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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 000-27376
---------------
ELCOM INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 04-3175156
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10 OCEANA WAY
NORWOOD, MASSACHUSETTS 02062
(781) 440-3333
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
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 whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act.)
Yes [ ] No [X]
The registrant had 30,901,837 shares of common stock, $.01 par value,
outstanding as of October 31, 2003.
INDEX
Part I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of December 31, 2002
and September 30, 2003 (unaudited).................................... 2
Consolidated Statements of Operations and Other Comprehensive
Income (Loss) - Three and Nine Month Periods Ended
September 30, 2002 and 2003 (unaudited)............................... 3
Consolidated Statements of Cash Flows - Nine Month Period Ended
September 30, 2002 and 2003 (unaudited)............................... 4
Notes to Consolidated Financial Statements (unaudited)................ 5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS...................................................... 9
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................. 16
ITEM 4. CONTROLS AND PROCEDURES.................................................... 16
Part II - OTHER INFORMATION
ITEM 1. NONE.
ITEM 2. NONE.
ITEM 3. NONE.
ITEM 4. NONE.
ITEM 5. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................ 17
ITEM 6. RECENT SALE OF UNREGISTERED SECURITIES..................................... 17
ITEM 7. EXHIBITS AND REPORTS ON FORM 8-K........................................... 18
SIGNATURES AND CERTIFICATION ........................................................... 19
1
ELCOM INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
ITEM 1. FINANCIAL STATEMENTS.
DECEMBER 31, SEPTEMBER 30,
2002 2003
---------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,302 $ 123
---------- ----------
Accounts receivable 348 323
Less- Allowance for doubtful accounts (28) (17)
---------- ----------
Accounts receivable, net 320 306
Prepaid expenses and other current assets 205 231
Current assets of discontinued operations (Note 5) 238 31
---------- ----------
Total current assets 3,065 691
---------- ----------
PROPERTY, EQUIPMENT AND SOFTWARE, AT COST:
Computer hardware and software 17,741 17,763
Land, buildings and leasehold improvements 1,333 1,333
Furniture, fixtures and equipment 3,544 3,704
---------- ----------
22,618 22,800
Less- Accumulated depreciation and amortization (20,772) (21,874)
---------- ----------
1,846 926
---------- ----------
OTHER ASSETS 113 72
NON-CURRENT ASSETS OF DISCONTINUED OPERATIONS (Note 5) 106 --
---------- ----------
TOTAL ASSETS $ 5,130 $ 1,689
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable $ 335 $ 879
Loan Payable (Note 6) -- 983
Deferred revenue 405 342
Accrued expenses and other current liabilities 2,476 1,603
Current portion of capital lease obligations 275 7
Current liabilities of discontinued operations (Note 5) 41 100
---------- ----------
Total current liabilities 3,532 3,914
---------- ----------
LONG TERM LIABILITIES
Convertible Debentures, net of discount (Note 6) -- 263
---------- ----------
TOTAL LIABILITIES 3,532 4,177
========== ==========
STOCKHOLDERS' EQUITY (DEFICIT) :
Preferred stock, $.01 par value; Authorized -- 10,000,000 shares --
Issued and outstanding - none -- --
Common stock, $.01 par value; Authorized -- 100,000,000 shares --
Issued -- 31,432,546 shares 314 314
Additional paid-in capital 114,817 115,533
Accumulated earnings (deficit) (107,920) (112,720)
Treasury stock, at cost -- 530,709 shares (4,712) (4,712)
Accumulated other comprehensive income (loss) (901) (903)
---------- ----------
Total stockholders' equity (deficit) 1,598 (2,488)
---------- ----------
$ 5,130 $ 1,689
========== ==========
The accompanying notes are an integral part of these consolidated
financial statements.
2
ELCOM INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND OTHER COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2002 2003 2002 2003
-------- -------- -------- --------
Net sales
License and associated fees $ 1,033 $ 261 $ 2,420 $ 1,042
Professional services 122 106 668 525
-------- -------- -------- --------
Total net sales 1,155 367 3,088 1,567
Cost of sales 386 36 906 365
-------- -------- -------- --------
Gross profit 769 331 2,182 1,202
Operating Expenses:
Selling, general and administrative 3,027 1,610 10,174 6,417
Research and development 125 67 786 194
Asset impairment charges -- -- 338 --
-------- -------- -------- --------
Total operating expenses 3,152 1,677 11,298 6,611
-------- -------- -------- --------
Operating loss (2,383) (1,346) (9,116) (5,409)
-------- -------- -------- --------
Interest expense (12) (31) (50) (72)
Interest income and other, net 872 99 896 79
-------- -------- -------- --------
Net loss from continuing operations before tax (1,523) (1,278) (8,270) (5,402)
Income tax benefit -- -- -- 492
-------- -------- -------- --------
Net loss from continuing operations (1,523) (1,278) (8,270) (4,910)
Discontinued operations:
Net income (loss) from discontinued operations,
net of tax 87 (197) (1,420) 110
Gain on sale of assets 167 -- 1,079 --
-------- -------- -------- --------
Net loss (1,269) (1,475) (8,611) (4,800)
Foreign currency translation adjustment, net of tax (9) 3 662 (2)
-------- -------- -------- --------
Other comprehensive loss $ (1,278) $ (1,472) $ (7,949) $ (4,802)
======== ======== ======== ========
Basic and diluted net income (loss) per share data:
Continuing operations $ (0.05) $ (0.04) $ (0.27) $ (0.16)
Discontinued operations -- (0.01) (0.04) --
Gain on sale of assets 0.01 -- 0.03 --
-------- -------- -------- --------
Basic and diluted net loss per share $ (0.04) $ (0.05) $ (0.28) $ (0.16)
======== ======== ======== ========
Weighted average number of basic and diluted
shares outstanding 30,902 30,902 30,901 30,902
======== ======== ======== ========
The accompanying notes are an integral part of these consolidated
financial statements.
3
ELCOM INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended
September 30,
-----------------------
2002 2003
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from continuing operations $ (8,270) $ (4,910)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities -
Depreciation and amortization 2,369 1,126
Asset impairment charge 338 --
Loss on sale of assets 45 --
Changes in current assets and liabilities:
Accounts receivable (946) 14
Prepaids expenses and other current assets (301) (25)
Accounts payable (1,080) 544
Deferred revenue 1,542 (63)
Accrued expenses and other current liabilities (2,800) (873)
-------- --------
Net cash used in continuing operations (9,103) (4,187)
-------- --------
Net cash provided by (used in) discontinued operations (270) 482
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, equipment and software (12) (177)
Change in deferred costs and other assets 19 41
Proceeds from sale of assets 5 --
-------- --------
Net cash provided by (used in) investing activities 12 (136)
-------- --------
Net cash provided by discontinued operations 2,118 --
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of capital lease obligations and debt (383) (268)
Proceeds from Loan Payable -- 983
Proceeds from issuance of convertible debentures -- 949
-------- --------
Net cash provided by (used in) financing activities (383) 1,664
-------- --------
FOREIGN EXCHANGE EFFECT ON CASH 665 (2)
-------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS (6,961) (2,179)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 10,813 2,302
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,852 $ 123
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid on capital leases $ 50 $ 13
======== ========
Income taxes paid $ 15 $ --
======== ========
The accompanying notes are an integral part of these consolidated
financial statements.
