U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
|X| Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2004
------------------
|_| Transition report under Section 13 or 15(d) of the Exchange Act of 1934
For the transition period from __________ to __________
Commission file number 1-9224
CNE GROUP, INC.
---------------
(Exact Name of Small Business Issuer as Specified in Its Charter)
DELAWARE 56-2346563
-------- ----------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
200 West 57th Street, Suite 507, New York, N.Y. 10019
-----------------------------------------------------
(Address of Principal Executive Offices)
212-977-2200
------------
(Issuer's Telephone Number, Including Area Code)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes |X| No |_|
The number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
Class Outstanding at October 31, 2004
----- -------------------------------
Common stock - par value $.00001 10,790,915 shares
-------------------------------- -----------------
PART I
FINANCIAL INFORMATION
Item l. Financial Statements.
The following consolidated financial statements of CNE Group, Inc.
and subsidiaries (collectively referred to as the "Company," unless
the context requires otherwise) are prepared in accordance with the
rules and regulations of the Securities and Exchange Commission for
Form 10-QSB and reflect all adjustments (consisting of normal
recurring accruals) and disclosures which, in the opinion of
management, are necessary for a fair statement of results for the
interim periods presented. It is suggested that these financial
statements be read in conjunction with the financial statements and
notes thereto included in the Company's Annual Report on Form 10-KSB
for the year ended December 31, 2003, which was filed with the
Securities and Exchange Commission.
The results of operations for the three and nine months ended
September 30, 2004 are not necessarily indicative of the results to
be expected for the entire fiscal year.
1
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, December 31,
2004 2003
------------- ------------
(Unaudited)
ASSETS
Current:
Cash and cash equivalents $ 51,702 $ 460,832
Accounts receivable, net of allowance for doubtful
accounts of $64,707 in 2004 and $51,500 in 2003 152,902 208,358
Inventory 356,158 246,719
Other 13,806 27,840
------------ ------------
Total current assets 574,568 943,749
Fixed assets, net 417,497 447,579
Intellectual property rights, net 1,390,247 1,475,145
Goodwill 7,285,894 7,285,894
Other assets 21,962 18,961
------------ ------------
Total assets $ 9,690,168 $ 10,171,328
============ ============
LIABILITIES
Current:
Accounts payable and accrued expenses $ 1,343,772 $ 1,030,203
Short-term credit arrangements 86,365 210,093
Notes payable 639,318 146,988
Subordinated notes payable 941,747 --
Debenture payable 100,000 100,000
------------ ------------
Total current liabilities 3,111,202 1,487,284
Notes payable, net of current portion 29,060 326,045
Subordinated notes payable -- 1,767,000
Deferred revenue 16,705 23,620
Deferred grant revenue 300,000 300,000
------------ ------------
Total liabilities 3,456,967 3,903,949
------------ ------------
Commitments and contingencies (Note I)
STOCKHOLDERS' EQUITY
Preferred stock (Note D) 134 124
Common stock (Note E) 121 101
Paid-in surplus 29,919,185 28,258,215
Accumulated deficit (20,813,139) (19,117,961)
------------ ------------
9,106,301 9,140,479
Less treasury stock, at cost - 1,238,656 shares (2,873,100) (2,873,100)
------------ ------------
Total stockholders' equity 6,233,201 6,267,379
------------ ------------
Total liabilities and stockholders' equity $ 9,690,168 $ 10,171,328
============ ============
See Notes to Consolidated Financial Statements.
