the reduction of
an estimated accrual of tax expense for the year ended November 30,
2003, offset by tax expense of $22,000 for the year ended November 30,
2004.
10. Subsidiary's Plan of Reorganization
-----------------------------------
On April 8, 2004, the United States Bankruptcy Court for the Southern
District of New York confirmed a Plan of Reorganization (the "Plan")
for Telecarrier Services, Inc. ("TSI"). On July 29, 2002, TSI, a
wholly-owned subsidiary, had filed a voluntary petition for relief
under Chapter 11 of the Federal Bankruptcy Code in the United States
Bankruptcy Court for the Southern District of New York. The Plan
authorized the Company to disburse $325,000 to creditors in full
satisfaction of claims amounting to approximately $1,229,000.
F-26
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
10. Subsidiary's Plan of Reorganization (Continued)
-----------------------------------------------
For the year ended November 30, 2004, TSI reported a gain of $904,027
as a result of being judicially released from liabilities and claims as
follows:
Pre-petition claims:
Unsecured line of credit $ 150,000
Trade payables and due to related party 618,482
Other accrued expenses 103,250
----------
Total pre-petition claims 871,732
Post-petition payables and accrued expenses 68,124
Administrative claims and legal costs 289,171
----------
Total claims 1,229,027
Distribution to creditors 325,000
----------
Gain on debt reduction $ 904,027
----------
TSI had an agreement, effective January 2, 2002, with Telco Services,
Inc. ("Telco"), a corporation owned by a former shareholder of the
Company, under which Telco provided TSI with collection, sales and
other services. As a result of a court-stipulated agreement between TSI
and Telco, entered into on February 6, 2004, the amount owed Telco for
such services was reduced by approximately $51,000. Such reduction was
included in the gain on settlement with creditors for the year ended
November 30, 2004. As of November 30, 2004, all of Telco's claims
related to the TSI bankruptcy had been paid in full, including $65,000
in administrative claims and approximately $31,000 in unsecured claims.
11. Pension Plans
-------------
The Company sponsors a defined benefit plan covering one active
employee and a number of former employers. The Company's funding policy
with respect to the defined benefit plan is to contribute annually not
less than the minimum required by applicable law and regulation to
cover the normal cost and to fund supplemental costs, if any, from the
date each supplemental cost was incurred. Contributions are intended to
provide not only for benefits attributed to service to date, but also
for those expected to be earned in the future. Plan assets consist
primarily of investments in conservative equity and debt securities.
The Company uses a November 30 measurement date for its pension plan.
F-27
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
11. Pension Plans (Continued)
-------------------------
Effective June 30, 1995, the plan was frozen, ceasing all benefit
accruals and resulting in a plan curtailment.
Obligations and Funded Status at November 30:
Pension Benefits 2006 2005
--------- ---------
Change in benefit obligation:
Benefit obligation at beginning of year $(961,536) $(867,026)
Interest cost (60,362) (58,435)
Actuarial loss (30,401) (99,785)
Benefits paid 52,306 63,710
--------- ---------
Benefit obligation at end of year $(999,993) $(961,536)
--------- ---------
Change in plan assets:
Fair value of plan assets at beginning of
year $ 634,743 $ 580,073
Actuarial return on plan assets 54,154 48,380
Employer contribution 111,500 70,000
Asset gain or loss deferred (3,496) --
Benefits paid (52,306) (63,710)
--------- ---------
Fair value of plan assets at end of year $ 744,595 $ 634,743
--------- ---------
2006 2005 2004
--------- --------- ---------
Funded status $(255,398) $(326,793) $(286,953)
--------- --------- ---------
Net amount recognized $(255,398) $(326,793) $(286,953)
--------- --------- ---------
Amounts recognized in the statement of financial position consist of:
2006 2005
--------- ---------
Accrued benefit cost $(255,398) $(326,793)
--------- ---------
Net amount recognized $(255,398) $(326,793)
--------- ---------
The accumulated benefit obligation for the Company's defined benefit
pension plan was $999,993 and $961,536 at November 30, 2006 and 2005,
respectively.