4
ELCOM INTERNATIONAL, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Elcom
International, Inc. and its wholly-owned subsidiaries (collectively, "Elcom" or
the "Company"). On March 29, 2002, the Company sold certain assets and
liabilities of its United States ("U.S.") information technology remarketer
business. The results of operations for that business have been presented under
the financial reporting requirements for discontinued operations for all
applicable periods presented. Commencing for the June 30, 2003 quarter, the
Company has reclassified revenues from prior periods into two categories to
conform to the current and other applicable periods presented
In the opinion of management, the accompanying unaudited
consolidated financial statements contain all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the financial position
of the Company as of September 30, 2003, and the results of operations and cash
flows for the three month and nine month periods ended September 30, 2002 and
2003. All significant intercompany accounts and transactions have been
eliminated. The results of operations for these periods are not necessarily
comparable to, or indicative of, results of any other interim period or for the
year as a whole. Certain financial information that is normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the U.S., but which is not required for interim reporting purposes,
has been omitted. For further information, reference should be made to the
consolidated financial statements and accompanying notes included in the
Company's Annual Report on Form 10-K as of and for the year ended December 31,
2002.
2. STOCK BASED COMPENSATION
The Company applies SFAS No. 123, Accounting for Stock Based
Compensation, as amended by SFAS no. 148, Accounting for Stock Based
Compensation Transition and Disclosure, an amendment to FASB Statement No. 123,
which requires entities to recognize as expense over the vesting period the fair
value of stock-based awards on the date of grant or measurement date. For
employee stock-based awards, however, SFAS No. 123 allows entities to continue
to apply the provisions of Accounting Principles Board ("APB") Opinion No. 25
and provide pro forma net earnings disclosures as if the fair-value-based method
defined in SFAS No. 123 had been applied. The Company has elected to apply the
provisions of APB Opinion No. 25 and provide the pro forma disclosures of SFAS
No. 123.
Had compensation cost for awards under the Company's Stock Option
Plans been determined based on the fair value method set forth in SFAS No. 123,
the effect on the Company's net loss and per share amounts would have been as
follows (in thousands, except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2002 2003 2002 2003
-------- -------- -------- --------
Net loss, as reported $ (1,269) $ (1,475) $ (8,611) $ (4,800)
Less: Compensation expense for
option awards determined under fair
value based method, net of tax effects 1,061 (77) (950) (872)
-------- -------- -------- --------
Pro forma net loss $ (208) $ (1,552) $ (9,561) $ (5,672)
======== ======== ======== ========
Net loss per share:
As reported - basic and diluted $ (0.04) $ (0.05) $ (0.28) $ (0.16)
Pro forma - basic and diluted $ (0.01) $ (0.05) $ (0.31) $ (0.18)
5
3. NET LOSS PER SHARE
Basic net income (loss) per share (EPS) is calculated by dividing
net loss by the weighted average number of shares of common stock outstanding
during the period. Fully diluted EPS is calculated by dividing net income (loss)
by the weighted average number of shares outstanding plus the dilutive effect,
if any, of outstanding stock options and warrants using the "treasury stock"
method and the dilutive effect of convertible debt outstanding using the "if
converted" method. During periods of net loss, diluted net loss per share does
not differ from basic net loss per share since potential shares of common stock
from stock options and warrants are anti-dilutive and therefore, are excluded
from the calculation. Common Stock issuable upon conversion of the Company's
convertible debentures, totaling 7,569,705 shares, was excluded from the fully
diluted earnings per share calculation because their impact was anti-dilutive.
Based on the average market price of the Company's common stock in
the three month period ended September 30, 2003, a net total of 3,127,370 shares
covered by options, if exercised, would have been dilutive and 8,762,695 shares
covered by options and warrants with per share exercise prices ranging from
$0.25 to $24.06 would have been anti-dilutive. Based on the average market price
of the Company's common stock in the three month period ended September 30,
2002, a net total of 1,128,016 shares covered by options would have been
dilutive, 12,916,056 shares covered by options and warrants with per share
exercise prices ranging from $0.45 to $28.71 would have been anti-dilutive.
Based on the average market price of the Company's common stock in
the nine month period ended September 30, 2003, a net total of 2,418,075 shares
covered by options, if exercised, would have been dilutive, and 9,341,877 shares
covered by options and warrants with per share exercise prices ranging from
$0.25 to $24.06 would have been anti-dilutive. Based on the average market price
of the Company's common stock in the nine month period ended September 30, 2002,
a net total of 2,261,243 shares covered by options would have been dilutive, and
10,455,338 shares covered by options and warrants with per share exercise prices
ranging from $0.74 to $28.71 would have been anti-dilutive.
4. BUSINESS SEGMENT INFORMATION
The Company's continuing operation is classified as a single
business segment, specifically the development and sale of electronic purchasing
solutions ("ePurchasing") and electronic marketplace ("eMarketplace")
Internet-based software solutions which automate many supply chain and financial
settlement functions associated with procurement. Prior to the divestiture of
the U.K. computer-oriented information technology products ("IT Products")
business on December 31, 2001 and the U.S. IT Products and services business on
March 29, 2002, the Company separately disclosed that business segment in its
business segment footnote. Discontinued operations represents all of the U.S. IT
Products and services business for all applicable periods presented. The Company
operates both in the U.S. and U.K. and geographic financial information for the
quarters and nine month periods ended September 30, 2002 and 2003, were as
follows (in thousands):
Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
2002 2003 2002 2003
-------- -------- -------- --------
Net sales from continuing operations
U.S. $ 275 $ 204 $ 842 $ 846
U.K. 880 163 2,246 721
-------- -------- -------- --------
Net sales $ 1,155 $ 367 $ 3,088 $ 1,567
======== ======== ======== ========
Operating profit (loss) from continuing operations
U.S. $ (1,782) $ (1,162) $ (8,326) $ (4,539)
U.K. (601) (184) (790) (870)
-------- -------- -------- --------
Operating loss $ (2,383) $ (1,346) $ (9,116) $ (5,409)
======== ======== ======== ========
December 31, September 30,
2002 2003
-------- --------
Identifiable assets from continuing operations
U.S. $ 4,311 $ 1,420
U.K. 475 237
-------- --------
Identifiable assets $ 4,786 $ 1,657
======== ========
6
5. DISCONTINUED OPERATIONS
On March 29, 2002, the Company sold certain assets and liabilities
of its IT Products and associated services business in the U.S. conducted by its
subsidiary, Elcom Services Group, Inc. ("Elcom Services Group"). The sale price
for the transaction consisted of cash consideration of $2.15 million, of which
approximately $.6 million was held in escrow and subsequently released in its
entirety. As part of the sale transaction, the Company also issued warrants to
purchase 300,000 shares of the Company's common stock to this company. The
warrants are exercisable after September 29, 2002, have an exercise price of
$1.03 and expire on March 29, 2009.
In accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, the results of operations and balance sheet
information have been prepared under the financial reporting requirements for
discontinued operations, pursuant to which all historical results of the IT
Products and services business in the U.S. are included in the results of
discontinued operations rather than the results of continuing operations for all
applicable periods presented. The results of discontinued operations for the
three and nine-month periods ended September 30, 2002 and 2003 were as follows
(in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2002 2003 2002 2003
-------- -------- -------- --------
Net sales from discontinued operations $ (2) $ -- $ 4,880 $ --
======== ======== ======== ========
Gross profit from discontinued operations $ (107) $ -- $ 1,815 $ --
======== ======== ======== ========
Net Income (loss) from discontinued operations $ 87 $ (197) $ (1,420) $ 110
======== ======== ======== ========
Gain on Sale of assets of discontinued
operations $ 167 $ -- $ 1,079 $ --
======== ======== ======== ========
6. FINANCING ARRANGEMENTS
a. Convertible Debentures
On April 25, 2003, the Company closed a private placement to
accredited investors (the "Private Placement") of ten-year 10%
Senior Convertible Debentures (the "Debentures"), generating gross
proceeds of $949,000 and net cash to the Company of $702,000. Robert
J. Crowell, the Chairman and CEO invested $300,000, John E. Halnen,
the President and COO invested $60,000, William W. Smith, the
Company's Vice Chairman and Director invested $300,000, Andres
Escallon, the Chief Technology Officer invested $50,000,
(collectively, the "Inside Investors"). The Company paid Robert J.
Crowell $187,000 and John E. Halnen $60,000 in repayment of a
portion of their salaries which they had voluntarily suspended
during 2002 in order to assist the Company in its efforts to retain
cash. Robert J. Crowell and John E. Halnen immediately reinvested
these proceeds into their purchase of the Debentures. In addition,
Smith & Williamson LLC (U.K.) and other Elcom stockholders in the
U.K. invested $239,000. Inside Investors are considered related
parties and invested a total of $710,000 in the Company via
purchases of Debentures.
The Debentures carry a 10% interest rate, which is payable in cash
or payment in-kind. Interest is due annually, in arrears, commencing
April 25, 2004 and is expected to be paid in-kind. The principal
amount is due at maturity on April 25, 2013. The Company has accrued
$31,391 in interest expense for these Debentures as of September 30,
2003.
The Debentures are collateralized by a security interest in
substantially all of the Company's assets for a two-year period
ending April 25, 2005. They are convertible into common stock of the
Company at a conversion price of $0.125 per share, subject to
anti-dilution clauses. The Debentures are convertible at the
election of the holder at any time commencing on April 25, 2005
through April 25, 2013. However, if the Company has two sequential
quarters of profitability with respect to continuing operations, the
Holder may convert the Debentures at his option. The Holders also
have certain registration rights upon conversion. The Company
recorded a beneficial conversion feature (the "Debenture discount")
of $716,000 in conjunction with the issuance of these
7
Debentures. This Debenture discount is being amortized as interest
expense over the ten-year term of the Debentures. At September 30,
2003, the Company has accrued $26,158 of interest expense for this
Debenture discount. At September 30, 2003, the Debentures are
convertible into 7,569,705 shares of common stock.
The Company has the right to convert the Debentures upon the
occurrence of one of the following events:
- A change of control, as defined in the agreement, or
- the Company's option as of April 23, 2007, or subsequent to
this date upon written notice to the Holder.
The Senior Convertible Debentures are not registered under the
Securities Act of 1933, as amended, or applicable state securities
laws and may not be offered or sold in the United States absent
registration under the Securities Act of 1933, and applicable state
securities laws or available exemptions from the registration
requirements. This private placement has been extended to November
27, 2003 and will terminate on that date unless otherwise extended
or earlier terminated by the Company. Exemption from registration
with respect to the Sale of the Debentures is claimed pursuant to
Section 4(a) of the Securities Act of 1933, as amended.
b. Loan Payable
On April 3, 2003, the Company signed an agreement whereby Cap Gemini
Ernst and Young UK Plc ("CGEY") agreed to advance L625,000 or
$983,000 to the Company representing an advance of a lump-sum
license payment expected to be paid to the Company by the end of
2003 or during Q1 2004, under its contract with CGEY related to the
Scottish Executive. This loan was contingent upon the Company
providing assistance to CGEY to set up a back-up system in Toronto,
Canada in order for CGEY to provide Disaster Recovery and Business
Continuity Services ("Services") for Elcom's clients. These
contingencies have been met. These Services are expected to be made
available to Elcom's clients for a fee and would provide a back-up
system to allow CGEY to provide Business Continuity Services (e.g.
to host, operate and manage), Elcom's ePurchasing system, if Elcom
were unable to do so for any reason. The Company believes this
license fee(s) will become due and be paid, offsetting this advance,
during Q4 2003 or Q1 2004 pursuant to its contract with CGEY
relating to the Scottish Executive. If the Company is not able to
invoice CGEY for an amount equal to the license fee advance from
CGEY by the end of 2003, the Company will begin a two year repayment
plan with CGEY which is equal to the HSBC Bank Plc rate, currently
3.75%, plus a 2% interest penalty calculated from the date of
advance. This amount advanced, has been accounted for as a Loan
payable and will be recognized as revenue when earned.
7. SUBSEQUENT EVENTS RELATED TO LIQUIDITY
On October 16, 2003, the Company announced a second closing of the
private placement of its Debentures (the "Second Closing", which is not
reflected in the unaudited financial statements contained in this Form 10-Q,
generating cash proceeds of $315,000. Robert J. Crowell, the Chairman and CEO
invested $150,000, William W. Smith, the Vice Chairman and Director invested
$50,000 (both the "Inside Investors") and Smith & Williamson LLC (U.K.) and one
other Elcom stockholder invested $115,000. Inside Investors are considered
related parties and invested a total of $200,000 in the Company via purchases of
Debentures in the Second Closing.
As of October 16, 2003, Inside Investors have invested an aggregate
$910,000 of the $1,264,000 invested in the Company via the purchases of
Debentures.
On October 31, 2003, the Company received an unanticipated payment
of L466,981 ($793,000) representing license fees in arrears, due to the
termination of a license originally signed in September 1998, by a U.K.-based
licensee. This amount will be recorded as license revenue in the quarter ending
December 31, 2003.
The Second Closing, combined with anticipated revenues and other
monies received as described herein, is expected to fund the Company's
operations through the end of the first quarter of 2004. Prior to that time, the
Company intends to raise additional funding sufficient to support the Company's
future operations. There can be no assurance that the Company will receive any
such funding or on what terms or what the timing thereof might be.