2
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------------- -----------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
(Unaudited (Unaudited) (Unaudited) (Unaudited)
Revenues:
Product sales $ 385,711 $ 268,591 $ 1,279,111 $ 624,684
Service fee income 215,364 244,413 798,017 412,932
Internet related income 41,920 39,592 99,127 119,450
----------- ----------- ----------- -----------
642,995 552,596 2,176,255 1,157,066
Cost of goods sold 300,574 294,863 1,085,889 573,216
----------- ----------- ----------- -----------
Gross profit 342,421 257,733 1,090,366 583,850
----------- ----------- ----------- -----------
Other expenses:
Advertising 5,909 6,591 42,837 23,682
Compensation and related costs 207,324 387,467 1,028,916 791,402
General and administrative 322,507 341,657 985,806 779,678
Product development 92,904 -- 130,513 --
Depreciation and amortization 48,848 70,193 145,204 93,463
----------- ----------- ----------- -----------
677,492 805,908 2,333,276 1,688,225
----------- ----------- ----------- -----------
Loss before other income (expenses) (335,071) (548,175) (1,242,910) (1,104,375)
Other income (expenses):
Amortization of debt discount (24,963) (175,750) (174,747) (292,250)
Interest expense (110,757) (82,320) (278,099) (319,163)
Tax settlement adjustment -- 895,622 -- 895,622
Interest income 277 -- 576 --
----------- ----------- ----------- -----------
(Loss) income before provision for
income taxes (470,514) 89,377 (1,695,180) (820,166)
Provision for income taxes -- -- -- --
----------- ----------- ----------- -----------
(Loss) Income from continuing operations (470,514) 89,377 (1,695,180) (820,166)
Discontinued operations:
Income from discontinued
operations (Note J) -- 533,634 -- 533,634
----------- ----------- ----------- -----------
Net (loss) income $ (470,514) $ 623,011 $(1,695,180) $ (286,532)
=========== =========== =========== ===========
See Notes to Consolidated Financial Statements.
3
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations, continued
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------------- -------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
(Loss) income per common share:
Basic:
(Loss) income from continuing operations $ (.04) $ .01 $ (.16) $ (.12)
Income from discontinued operations -- .07 -- .08
------------ ------------ ------------ ------------
Net (loss) income $ (.04) $ .08 $ (.16) $ (.04)
============ ============ ============ ============
Diluted:
(Loss) income from continuing operations $ (.04) $ .01 $ (.16) $ (.12)
Income from discontinued operations -- .07 -- .08
------------ ------------ ------------ ------------
Net (loss) income $ (.04) $ .08 $ (.16) $ (.04)
============ ============ ============ ============
Weighted average number of common shares outstanding:
Basic 10,690,915 7,674,253 10,463,137 6,585,372
============ ============ ============ ============
Diluted 10,690,915 7,970,808 10,463,137 6,741,610
============ ============ ============ ============
See Notes to Consolidated Financial Statements.
4
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Nine Months Ended September 30,
-------------------------------
2004 2003
----------- -----------
(Unaudited) (Unaudited)
Cash flows from operating activities:
Loss from continuing operations $(1,695,180) $ (820,166)
Adjustments to reconcile loss from continuing operations to net cash used in
operating activities:
Depreciation and amortization 145,204 93,463
Provision for doubtful accounts 13,207 --
Issuance of common stock for services 50,000 96,250
Amortization of debt discount 174,747 292,250
Changes in:
Accounts receivable 42,249 (149,404)
Inventory (109,439) (37,765)
Prepaid expenses and other assets 11,003 (33,750)
Accounts payable, accrued expenses and other liabilities 346,686 (563,945)
Deferred grant revenue -- 8,173
----------- -----------
Net cash used in operating activities (1,021,523) (1,114,894)
----------- -----------
Cash flows from investing activities:
Purchase of furniture and equipment (30,224) (35,572)
----------- -----------
Net cash used in investing activities (30,224) (35,572)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of 10% subordinated notes payable -- 1,000,000
Proceeds from short-term credit arrangements 20,853 --
Net proceeds from issuance of 1,750,000 shares of common stock 571,000 --
Proceeds from issuance of 10% notes payable 150,000 --
Proceeds from issuance of 18% notes payable 300,000 --
Proceeds from issuance of 24% notes payable 150,000 --
Principal repayments on short-term credit arrangements (144,581) --
Principal repayments on notes payable (404,655) (110,000)
Payment of accounts receivable due Sellers of Econo-Comm, Inc. -- (100,000)
----------- -----------
Net cash provided by financing activities 642,617 1,090,000
----------- -----------
Decrease in cash and cash equivalents (409,130) (60,466)
Cash and cash equivalents at beginning of period 460,832 183,200
----------- -----------
Cash and cash equivalents at end of period $ 51,702 $ 122,734
=========== ===========
See Notes to Consolidated Financial Statements.