F-28
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
11. Pension Plans (Continued)
-------------------------
Information required for pension plan with an accumulated benefit
obligation in excess of plan assets:
November 30
----------------------
2006 2005
--------- ---------
Projected benefit obligation $(999,993) $(961,536)
Accumulated benefit obligation (999,993) $(961,536)
Fair value of plan assets 744,595 $ 634,743
Components of Net Periodic Benefit Cost:
2006 2005 2004
-------- -------- --------
Interest cost $ 60,362 $ 58,435 $ 52,125
Expected return on plan assets (54,154) (45,474) (41,930)
Amortization of net loss 21,151 16,834 37,356
-------- -------- --------
Net periodic benefit cost $ 27,359 $ 29,795 $ 47,551
-------- -------- --------
Assumptions
Weighted-average assumptions used to determine net periodic
benefit cost as of November 30:
2006 2005 2004
---- ---- ----
Discount rate 6.25% 6.25% 6.25%
Expected long-term return
on plan assets 8.00% 8.00% 8.00%
The expected return on Plan assets should remain constant from year to
year since the long-term expectation should not change significantly
based on a single year's experience. A rate of 8% was adopted for this
purpose.
F-29
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
11. Pension Plans (Continued)
Plan Assets
The Company's pension plan weighted-average asset allocations at
November 30, 2006 and 2005, by asset category are as follows:
November 30
----------------
2006 2005
------ ------
Asset Category
Equity securities 59.0% 56.0%
Debt securities 36.0% 22.0%
Other 5.0% 22.0%
------ ------
Total 100.0% 100.0%
------ ------
The current investment policy for pension plan assets is to reduce
exposure to equity market risks. The current strategy for Plan assets
is to invest in conservative equity and debt securities. The Plan also
maintains a significant cash balance.
Equity securities include the Company's common stock in the amounts of
approximately $13,500 (1.8% of plan assets) and $25,700 (4.4% of plan
assets) at November 30, 2006 and 2005.
Cash flows - Contributions
The Company expects to contribute approximately $50,000 to its defined
benefit plan in fiscal 2007.
Estimated Future Benefit Payments
The following pension benefit payments are expected to be paid:
2007 $ 48,352
2008 52,283
2009 50,999
2010 54,038
2011 52,541
2012-2016 310,624
--------
$568,837
--------
F-30
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
11. Pension Plans (Continued)
-------------------------
Defined Contribution Plan
The Company has a 401(k) profit sharing plan for the benefit of all
eligible employees, as defined. The plan provides for voluntary
contributions not to exceed the statutory limitation provided by the
Internal Revenue Code. The Company may make discretionary
contributions. There were no contributions made for the years ended
November 30, 2006, 2005 and 2004.
12. Commitments and Contingencies
-----------------------------
Operating Leases
The Company leases facilities under noncancelable operating lease
agreements which expire through 2008.
Rent expense was approximately $140,000, $130,000 and $82,000 in fiscal
2006, 2005 and 2004, respectively. In addition to the annual rent, the
Company pays real estate taxes, insurance and other occupancy costs on
its leased facilities.
The minimum annual commitments under all operating leases that have
remaining noncancelable terms in excess of one year are approximately
as follows:
Year ended November 30
----------------------
2007 $ 133,000
2008 90,000
2009 --
---------
$ 223,000
---------
Capital Lease Obligations
The Company leases certain machinery and equipment under capital leases
with lease terms through 2011. Obligations under capital leases have
been recorded in the accompanying financial statements at the present
value of future minimum lease payments, discounted at interest rates
ranging from 11.7% to 16.6%. The capitalized cost and accumulated
depreciation included in property and equipment was as follows:
2006 2005
-------- --------
Cost $347,627 $134,563
Accumulated depreciation 90,985 72,868
-------- --------
$256,642 $ 61,695
-------- --------
F-31
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
12. Commitments and Contingencies (Continued)
-----------------------------------------
The future minimum lease payments under the capital lease and net
present value of future minimum lease payments for the ensuing years
are summarized as follows:
Year ended November 30
----------------------
2007 $120,702
2008 80,013
2009 77,808
2010 66,198
2011 51,187
--------
$395,908
Less amount representing interest 103,119
--------
Present value of future minimum
lease payments $292,789
--------
Purchase commitments
New Rochelle Telephone Company ("NRTC"), a wholly-owned subsidiary of
the Company, completed its negotiations with Verizon Services Corp.