The Company's cash balance as of October 31, 2003 was $1,270,000.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company develops and licenses remotely-hosted, self-service
ePurchasing and eMarketplace, Internet and intranet-based purchasing systems
which automate many supply chain and financial settlement functions associated
with procurement. The Company has licensed a dynamic trading system platform to
provide auction, reverse auction, and other electronic negotiation, or
"eNegotiation" functions and also markets an asset management system, both
licensed from third party companies. Since its inception in 1992, Elcom has
developed its PECOS(TM) (Professional Electronic Commerce Online System)
technology. The Company's PECOS(TM) technology can support large numbers of
end-user clients, products, suppliers and transactions and its transaction
server middleware provides a scalable foundation for robust system performance
and high transaction capacity. The ePurchasing and eMarketplace systems the
Company offers for licensing include:
PECOS Internet Procurement Manager ("PECOS.ipm"). PECOS.ipm is a robust
and feature-rich Internet-based, remotely-hosted, automated procurement system
and is based on eleven years of eCommerce technology development. As an
Internet-based system, PECOS.ipm has been in development for approximately six
years. As a remotely-hosted system, PECOS.ipm allows the Company's clients to
use their intranet/Internet to access the system to identify and select
products, check pricing, automate the internal approval process and facilitate
invoicing and payment to suppliers. Since it is remotely-hosted, PECOS.ipm is
rapidly deployable and has a minimal impact on a client's computer system and
personnel resources. Elcom acts as its own application service provider and
hosts PECOS.ipm on its own hardware platform, giving clients a single point of
contact and responsibility. In addition, PECOS.ipm is configurable by a client
and does not require scripting or consultants to modify administrative items or
approval workflows. Because it has invoicing and receiving functionality and has
automated financial settlement functions (including robust support for
procurement card technology), PECOS.ipm can operate as a standalone system
without an expensive back-end Enterprise Resource Planning ("ERP") system in
place, thereby enabling easier implementation for clients. Clients may integrate
PECOS.ipm into their ERP system using data feeds with PECOS.ipm already
operating. Further, the Company facilitates supplier catalog loads for the
client when the system is remotely-hosted. In October 2001, the Company
announced version 8.0 of its next generation PECOS(TM) technology. This version
of PECOS(TM) is designed to offer a single solution which includes robust
ePurchasing functionality, including "buy-side", which is the capability of a
client to order products from its supplier, ePurchasing functionality, including
"sell-side", which is the capability of a client to have its customers make
purchases electronically, and private eMarketplace functionality, which is the
capability for a client to offer an eMarketplace to both buy and sell products
in a "community" of users which may include both suppliers and customers.
DIVESTED IT PRODUCTS AND SERVICES BUSINESS
Prior to the divestiture of the IT Products and services business in the
U.S. on March 29, 2002, the Company had historically marketed 130,000 IT
Products to commercial, educational and government accounts. The Company decided
to exit the IT Products and services business after the September 11, 2001
terrorist attacks to reduce costs as demand declined dramatically and to allow
the Company to focus exclusively on its core ePurchasing and eMarketplace
technology.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of consolidated financial statements requires the Company
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenue and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, the Company evaluates its estimates,
including those related to income taxes, impairment of long-lived assets,
software development costs and revenue recognition. The Company bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
The Company believes that the following critical accounting policies
affect its more significant judgments and estimates used in the preparation of
its consolidated financial statements:
9
(i) Income Taxes:
The Company records a valuation allowance to reduce its deferred tax
assets to the amount that is more likely than not to be realized. Based on
the Company's recent losses and expectation that 2003 will result in an
overall operating loss, the Company has recorded a valuation allowance to
reduce its deferred tax assets to $0.
(ii) Impairment of Long-Lived Assets:
The Company records impairment losses on long-lived assets to be held and
used or to be disposed of other than by sale when events and circumstances
indicate that the assets might be impaired and the net undiscounted cash
flows estimated to be generated by those assets are less than the carrying
amount of those items. The Company's cash flow estimates are made for the
remaining useful life of the assets and are based on historical results
adjusted to reflect the best estimate of future market and operating
conditions. The net carrying value of assets not recoverable is reduced to
fair value less estimated selling costs. The Company's estimates of fair
value represent a good faith estimate based on industry trends and
reference to market rates and transactions.
(iii) Revenue Recognition:
Revenue consists principally of fees for licenses of the Company's
software products, maintenance, hosting, consulting, and training. The
Company recognizes revenue using the residual method in accordance with
Statement of Position ("SOP") 97-2, Software Revenue Recognition, as
amended by SOP 98-9, Modification of SOP 97-2, Software Revenue
Recognition, with Respect to Certain Transactions. Under the residual
method, revenue is recognized in a multiple element arrangement in which
Company-specific objective evidence of fair value exists for all of the
undelivered elements in the arrangement, but does not exist for one or
more of the delivered elements in the arrangement. Company-specific
objective evidence of fair value of maintenance and other services is
based on our customary pricing for such maintenance and/or services when
sold separately. We sell our Professional services separately on a
time-and-materials basis and at times without a software license, and we
have established Company-specific objective evidence on this basis.
Company-specific objective evidence for maintenance is determined based
upon either the renewal rates when maintenance is sold separately or the
option price for annual maintenance renewals included in the underlying
customer contract. At the outset of the arrangement with the customer, we
defer revenue for the fair value of its undelivered elements (e.g.,
maintenance, consulting, and training) and recognize revenue for the
remainder of the arrangement fee attributable to the elements initially
delivered in the arrangement (i.e., software product) when the basic
criteria in SOP 97-2 have been met. If such evidence of fair value for
each element of the arrangement does not exist, all revenue from the
arrangement is deferred until such time as evidence of fair value does
exist or until all elements of the arrangement are delivered. If evidence
of fair value does not exist for maintenance and/or hosting and there are
no other undelivered elements, all revenue is recognized ratably over the
maintenance period. Changes to the elements of a software arrangement, the
ability to identify which company-specific objective evidence and the fair
value of the respective elements could materially impact the amount of
earned and deferred revenue.
Under SOP 97-2, revenue attributable to an element in a customer
arrangement is recognized when persuasive evidence of an arrangement
exists, delivery has occurred, the fee is fixed or determinable,
collection of the resulting receivable is probable, and the arrangement
does not require future services for that fee, that are essential to the
functionality of the software. Our ability to estimate whether the
collection of the resulting receivable is probable could materially impact
the amount of revenue we record.
Our arrangements generally do not include acceptance clauses. However, if
an arrangement includes an acceptance provision, acceptance occurs upon
the earlier of receipt of a written customer acceptance or expiration of
the acceptance period. Our arrangements generally do not provide for a
right of return, and historically product returns have not been
significant.