5
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, continued
Nine Months Ended September 30,
-------------------------------
2004 2003
----------- -----------
(Unaudited) (Unaudited)
Supplemental disclosures of cash flow information related to
continuing operations:
Cash paid during the period for:
Interest $ 212,769 $ 12,615
Income taxes $ -- $ --
Non-cash investing and financing activities relating to the acquisition of
subsidiaries and certain intellectual property rights, conversion of debt
to preferred stock, forgiveness of interest indebtedness to an officer and
an employee of the Company, and issuance of common stock for services:
Accounts receivable $ 102,048
Inventory 236,959
Intellectual property rights 1,550,609
Intangibles 7,285,894
Other assets 518,586
Accrued expenses and other liabilities (1,622,015)
Interest payable $ 40,000
8% notes payable 1,000,000 (2,000,000)
Issuance of preferred stock, at par (10) (119)
Issuance of common stock, at par (2) (9)
Paid in surplus (1,089,988) (6,048,075)
See Notes to Consolidated Financial Statements.
6
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE A - THE COMPANY
Business
--------
CNE Group, Inc. (the "Company" or "CNE") is a holding company whose primary
operating subsidiaries are SRC Technologies, Inc. ("SRC") and U.S. Commlink,
Ltd. ("USCL"). SRC, also a holding company, is the parent of Connectivity, Inc.
("Connectivity") and SRC-ECI, Inc. ("ECI") (d/b/a Econo-Comm, Inc. and Mobile
Communications). Connectivity, ECI and USCL market, manufacture, repair and
maintain remote radio and cellular-based emergency response products to a
variety of federal, state and local government institutions, and other vertical
markets throughout the United States. The Company has intellectual property
rights to certain key elements of these products - specifically, certain
communication, data entry and telemetry devices.
The Company also generates revenue from its subsidiary, CareerEngine, Inc.,
which is engaged in the business of e-recruiting. This segment is not
significant to the operations of the Company.
Going Concern
-------------
The Company has incurred substantial losses, sustained substantial operating
cash outflows and has a working capital deficit at both September 30, 2004 and
December 31, 2003. The above factors raise substantial doubt about the Company's
ability to continue as a going concern. The Company's continued existence
depends on its ability to obtain additional equity and/or debt financing to fund
its operations and ultimately to achieve profitable operations. The Company is
continuously in the process of raising additional financing and has initiated a
cost reduction strategy. At September 30, 2004, management believes that the
working capital deficit, losses and negative cash flow will ultimately be
improved by (i) the acquisition and increased operations of SRC and ECI and (ii)
cost reduction strategies initiated in January and June 2004. There is no
assurance that the Company can obtain additional financing or achieve profitable
operations or generate positive cash flow. The 2004 and 2003 financial
statements do not include any adjustments relating to the recoverability or
classification of recorded asset amounts or the amount and classification of
liabilities that might be necessary as a result of this going concern
uncertainty.
American Stock Exchange Listing
-------------------------------
On January 2, 2004, the Company received a notice dated December 31, 2003 from
the American Stock Exchange Staff indicating that the Company had demonstrated
compliance with the requirements necessary for continued listing on the American
Stock Exchange.
As is the case for all listed issuers, the Company's continued listing
eligibility will be assessed on an ongoing basis; however, during the year
ending December 31, 2004, the Company will be subject to additional scrutiny (as
set forth in Section 1009(h) of the AMEX Company Guide) as is the case for any
listed company that has regained compliance.