("Verizon") and signed a Wholesale Advantage Services Agreement (the
"Agreement") effective January 1, 2005. The Agreement is a long-term
commercial alternative to the unbundled network elements platform
("UNE-P") and allows NRTC to purchase from Verizon wholesale dial tone
services on terms that preserve, in all material respects, the
features, functionality and ordering processes previously available to
NRTC under Verizon's UNE-P service offering. The rates and charges for
such services are fixed at agreed upon price levels that should allow
NRTC to continue to offer its existing telephone services at
competitive prices. Pursuant to the Agreement, NRTC and the Company are
required to keep confidential all additional terms and provisions of
the Agreement. The Company has minimum line commitments in connection
with the Agreement.
Other commitments
During the year ended November 30, 2005, the Company entered into
minimum purchase agreements with certain wholesale providers of
services needed for the VoIP business. The agreements require minimum
fees as follows:
Year ended November 30
----------------------
2007 $ 34,000
2008 13,000
2009 --
--------
$ 47,000
--------
Litigation
The Company is subject to legal proceedings and claims that arise in
the ordinary course of its business. In the opinion of management, the
amount of ultimate liability, if any, is not likely to have a material
effect on the financial condition, results of operations or liquidity
of the Company. However, as the outcome of litigation or legal claims
is difficult to predict, significant changes in the estimated exposures
could occur.
F-32
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
13. Stockholders' Equity
--------------------
The Company is authorized 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.
In November 2006, the company completed a private placement of
5,180,000 shares of its common stock, par value $0.10 per share
("Common Stock"), to accredited investors at a price of $.10 per share.
The placement of shares was assisted by a broker dealer that acted as a
finder (the "Finder") in the transaction and received a finder's fee
consisting of 8% cash and 8% warrant coverage of the monies it raised.
Of the gross proceeds of $518,000 received by the Company, the Finder
raised $353,000 and the Company's management raised $165,000. The
Finder received a cash fee of $28,240 and warrants to purchase 282,400
shares of Common Stock at a price of $0.12 per share. The value of the
warrants received by the Finder amounted to $42,742, using the
Black-Sholes method with an interest rate of 4.87%, volatility of 106%,
zero dividends and expected term of four years.
The following is a summary of outstanding options:
Weighted-
Average
Number of Exercise Price Exercise
Shares Per Share Price
------------ ------------ ------------
Outstanding December 1, 2003 1,723,334 $.10 - $2.50 $ 0.84
Granted during year ended
November 30, 2004 2,185,000 $.16 - $0.28 $ 0.23
Canceled during year ended
November 30, 2004 (435,834) $.10 - $2.25 $ 1.35
------------
Outstanding November 30, 2004 3,472,500 $.10 - $2.50 $ 0.40
Granted during year ended
November 30, 2005 1,625,500 $.36 - $0.59 $ 0.43
Exercised/canceled during year
ended November 30, 2005 (909,000) $.10 - $2.50 $ 0.80
------------
Outstanding November 30, 2005 4,189,000 $.10 - $1.44 $ 0.32
Granted during year ended
November 30, 2006 10,000 $ 0.35 $ 0.35
Exercised/canceled during year
ended November 30, 2006 (780,500) $.10 - $1.44 $ 0.80
------------
Outstanding November 30, 2006 3,418,500 $.10 - $0.58 $ 0.28
Options exercisable,
November 30, 2006 2,207,833 $.10 - $0.58 $ 0.26
------------
Options exercisable,
November 30, 2005 926,500 $.10 - $1.44 $ 0.40
------------
Options exercisable,
November 30, 2004 937,500 $.10 - $2.50 $ 0.40
------------
F-33
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
13. Stockholders' Equity (Continued)
--------------------------------
The following table summarizes information about the options
outstanding at November 30, 2006:
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
--------------- ----------- ------------ --------- ----------- -----
$ .10 - $ .58 3,418,500 2.92 $ .28 2,207,833 $ .26
On October 24, 1996, the shareholders of the Company adopted the eLEC
Communications Corp. 1996 Restricted Stock Award Plan (the "Restricted
Stock Award Plan"). An aggregate of 400,000 shares of common stock of
the Company have been reserved for issuance in connections with awards
granted under the Restricted Stock Award Plan. Such shares may be
awarded from either authorized and unissued shares or treasury shares.