Deferred revenue includes amounts received from customers for which
revenue has not been recognized that generally result from deferred
maintenance and support, hosting, consulting or training services not yet
rendered and license revenue deferred, until the requirements under SOP
97-2 are met. Deferred revenue is recognized upon delivery of our product,
as services are rendered, or as other requirements requiring deferral
under SOP 97-2 are satisfied.
10
(iv) Software Development Costs:
We account for software development costs in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 86, Accounting for the Costs
of Computer Software to Be Sold, Leased, or Otherwise Marketed. SFAS No.
86 specifies that costs incurred internally in creating a computer
software product should be charged to expense when incurred as research
and development costs until technological feasibility has been established
for the product. Once technological feasibility is established, all
development costs should be capitalized until the product is available for
general release to customers. For new versions of our products we
typically achieve technological feasibility far enough in advance of
general release to warrant the capitalization of subsequent development
costs. Judgment is required in determining when the technological
feasibility of a product is established and in estimating the life of the
product for which the capitalized costs will be amortized.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued Statement of Financial Accounting Standards
No. 150, Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity ("FAS 150"). This statement establishes standards
for how an issuer classifies and measures, in its statement of financial
position, certain financial instruments with characteristics of both liabilities
and equity. In accordance with the standard, financial instruments that embody
obligations for the issuer are required to be classified as liabilities. FAS 150
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after September 15, 2003. The Company does not expect the provisions
of this statement to have a significant impact on the Company's results of
operations or financial position.
The following table shows the Company's contractual obligations (in thousands)
payable or maturing in the years indicated:
Payments Due by Period
------------------------------------------------------
Less than After
Total 1 year 1-3 years 4-5 years 5 years
------ -------- --------- --------- -------
Capital lease obligations $ 7 $ 7 $ -- $ -- $ --
Operating leases 1,772 719 1,053 -- --
Loan Payable 983 983
Debenture 1,900 95 190 190 1,425
------ ------ ------ ------ ------
Total contractual obligations $4,662 $1,804 $1,243 $ 190 $1,425
====== ====== ====== ====== ======
The Company's interest payments on its Debentures are expected to be payment
in-kind (additional Debentures) and therefore are not expected to affect cash.
Off-Balance Sheet Financings
The Company does not have any off-balance sheet financings. The Company
has no majority-owned subsidiaries that are not included in the financial
statements, nor does it have any interests in or relationships with any special
purpose entities or variable interest entities.
RESULTS OF OPERATIONS
The results of operations for the divested IT Products and services
business in the U.S. has been presented as discontinued operations for all
applicable periods presented.
Quarter ended September 30, 2003 compared to the quarter ended September 30,
2002.
Net Sales. Net sales for the quarter ended September 30, 2003 were
$367,000 compared to $1,155,000 from the same period of 2002, a decrease of
$788,000 or 68%. Professional services fees in the U.S. and U.K. decreased by
$16,000 and License and associated fees decreased by $772,000. The reduction in
License and associated fees was due primarily to the Company's receiving
substantially larger license fees in 2002 under its contract with CGEY and the
revenue recognition of the amounts thereof, and to fewer implementations of
PECOS than anticipated under the
11
Company's contract with CGEY for the quarter ended September 30, 2003, compared
to the third quarter of 2002 ($94,000 and $850,000, respectively). License and
associated fees include license fees, annual fees and joining fees. Annual fees,
joining fees and user fees, if not associated directly with Professional
services, are recorded ratably over twelve months. Professional services fees
were $106,000, a decrease of $16,000 or 13% from the $122,000 in the third
quarter of last year, due primarily to fewer implementations of PECOS than
anticipated as stated above. Maintenance fees are included in License and
associated fees because they are not material at this time.
Gross Profit. Gross profit for the quarter ended September 30, 2003
decreased to $331,000 from $769,000 in the comparable 2002 quarterly period, a
decrease of $438,000, or 57%. This decrease is primarily a result of lower
License and associated fees and Professional services revenues.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses ("SG&A") for the quarter ended September 30, 2003 was
$1,610,000 compared to $3,027,000 in the 2002 quarter, a decrease of $1,417,000
or 47%. Throughout 2002 and the first three quarters of 2003, the Company has
continued to implement cost containment measures designed to align its SG&A
expenses and disbursements related thereto, with fewer than anticipated
revenues. Those measures included personnel reductions throughout most areas ,
which resulted in a decrease in total personnel and associated expenses in the
third quarter of 2003 of $609,000 from the comparable quarter last year. The
Company also received a state income and franchise tax refund of $284,000, which
was an offset to SG&A for the 2003 quarter.
Research and Development Expense. Research and development expense for the
quarters ended September 30, 2003 and 2002, were $67,000 and $125,000,
respectively. This reduction was due primarily to the implementation of various
cost containment measures.
Operating Loss from Continuing Operations. The Company reported an
operating loss from continuing operations of $1,346,000 for the quarter ended
September 30, 2003 compared to a loss of $2,383,000 reported for the comparable
quarter of 2002, an improvement of $1,037,000 or 44%. The lower operating loss
from continuing operations in the third quarter of 2003 compared to the 2002
quarter was due primarily to reductions in personnel and associated costs and a
state income and franchise tax refund of $284,000, partially offset by a
reduction in gross profit. Reductions in personnel resulted in a decrease in
personnel and associated expenses in the third quarter of 2003 of $609,000, when
compared to the third quarter of 2002.
Interest Expense. Interest expense for the quarter ended September 30,
2003 was $31,000 compared to $12,000 for the third quarter of 2002. This
increase was due primarily to interest accrued on the Company's ten-year 10%
Senior Convertible Debentures of $14,000 and the amortization of the Debenture
discount of $15,000.
Interest Income and Other, Net. Interest income and other, net, for the
quarter ended September 30, 2003 was $99,000, which includes $96,000 of interest
income on the state income and franchise tax refund, compared to $872,000 for
the comparable 2002 quarter. During the Company's 2002 quarter, it recognized
$650,000 paid to it via a settlement with a software vendor where the product
did not perform as represented. In addition, during the third quarter of 2002,
the Company reversed $100,000 in state franchise taxes, had income of $30,000
from the sale of miscellaneous assets, interest income of $23,000 and
miscellaneous other income items totaling $33,000.
Net Loss from Continuing Operations. The Company's net loss from
continuing operations for the quarter ended September 30, 2003 was $1,278,000,
an improvement of $245,000 or 16% from the comparable quarterly loss in 2002 of
$1,523,000. The improvement was due primarily to reductions of personnel and
associated expenses, and a state tax refund, partially offset by lower gross
profit.
Net Income (Loss) From Discontinued Operations. The net loss from
discontinued operations in the quarter ended September 30, 2003 was $(197,000)
compared to net income from discontinued operations in the quarter ended
September 30, 2002 of $87,000. The third quarter loss is related to a leased
facility that had been subleased. The sub-tenant filed for bankruptcy during the
second quarter and the Company was forced to incur the expense and payments for
the sub-tenant's lease payments. This lease and associated costs will terminate
on December 31, 2003.