Private Financings
------------------
On April 23, 2003, the Company completed a private financing pursuant to which
it issued notes (the "Notes") in the aggregate principal amount of $1,000,000,
of which $650,000 was to the officers of the Company, and 4,165,800 ten year
cashless Class B Warrants, each to purchase one share of its Common
7
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE A - THE COMPANY (CONTINUED)
Stock at $0.50 per share. The Notes bear interest at the annual rate of 10%
payable quarterly and were due on April 30, 2004. The aggregate number of shares
for which the Warrants may be exercised must equal 15% of the Company's
outstanding Common Stock on a fully-diluted basis. These Warrants are
anti-dilutive until the Notes have been repaid. The due date of the Notes may be
extended at the Company's option for an additional year in consideration for the
issuance of 10-year warrants to purchase an additional 4% of the Company's then
outstanding common stock at $0.50 per share. These Warrants would also be
anti-dilutive until the Notes have been repaid. In addition, the Company valued
the warrants, utilizing the Black-Scholes Pricing Model, at $699,000, which is
being accounted for as debt discount and is being amortized ratably over the
one-year term of the Notes.
On March 12, 2004, the Company notified the Class B Warrant holders that, to
satisfy the 15% non-dilutive provisions of their Warrants, these Warrants were
now exercisable for an aggregate of 5,245,200 shares of the Company's common
stock at approximately $0.40 per share. On this date, the Company also exercised
its option to extend the maturity date of the notes to April 30, 2005 and
satisfied the requirement for the additional 4% non-dilutive interest in the
Company by issuing to the noteholders Class B Warrants to purchase an additional
1,708,900 shares of the Company's common stock at $0.50 per share. The
non-dilutive provisions of the Warrants terminate when all of the notes have
been paid in full.
1. On September 17, 2003, the Company sold 1,250,000 shares of its
Common Stock at $0.40 per share to an existing noteholder and
stockholder of the Company.
2. On January 21, 2004, a secured factoring arrangement with an
individual, which amounted to $300,000 at December 31, 2003, was
restructured into a $300,000 unsecured Note Payable due February 10,
2005. The individual was also issued Class BB Warrants to purchase
150,000 shares of the Company's common stock at $0.50 per share.
3. On February 10, 2004, the Company sold 1,750,000 shares of its
Common Stock at $0.40 per share. The net proceeds of the transaction
amounted to $571,000. The Company used the funds obtained from this
financing primarily for working capital purposes.
4. On June 10, 2004, the two holders of the Company's 8% Subordinated
Promissory Notes, in the aggregate principal amount of $1,000,000,
converted their notes into 1,000,000 shares of the Company's Series
AA 8% Cumulative Preferred Stock, par value $0.00001 per share (the
"Series AA Preferred Stock"). The aggregate liquidating value of the
Series AA Preferred Stock acquired by the converting noteholders,
one of whom is an officer and the other an employee of a subsidiary
of the Company, is $1,000,000.
5. On June 10, 2004, an officer and employee of a subsidiary
relinquished all their rights to an aggregate 420,000 vested
incentive stock options of the Company for an aggregate payment of
$50,000 cash which is included in compensation and related costs.
6. In June 2004, in an effort to conserve the financial resources of
the Company, the Board of Directors of the Company deferred 100% of
the salaries of four officers of the Company until such time as the
Board deems otherwise. In September 2004, three of the
aforementioned officers were terminated by the Company. The
accompanying financial statements include (i) the
8
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE A - THE COMPANY (CONTINUED)
accrued salary owed to the non-terminated officer for the amounts so
deferred, and (ii) with regard to the terminated officers, the
accrued salaries owed to these officers for the amounts so deferred
until their termination. See Note I.
7. On June 28, 2004 the Company repaid, in full, one of its outstanding
lines of credit amounting to approximately $146,000. On the same
date the Company issued a secured note payable to an employee of a
subsidiary of the Company in the amount of $150,000. The note is
secured by the equipment of a subsidiary of the Company. The note
bears interest at 10% per annum and the principal and all interest
thereon was due September 28, 2004. The Company is currently
negotiating new terms with regard to this note.
8. As of July 1, 2004, 80% of the holders of the Company's 10%
subordinated notes agreed to defer $20,000 of interest due on such
date to October 1, 2004 in consideration of the Company issuing to
them 153,846 Class B Warrants of the Company, each to give the
holder thereof the right to purchase a share of common stock at
$0.39 per share. As of October 1, 2004, 75% of the holders of the
Company's 10% subordinated notes agreed to further defer $18,750 of
interest from October 1, 2004 to January 1, 2005 in consideration of
the Company issuing to them an additional 170,455 Class B Warrants
of the Company, each to give the holder thereof the right to
purchase a share of common stock at $0.33 per share. The noteholders
include two officers of the Company.