The maximum number of shares that may be awarded under the Restricted
Stock Award Plan to any individual officer or key employee is 100,000.
No shares were awarded during fiscal 2006, 2005 and 2004.
As of November 30, 2006 and 2005, warrants were outstanding to purchase
up to 7,434,668 and 3,393,841 shares of the Company's common stock at
prices ranging from $.10 to $.95 and $.10 to $1.63, respectively. The
warrants expire through November 2020.
14. Earnings (Loss) Per Common Share
--------------------------------
Earnings (loss) per common share data was computed as follows:
2006 2005 2004
------------ ------------ ------------
Net income (loss) $ (2,345,055) $ (2,265,795) $ 170,253
------------ ------------ ------------
Weighted average common
shares outstanding 17,338,268 16,770,789 16,254,282
Effect of dilutive securities, stock
options and preferred stock -- -- 461,526
------------ ------------ ------------
Weighted average dilutive
common shares outstanding 17,338,268 16,770,789 16,715,808
------------ ------------ ------------
Earnings (loss)
per common share - basic $ (.14) $ (.14) $ .01
------------ ------------ ------------
Earnings (loss)
per common share - diluted $ (.14) $ (.14) $ .01
------------ ------------ ------------
F-34
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
15. Risks and Uncertainties
-----------------------
The Company buys substantially all of the telecommunications services
that it resells from Regional Bell Operating Companies ("RBOC's"), and
long distance carriers and is, therefore, highly dependent upon them.
The Company believes that its relationship with them is satisfactory.
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 such vendors or a significant
unfavorable change in the regulatory agreements structure would have a
severe near-term impact on the Company's ability to conduct its resale
business.
Future results of operations involve a number of risks and
uncertainties. Factors that could affect future operating results and
cash flows and cause actual results to vary materially from historical
results include, but are not limited to:
o The Company's business strategy with respect to bundled local and
long distance services may not succeed.
o Failure to manage, or difficulties in managing, the Company's
growth operations or restructurings including attracting and
retaining qualified personnel and opening up new territories for
its service with favorable gross margins.
o Dependence on the availability or functionality of incumbent
local telephone companies' networks and the resale of such
services.
o Increased price competition in local and long distance service.
o Failure or interruption in the Company's network and information
systems.
o Changes in government policy, regulation and enforcement.
o Failure of the Company's collection management system and credit
controls efforts for customers.
o Inability to adapt to technological change.
o Competition in the telecommunications industry.
o Inability to manage customer attrition and bad debt expense.
o Adverse change in Company's relationship with third-party
carriers.
o Failure or bankruptcy of other telecommunications companies whom
the Company relies upon for services and revenues.
o Lack of capital, borrowing capacity, and inability to generate
cash flow.
o The Company is in default of its financing agreement with its
principal lender, and such loans may be called at any time.
o The Company relies on the services of one small software
developer for its IP telecommunication services.
F-35
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
16. Selected Quarterly Financial Information (Unaudited)
----------------------------------------------------
For the first three quarters of the year ended November 30, 2005, the
Company accreted the interest related to the debt discounts of the
February 2005 Financing and amortized the debt issue costs related
thereto over a one year period. During the fourth quarter of the year
ended November 30, 2005, the Company reevaluated the appropriateness of
the one year amortization period, and determined that the related
indebtedness had an initial three year maturity date, and that such
three-year period was the appropriate period for the related accretion
and amortization. The Company initially used a one year period based on
a clause in the documents relating to the February 2005 Financing that
required the Company to enter into a service provider agreement with a
wholesale telephone service provider in order for the maturity date of
the loan to be extended from February 8, 2006 to February 8, 2008.