Net Gain From Disposal of Discontinued Operations. A net gain of $167,000
was recorded in the third quarter of 2002 from the recognition of a release from
escrow of $167,000 related to the IT Products and services business in the U.S.
Net Loss from Total Operations. The 2003 quarterly net loss from total
operations (including both discontinued and continuing operations) was
$1,475,000 compared to $1,269,000 in the 2002 quarter. Basic and fully diluted
net loss
12
from total operations per share for the third quarter of 2003 was $(0.05),
compared with a basic net loss from total operations per share of $(0.04) in the
third quarter of 2002.
Nine month period ended September 30, 2003 compared to the nine month period
ended September 30, 2002.
Net Sales. Net sales from continuing operations for the nine months ended
September 30, 2003 were $1,567,000 compared to $3,088,000 in the nine months of
2002, a decrease of $1,521,000 or 49%. Professional services fees in the U.S.
and U.K. decreased by $143,000 while License and associated fees decreased by
$1,378,000. The reduction in License and associated fees was due primarily to
the Company's receiving substantially larger license fees in 2002 under the
Company's contract with CGEY and the revenue recognition of the amounts thereof,
and to fewer implementations of PECOS than anticipated under the Company's
contract with CGEY for the nine months ended September 30, 2003, compared to the
nine months ended September 30, 2002 ($406,000 and $1,557,000, respectively).
Professional services fees for the nine months ended September 30, 2003 were
$525,000 compared to $668,000 in the comparable nine months last year, a
decrease of $143,000 or 21%, due primarily to fewer implementations of PECOS
than anticipated as stated above.
Gross Profit (Loss). The Company recorded a gross profit of $1,202,000 in
the nine month period ended September 30, 2003, compared to a gross profit of
$2,182,000 in the nine month period ended September 30, 2002, a decrease of
$980,000 or 45%, due to lower sales as described above.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses ("SG&A") for the nine month period ended September 30,
2003 decreased to $6,417,000 from $10,174,000 in the 2002 period, a reduction of
$3,757,000 or 37%. Throughout 2003, the Company has continued to implement cost
containment measures designed to align its SG&A costs with lower than
anticipated revenues. Those measures included personnel reductions throughout
most areas. Reductions in personnel resulted in a decrease in total personnel
and associated expenses for the nine months ended September 30, 2003 of
$2,747,000 compared to the same nine month period last year. Additionally, the
Company reversed a tax accrual of $506,000 during the nine months ended
September 30, 2003 as payment was no longer considered probable based on a
settlement with the Inland Revenue Service. During the nine months ended
September 30, 2003, depreciation expense was $1,000,000 lower and the Company
received a state income and franchise tax refund of $284,000, which was an
offset to SG&A.
Research and Development Expense. Research and development expense for the
nine month periods ended September 30, 2003 and 2002 were $194,000 and $786,000,
respectively. This reduction was due primarily to the implementation of various
cost containment measures.
Operating Loss From Continuing Operations. The Company reported an
operating loss from continuing operations of $5,409,000 for the nine months
ended September 30, 2003 compared to $9,116,000 reported for the comparable
quarter of 2002, an improvement of $3, 707000 or 41%. The lower operating loss
from continuing operations in the third quarter of 2003 was due primarily to
reductions in personnel and associated costs of $2,747,000, a state income and
franchise tax refund of $284,000 and a reduction in depreciation expense of
approximately $1,000,000, partially offset by a reduction in gross profit.
Asset Impairment Charges. For the nine month periods ended September 30,
2003 and 2002, the Company recorded asset impairment charges of $0 and $338,000,
respectively. The asset impairment charges in 2002 related to software initially
purchased to augment the Company's PECOS technology, which was deemed to have no
further value.
Interest Expense. Interest expense for the nine month period ended
September 30, 2003 was $72,000 compared to $50,000 for the comparable 2002
period. The increase in interest expense is due primarily to interest of $31,000
accrued on the Company's ten-year 10% Senior Convertible Debentures and
amortization of the Debenture discount of $27,000.
Interest Income and Other, Net. Interest Income and Other, net, for the
nine month period ended September 30, 2003 decreased to $79,000, which includes
$96,000 of interest income on the state income and franchise tax refund from
income of $896,000 in the comparable 2002 nine month period, primarily due to
the Company's recognizing $650,000 paid to it via a settlement with a software
vendor where the product did not perform as represented, the reversal of
$100,000 in state franchise taxes, income of $30,000 from the sale of
miscellaneous assets, interest income of $23,000 and miscellaneous other income
items totaling $33,000.
13
Net Loss from Continuing Operations. The Company generated a net loss from
continuing operations for the nine month period ended September 30, 2003 of $4.9
million, versus a net loss of $8.3 million, an improvement of $3.4 million or
41% from the comparable period of 2002, as a result of the factors described
herein.
Net Income (Loss) From Discontinued Operations. Net income from
discontinued operations for the nine month period ended September 30, 2003 was
$110,000 compared to a net loss from discontinued operations for the nine month
period ended September 30, 2002 of $(1,420,000).
Net Gain From Disposal of Discontinued Operations. The net gain for the
nine month period ended September 30, 2002 from the divestiture on March 29,
2002 of the Company's IT Products and services business in the U.S. was
$1,079,000.
Net Loss from Total Operations. The net loss from total operations
(including both discontinued and continuing operations) for the first nine
months of 2003 was $4,799,000 compared to $8,611,000 in the 2002 nine month
period. Basic net loss from total operations per share for the nine month period
of 2003 were ($0.16), compared with a basic and fully diluted net loss from
total operations per share of ($0.28) in the nine month period.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents as of September 30, 2003 were approximately
$123,000. Although the Company recorded a net loss from total operations of
$4,800,000 for the nine month period ended September 30, 2003, cash and cash
equivalents decreased by only $2,179,000 between December 31, 2002 and September
30, 2003. The principal differences between the net loss and the decrease in
cash and cash equivalents during the period included cash generated via the
Company's issuance of its Senior Convertible Debentures in the gross amount of
$949,000 and the advance of a license fee (accounted for as a loan) of $983,000
and the recording of non-cash expenses of $783,000, offset by a capital
expenditure of $177,000 for software and payment on capital leases of $268,000.
As of September 30, 2003, the Company's principal sources of liquidity
were cash and cash equivalents of $123,000 (See "Risk Factors Related to
Liquidity" and "Subsequent Events Related to Liquidity", below).
The Company's principal commitments consist of leases on its office
facilities and capital leases and a $983,000 loan payable to CGEY.