9. In July and August 2004, the Company issued $150,000 of its 24%
Secured Notes due April 30, 2005 to the wife of the Chief Executive
Officer and an existing 10% subordinated noteholder of the Company.
Interest on the notes is payable quarterly in arrears. The notes are
secured by (i) all the stock of SRC and USCL, and (ii) the pledge of
Patent Nos. 6,060,979, 6,047,173 and 5,701,338 -all owned by the
Company. On October 1, 2004, 100% of the holders of the Company's
24% Secured Notes agreed to defer $5,786 of interest due on such
date to January 1, 2005 in consideration of the Company issuing to
them 76,712 Class B Warrants of the Company, each to give the holder
thereof the right to purchase a share of common stock at $0.33 per
share.
10. As of October 1, 2004, 75% of the holders of the Company's 10%
subordinated notes agreed to defer $18,750 of interest due on such
date to January 1, 2005 in consideration of the Company issuing to
them 170,455 Class B Warrants of the Company, each to give the
holder thereof the right to purchase a share of common stock at
$0.33 per share. The noteholders include two officers of the
Company.
11. In October 2004, the Company and USCL entered into a two-year
Project Financing Agreement with an institutional lender relating to
USCL's anticipated participation in the "Cellular Call Box Upgrade
and Maintenance Service" projects for numerous Service Authority for
Freeway Emergencies ("SAFE") programs within the state of
California. These call box programs operate over 17,000 motorist aid
analog call boxes that will require upgrades to digital cellular
technology available through USCL. This agreement provides the
Company with finished goods and accounts receivable financing of up
to $2,000,000 relating to these potential aforementioned projects.
The effective interest rate is approximately 3% per month on the
outstanding balance of
9
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE A - THE COMPANY (CONTINUED)
the amount receivables financed. The finished goods and accounts
receivable to be financed, as well as all the other assets of the
Company not previously pledged, will secure the borrowings under
this agreement.
12. In October and November 2004, the Company issued (i) $125,000 of its
10% Convertible Subordinated Notes due June 30, 2005 and (ii)
787,500 Class C Warrants of the Company, each to give the holder
thereof the right to purchase a share of common stock at $0.50 per
share. The notes were sold to the wife of the Chief Executive
Officer of the Company and other accredited investors and are
convertible by the holder, at any time, into common stock of the
Company at $0.50 per share. The warrants expire on April 30, 2013.
Interest on the notes is payable monthly in arrears.
The Company is using the funds obtained from these financings primarily
for working capital purposes. The aforementioned financings were effected
pursuant to the exemption from the registration provisions of the
Securities Act of 1993 provided by Section 4(2) thereof.
NOTE B - SIGNIFICANT ACCOUNTING POLICIES
[1] Inventory:
Inventory is stated at the lower of cost (determined by first-in,
first-out method) or market. The Company's inventory consists of the
following:
September 30, December 31,
2004 2003
------------- ------------
Raw materials $298,714 $158,347
Work in progress 24,497 3,089
Finished goods 32,947 85,283
-------- --------
Total $356,158 $246,719
======== ========
[2] Income (loss) per share:
Basic and diluted earnings (loss) per common share have been
computed in accordance with SFAS No. 128, "Earnings Per Share."
Basic earnings per share ("BEPS") is computed by dividing net income
(loss) by the weighted-average number of common shares outstanding
during the three and nine month period ended September 30, 2004. For
the three and nine month period ended September 30, 2003 diluted
earnings per share (diluted EPS) is computed by dividing net income
(loss) used in determining basic EPS by the weighted average number
of commons hares outstanding during the period, plus the incremental
shares, if any, that would have been outstanding upon the assumed
exercise of dilutive stock options. Common stock equivalents to
purchase common stock of the Company that were outstanding at
September 30, 2004 were not included in the computation of diluted
net loss per share as their effect would have been anti-dilutive.