However, the Company, as of the financing date, had already agreed to
the terms of the service provider agreement with Verizon, and had
effectively entered into such service provider agreement, which was
effective as of January 1, 2005. The Company had also miscalculated a
component of the accretion for the first three quarters of the year
ended November 30, 2005 related to the warrant component of the
discount. Accordingly, as a result of these errors, in the fourth
quarter of the year ended November 30, 2005, the Company determined
that previously recorded interest expense and amortization of deferred
financing costs had been overstated cumulatively by approximately
$245,000 through the third quarter of the year ended November 30, 2005,
and accordingly, reduced interest expense in the fourth quarter of the
year ended November 30, 2005 by such amount, of which approximately
$21,000 related to the quarter ended February 28, 2005, $106,000
related to the quarter ended May 31, 2005, and $118,000 related to the
quarter ended August 31, 2005.
The quarterly information for the fiscal year ended November 30, 2005
presented below has been restated from that originally included in Form
10-QSB filed for the respective quarters, however during the fiscal
year ended November 30, 2006, the Company restated such 2005
information in its 2006 quarterly filings on form 10-Q.
F-36
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
16. Selected Quarterly Financial Information (Unaudited) (Continued)
----------------------------------------------------------------
During the fourth quarter of the year ended November 30, 2005, the
Company reversed a liability in the amount of $198,059 that was related
to the discontinuance of the luggage business of the Company. There has
not been any demand for payment of the liabilities and the Company has
determined that the statute of limitations has expired. The liability
had been on the Company's balance sheet under the caption accounts
payable and accrued expenses at November 30, 2004.
First Second Third Fourth
November 30, 2006 Quarter Quarter Quarter Quarter
----------- ----------- ----------- -----------
Revenue $ 2,496,854 $ 2,155,557 $ 1,949,040 $ 1,755,144
----------- ----------- ----------- -----------
Operating loss $ (373,964) $ (584,075) $ (619,800) $ (708,703)
----------- ----------- ----------- -----------
Net loss $ (663,479) $ (647,941) $ (437,513) $ (596,122)
----------- ----------- ----------- -----------
Net loss per share-
basic $ (.04) $ (.04) $ (.03) $ (.03)
----------- ----------- ----------- -----------
Net loss per share-
diluted $ (.04) $ (.04) $ (.03) $ (.03)
----------- ----------- ----------- -----------
First Second Third Fourth
November 30, 2005 Quarter Quarter Quarter Quarter
----------- ----------- ----------- -----------
Revenue $ 3,863,479 $ 4,815,376 $ 4,146,759 $ 3,055,189
----------- ----------- ----------- -----------
Operating loss $ (395,729) $(1,138,964) $ (424,088) $ (443,171)
----------- ----------- ----------- -----------
Net loss $ (380,589) $(1,235,060) $ (257,140) $ (393,006)
----------- ----------- ----------- -----------
Net loss per share-
basic $ (.02) $ (.07) $ (.02) $ (.02)
----------- ----------- ----------- -----------
Net loss per share-
diluted $ (.02) $ (.07) $ (.02) $ (.02)
----------- ----------- ----------- -----------
For the year ended November 30, 2005, the sum of the four individual
quarters' earnings (loss) per share does not equal the amounts
presented on the Consolidated Statements of Operations due to rounding.
17. Accounts Payable and Accrued Expenses
-------------------------------------
November 30,
-----------------------
2006 2005
---------- ----------
Trade payables $1,982,888 $1,963,162
Accrued pension liability 255,398 326,793
Other, individually less than 5% of current liabilities 611,225 453,668
---------- ----------
$2,849,511 $2,743,623
---------- ----------
F-37
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
17. Accounts Payable and Accrued Expenses (Continued)
-------------------------------------------------
At November 30, 2006, the Company is disputing payment on invoices from
Verizon amounting to approximately $400,000 because it believes Verizon
overcharged the Company for certain calls made by the Company's
customers. Although the Company is not currently required to pay the
disputed amount, Verizon has initially rejected the claim. The Company
has escalated the claim and has hired a firm that specializes in
telecom disputes to analyze past call records, resubmit and pursue the
claim. The Company cannot be certain how much, if any, of the claim
will be honored. Consequently, the full amount of the disputed charges
has been recorded as a liability.
18. Business Segment Information
----------------------------
The Company has two reportable business segments: Wireline
Telecommunications Services and IP Telecommunications Services. The
operating results of these business segments are distinguishable and
are regularly reviewed by the Company's chief operating decision maker.