On April 25, 2003, the Company consummated the first closing of a Private
Placement of $949,000 in Debentures. (the "Debentures"), netting $702,000 in
cash proceeds to the Company. Robert J. Crowell invested $300,000 in the
Debentures and John E. Halnen invested $60,000 in the Debentures. Of these
amounts, the Company paid Robert J. Crowell $187,000 and John E. Halnen $60,000
in repayment of a portion of their salaries which they had voluntarily suspended
during 2002 in order to assist the Company in its efforts to retain cash. Robert
J. Crowell and John E. Halnen immediately reinvested these proceeds into their
purchase of the Debentures. The Debentures carry a 10% interest rate with
interest expected to be paid "in-kind" and are secured by substantially all of
the Company's assets. The Debentures are not convertible for two years by the
holder unless the Company achieves two sequential quarters of profitability from
continuing operations. The Debentures are convertible at a per share price of
$0.125 and may be converted by the Company upon a "change in control" (as
defined in the Debentures) or following April 25, 2007. At September 30, 2003,
the Debentures, if converted, would convert into 7,569,705 shares of common
stock. The private placement has been extended to November 27, 2003 and will
terminate on that date unless otherwise extended or earlier terminated by the
Company. Exemption from registration with respect to the sale of the Debentures
is claimed pursuant to Section 4(2) of the Securities Act of 1933, as amended.
Inside investors are considering related parties, therefor, related parties
invested a total of $710,000 in the Company.
Subsequent Events Related to Liquidity
On October 16, 2003, the Company announced that it had effected a Second
Closing of its Private Placement of Debentures (the "Second Closing") with
Robert J. Crowell, William W. Smith, one other outside investor, and Smith &
Williamson LLC (U.K.), investing $150,000, $50,000, $15,000 and $100,000,
respectively. Having invested a total of $200,000 in this closing, in the
aggregate, Inside Investors have invested $910,000 in the Debentures.
On October 31, 2003, the Company received an unanticipated payment of
L466,981 ($793,000) representing license fees in arrears, due to the termination
of a license originally signed in September 1998, by a U.K.-based licensee. This
amount will be recorded as license revenue in the quarter ending December 31,
2003.
14
The Second Closing, combined with anticipated revenues and other monies
received as described herein, is expected to fund the Company's operations
through the end of the first quarter of 2004. Prior to that time, the Company
intends to raise additional funding sufficient to support the Company's future
operations. There can be no assurance that the Company will receive any such
funding or on what terms or what the timing thereof might be.
The Company's cash balance as of October 31, 2003 was $1,270,000.
RISK FACTORS RELATED TO LIQUIDITY
As of September 30, 2003, the Company had $123,000 in cash. The
Company has incurred $49.2 million of cumulative net losses for the three year
period ended December 31, 2002 and incurred a further net loss of $4.8 million
in the nine month period ended September 30, 2003. The Company expects that it
will continue to incur losses throughout 2003. On April 3, 2003, the Company
signed an agreement with CGEY whereby CGEY advanced $983,000 in license fees to
the Company. The Company believes this license fee(s) will become due and be
paid, offsetting this advance, during Q4 2003 or Q1 2004 pursuant to its
contract with CGEY relating to the Scottish Executive. If the Company is not
able to invoice CGEY for an amount equal to the license fee advance from CGEY
(based on the number of entities signed by CGEY), by the end of 2003, the
Company will begin a two year repayment plan with CGEY which is equal to the
HSBC Bank Plc rate, currently 3.75%, plus a 2% interest penalty calculated from
the date of advance.
The Company's consolidated financial statements as of December 31, 2002
were prepared under the assumption that the Company will continue as a going
concern for the year ending December 31, 2003. The Company's independent
accountants, KPMG LLP, issued an audit report dated March 7, 2003 that included
an explanatory paragraph expressing substantial doubt regarding the Company's
ability to continue as a going concern without additional capital becoming
available. The Company's ability to continue as a going concern is dependent
upon its ability to generate revenue, attain further operating efficiencies and
attract new sources of capital. The Company is in the process of seeking
additional capital. There can be no assurance that the Company will be able to
raise capital and if so, on what terms or what the timing thereof might be. Due
to lower than anticipated revenues and an increase in lease expense due to the
bankruptcy of a Company's sub-tenant, the Company must raise additional working
capital to fund operations by the end of the first quarter of 2004. Without such
funding by the end of the first quarter of 2004, the Company believes it may be
forced to curtail operations, if no funds are raised, seek protection under
bankruptcy statutes. The consolidated financial statements do not include any
adjustments that might result from the outcome of this significant uncertainty.
FACTORS AFFECTING FUTURE PERFORMANCE
A substantial portion of the Company's revenues from continuing operations
are from license fees related to the Company's contract with CGEY relating to
the Scottish Executive. This license is expected to generate in excess of
$3 million in revenues for the Company over the next four years. If the Company,
in conjunction with CGEY, the primary contractor for the Scottish Executive, is
unable to perform under this license, it would have a material adverse affect on
the Company's financial statements. In January, March and October 2002, the
Company invoiced, and subsequently received, approximately $2.7 million from
CGEY as a portion of the license fees due Elcom from CGEY under Elcom's
sub-contractor license. A majority of the January and March amounts were
recorded as deferred revenue. Revenue recognition of the total amount was
$222,000, $518,000, $518,000, and $1,489,000 for each successive quarter of
2002. As the revenue recognition increased significantly each quarter in 2002,
with the final amount in the third and fourth quarter, including a third license
payment, Elcom's revenues and financial results in 2003, for each quarter
excepting the first quarter, will be compared to significantly increasing
revenues from the comparable quarterly period in 2002. Hence, the Company's
revenues and financial results for the fourth quarter of 2003 are expected to be
less than such comparable quarter of 2002.
STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
Except for the historical information contained herein, the matters
discussed in this filing could include forward-looking statements or
information. All statements, other than statements of historical fact,
including, without limitation, those with respect to the Company's objectives,
plans and strategies set forth herein and those preceded by or that include the
words "believes," "expects," "given," "targets," "intends," "anticipates,"
"plans," "intent", "projects", "forecasts" or similar expressions, are
forward-looking statements. Although the Company believes that such
forward-looking statements are reasonable, it can give no assurance that the
Company's expectations are, or will be, correct. These forward-looking
statements involve a number of risks and uncertainties which could cause the
Company's future results to differ materially from those anticipated, including:
(i) availability and terms of appropriate working capital and/or other financing
to keep the Company operating as a going concern, particularly in light of the
Company's cash position as of September 30, 2003 and its history of ongoing
operating losses; (ii) the overall marketplace and client's acceptance and
15
usage of eCommerce software systems, including corporate demand therefore, the
impact of competitive technologies, products and pricing, particularly given the
subsequently larger size and scale of certain competitors and potential
competitors, control of expenses, revenue generation by the acquisition of new
customers, the acceptance rate of the Company's system by individual agencies of
the Scottish Executive (Government of Scotland) under the Company's contract
with CGEY, and corporate demand for ePurchasing and eMarketplace solutions;
(iii) the consequent results of operations given the aforementioned factors; and
(iv) the necessity for the Company to raise additional working capital to fund
operations by the end of the first quarter of 2004 and the availability of any
such funding to the Company, or on the terms thereof. Without such funding by
that time, the Company believes it may be forced to curtail operations and, if
no funds are raised, seek protection under bankruptcy statutes. Other risks
should be noted as detailed from time to time in the Company's Annual Report on
Form 10-K and in its other SEC reports and statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from exchange rates, which
could affect its future results of operations and financial
condition.
The Company's investment in its U.K. subsidiaries is sensitive to
fluctuations in the exchange rate between the U.S. dollar and the
U.K. pound sterling. The effect of such fluctuations is included in
accumulated other comprehensive income in the Consolidated
Statements of Stockholders' Equity. From inception to date, such
fluctuations have amounted to an accumulated amount of $903,000.
ITEM 4. CONTROLS AND PROCEDURES
(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCESSES
The Company's Chief Executive Officer and Vice President, Finance
(Certifying Officers) performed an evaluation of the Company's
disclosure controls and procedures. Disclosure controls and
procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by an
issuer in the reports that it files or submits under the Exchange
Act is accumulated and communicated to the issuer's management,
including its Chief Executive Officer and Vice President, Finance,
as appropriate, to allow timely decisions regarding required
disclosures.
Based on this evaluation, the Certifying Officers have concluded
that the Company's disclosure controls and procedures are effective
as of September 30, 2003. In addition, there has been no significant
change in the Company's internal control over financial reporting
that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
(B) CHANGE IN INTERNAL CONTROLS
As of the quarter ended September 30, 2003, there have been no
significant changes in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to
the evaluation date.
16
PART II - OTHER INFORMATION
ITEM 5. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of the Company's stockholders was held on August 27,
2003. One matter was specified in the Company's Notice of Annual Meeting and
Proxy Statement dated July 9, 2003, (a copy of which has been previously filed
with the Securities and Exchange Commission), was considered, voted upon and
approved by the stockholders. The specific results of the voting on the matter
are as follows:
Proposal I: The size of the Company's Board of Directors was fixed at
seven and Mr. Richard J. Harries, Jr. was elected to the Board
of Directors of the Company, for a term to expire at the 2006
Annual Meeting, by the following votes:
Number of Shares Voted
For Withheld
---------- --------
Richard J. Harries, Jr. 28,036,418 319,720
For the meeting, each of Messrs. Robert J. Crowell, William W. Smith and
John Ortiz, continued as Directors of the Company.
For information on the manner in which the votes on the above matters were
tabulated, see the definitive proxy statement referenced above.
ITEM 6. RECENT SALES OF UNREGISTERED SECURITIES
(a) On April 25, 2003, the Company closed a private placement to
accredited investors of ten-year 10% Senior Convertible Debentures
(the "Debentures"), generating gross proceeds of $949,000. Robert J.
Crowell, the Chairman and CEO invested $300,000, John E. Halnen, the
President and COO invested $60,000, William W. Smith, the Company's
Vice Chairman and Director invested $300,000, Andres Escallon, the
Chief Technology Officer invested $50,000, (collectively, the
"Inside Investors"), and Smith & Williamson LLC (U.K.) and other
Elcom stockholders in the U.K. invested $239,000, (together the
"Holders"). Inside investors are considered related parties and
invested a total of $710,000 in the Debentures.
The Debentures carry a 10% interest rate, which is payable in cash
or payment in-kind. Interest is due annually, in arrears, commencing
April 25, 2004 and is expected to be paid in-kind. The principal
amount is due at maturity on April 25, 2013. The Company has accrued
$31,391 in interest expense for these Debentures as of September 30,
2003.
The Debentures are collateralized by a security interest in
substantially all of the Company's assets for a two-year period
ending April 25, 2005. They are convertible into common stock of the
Company at a conversion price of $0.125 per share, subject to
anti-dilution clauses. The Debentures are convertible at the
election of the holder at any time commencing on April 25, 2005
through April 25, 2013. However, if the Company has two sequential
quarters of profitability with respect to continuing operations, the
Holder may convert the Debentures at his option. The Holders also
have certain registration rights upon conversion. The Company
recorded a beneficial conversion feature (the "Debenture discount")
of $716,000 in conjunction with the issuance of these Debentures.
This Debenture discount is being amortized as interest expense over
the ten-year term of the Debentures. At September 30, 2003, the
Company has accrued $26,158 of interest expense for this Debenture
discount. At September 30, 2003, the Debentures are convertible into
7,569,705 shares of common stock.
The Company has the right to convert the Debentures upon the
occurrence of one of the following events:
- A change of control, as defined in the agreement, or
- the Company's option as of April 23, 2007, or subsequent
to this date upon written notice to the Holder.
The Senior Convertible Debentures are not registered under the
Securities Act of 1933, as amended, or applicable state securities
laws and may not be offered or sold in the United States absent
registration under the Securities Act of 1933, and applicable state
securities laws or available exemptions from the registration
requirements. This private placement has been extended to November
27, 2003 and will terminate on that date
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unless otherwise extended or earlier terminated by the Company.
Exemption from registration with respect to the Sale of the
Debentures is claimed pursuant to Section 4(a) of the Securities Act
of 1933, as amended.
Robert J. Crowell invested $300,000 in the Debentures and John E.
Halnen invested $60,000 in the Debentures. Of these amounts, the
Company paid Robert J. Crowell $187,000 and John E. Halnen $60,000
in repayment of a portion of their salaries which they had
voluntarily suspended during 2002 in order to assist the Company in
its efforts to retain cash. Robert J. Crowell and John E. Halnen
immediately reinvested these proceeds into their purchase of the
Debentures.
(b) On October 16, 2003, the Company announced a second closing of the
private placement to accredited investors of the Debentures (the
"Second Closing"), generating cash proceeds of $315,000, which is
not reflected in the unaudited financial statements contained in
this Form 10-Q. Robert J. Crowell, the Chairman and CEO invested
$150,000, William W. Smith, the Vice Chairman and Director invested
$50,000, (collectively, the "Inside Investors") and Smith &
Williamson LLC (U.K.) and one other Elcom stockholder invested a
total of $115,000. Thus related parties invested a total of $200,000
in the Second Closing of the Debentures.
To date in the aggregate, Inside Investors have invested $910,000 of
the $1,264,000 invested in the Debentures.
ITEM 7. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS:
31.1 Rule 13a-14(a) Certification of the Company's Chief Executive
Officer
31.2 Rules 13a-14(a) Certification of the Company's Principal
Financial Officer
32.1 Section 1350 Certification of the Company's Chief Executive
Officer
32.2 Section 1350 Certification of the Company's Principal
Financial Officer
(B) REPORTS ON FORM 8-K
(i) Current Report on Form 8-K dated October 16, 2003 regarding a
second closing of $315,000 of the Company's Debentures.
(ii) Current Report on Form 8-K, dated October 31, 2003 regarding a
change in the Company's Certifying Accountant.
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SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Elcom International, Inc.
Date: November 13, 2003 By:
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Robert J. Crowell
Chairman and CEO
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SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Elcom International, Inc.
Date: November 13, 2003 By:
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