The Wireline Telecommunication Services business segment resells
telephone services that run over a wireline network and switching
equipment provided by Verizon and Qwest Communications International
Inc. The IP Telecommunications business segment provides a range of
voice telephony service that run over the Internet on switching
equipment that the Company owns and manages.
Wireline IP
Telecommunication Telecommunication
Services Services Corporate Total
------------------------------------------------------------------------
Year ended November 30, 2006:
Revenues $ 8,153,328 $ 203,267 $ 8,356,595
Operating income (loss) 913,791 (2,021,171) $ (1,179,162) (2,286,542)
Depreciation and amortization 11,384 147,778 387,816 546,978
Other income and (expense) 817 (12,102) (47,228) (58,513)
Expenditures for long-lived assets 34,017 437,734 854,747 1,326,498
Total assets at November 30, 2006 839,769 1,099,642 2,248,807 4,188,218
Year ended November 30, 2005:
Revenues $ 15,849,561 $ 31,242 $ 15,880,803
Operating loss (660,794) (876,262) $ (864,896) (2,401,952)
Depreciation and amortization 4,694 45,539 146,144 196,377
Other income and (expense) (820) (1,181) 138,158 136,157
Expenditures for long-lived assets 17,617 437,135 676,342 1,131,094
Total assets at November 30, 2005 2,963,765 689,686 731,640 4,385,091
Year ended November 30, 2004:
Revenues $ 9,557,600 $ 9,557,600
Operating loss (362,426) $ (41,686) $ (238,038) (642,150)
Depreciation and amortization 991 13,489 14,480
Other income and (expense) (4,975) 48,414 43,439
Expenditures for long-lived assets 11,502 170,000 -- 181,502
Total assets at November 30, 2004 2,028,291 128,614 (253,103) 1,903,802
F-38
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
19. Subsequent Events
-----------------
On December 14, 2006, the Company entered into two separate definitive
purchase agreements ("Agreements") to sell the two wholly-owned
subsidiaries that constitute Wireline Telecommunications Segment to
Cyber Digital, Inc. ("Purchaser"), a publicly-traded shell company. The
planned sales are subject to the receipt of required regulatory
approvals and other closing conditions.
Purchaser shall acquire all the outstanding shares of the CLEC
subsidiaries and either pay or assume $1.3 million of outstanding debt
to the Company's lender. The Company has guaranteed levels of negative
working capital of the CLEC subsidiaries and indemnified the Purchaser
against liabilities that would reduce working capital, as defined in
the Agreements, below the agreed-upon levels. In accordance with an
amendment to the Agreements, if the closing of the transaction has not
occurred by April 12, 2007, the Company or the Purchaser may terminate
the Agreements with no penalty to the terminating party, so long as
such delay in closing the transaction is not the result of willful and
material breach by the terminating party of any of its obligations
under the Agreement.
Since management did not have the authority to approve the action or
commit to a plan to sell until December 14, 2006, among other reasons,
discontinued operation presentation is precluded for the year ended
November 30, 2006. This transaction will require the approval of the
principal lender.
F-39
eLEC COMMUNICATIONS CORP. AND SUBSIDIARIES
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED NOVEMBER 30, 2006, 2005 AND 2004
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, 2006:
Allowance for doubtful accounts $ 258,000 $ 172,000 (a) $ 200,000 $ 230,000
Valuation allowance for deferred
tax asset $ 7,900,000 $ 956,000 (b) $ -- $ 8,856,000
Year ended November 30, 2005:
Allowance for doubtful accounts $ 548,000 $ 3,612,000 (a) $ 3,902,000 $ 258,000
Valuation allowance for deferred
tax asset $ 7,280,000 $ 620,000 (b) $ -- $ 7,900,000
Year ended November 30, 2004:
Allowance for doubtful accounts $ 170,000 $ 1,049,000 (a) $ 671,000 $ 548,000
Valuation allowance for deferred
tax asset $ 6,700,000 $ 580,000 (b) $ -- $ 7,280,000
(a)Net of recoveries
(b)There were no charges to cost and expenses as there was an equivalent
increase in deferred tax assets.
S-1