10
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[3] Stock-based compensation:
As permitted under SFAS No. 123, Accounting for Stock-based
Compensation (SFAS No. 123), the Company has elected to continue to
follow the guidance of APB Opinion No. 25, Accounting for Stock
Issued to Employees (APB No. 25), and Financial Accounting Standards
Board Interpretation No. 44, Accounting for Certain Transactions
Involving Stock Compensation--an interpretation of APB Opinion No.
25 (FIN No. 44), in accounting for its stock-based employee
compensation arrangements. Accordingly, no compensation cost is
recognized for any of the Company's fixed stock options granted to
employees when the exercise price of each option equals or exceeds
the fair value of the underlying common stock as of the grant date
for each stock option. Changes in the terms of stock option grants,
such as extensions of the vesting period or changes in the exercise
price, result in variable accounting in accordance with APB Opinion
No. 25. Accordingly, compensation expense is measured in accordance
with APB No. 25 and recognized over the vesting period. If the
modified grant is fully vested, any additional compensation costs is
recognized immediately. The Company accounts for equity instruments
issued to non-employees in accordance with the provisions of SFAS
No. 123.
At September 30, 2004 and December 31, 2003, the Company had a
stock-based employee compensation plan - the 2003 Plan. Two of
Company's subsidiaries each had separate stock-based employee
compensation plans. These subsidiaries' plans were contractually
terminated by the Company upon the acquisition of SRC and ECI on
April 23, 2003. Furthermore, on March 14, 2003, all recipients of
options granted pursuant to these plans rescinded all of their
interests.
As permitted under SFAS No. 148, Accounting for Stock-Based
Compensation--Transition and Disclosure, which amended SFAS No. 123,
the Company has elected to continue to follow the intrinsic value
method in accounting for its stock-based employee compensation
arrangements as defined by APB No. 25 and related interpretations
including FIN No. 44. The following table illustrates the effect on
net loss and loss per share if the Company had applied the fair
value recognition provisions of SFAS No. 123 to stock-based employee
compensation for options granted under its plan.
Nine Month Period
Ended September 30,
-----------------------------
2004 2003
----------- -----------
Net loss, as reported $(1,695,180) $ (286,532)
Less, Total stock-based employee compensation
expense determined under fair value-based method for
all awards, net of related tax effects (246,430) --
----------- -----------
Pro forma net loss $(1,941,610) $ (286,532)
=========== ===========
Net loss per share - basic and diluted:
As reported $ (0.16) $ (0.04)
=========== ===========
Pro forma $ (0.18) $ (0.04)
=========== ===========
11
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
On April 30, 2003, incentive stock options to purchase 1,987,500
shares of the Company's Common Stock were granted by the Incentive
Compensation Committee to five officers (1,800,000) and one employee
(187,500) of the Company at a weighted average exercise price of
$1.32 per share. On November 4, 2003, incentive stock options to
purchase 950,000 shares of the Company's Common Stock were granted
by the Incentive Compensation Committee to three officers of the
Company at a weighted average exercise price of $1.09 per share. On
January 21 2004, incentive stock options to purchase 601,000 shares
of the Company's common stock were granted by the Incentive
Compensation Committee of the Board of Directors to one officer and
18 employees of the Company at a weighted average exercise price of
$0.50 per share. On September 12, 2004, incentive stock options to
purchase 500,000 shares of the Company's common stock were granted
by the Incentive Compensation Committee of the Board of Directors to
an officer of the Company at an exercise price of $0.28 per share.
On April 30, 2003 (435,000), November 4, 2003 (220,000), November
21, 2003 (100,000), January 21, 2004 (295,500) and September 12,
2004 (900,000), non-qualified stock options to purchase an aggregate
1,950,500 shares of the Company's Common Stock were granted by the
Board of Directors to certain independent contractors of the
Company. On June 10, 2004 an officer and an employee of a subsidiary
of the Company relinquished all their rights to an aggregate of
420,000 incentive stock options in consideration of $50,000 cash. No
options granted have been exercised.
[4] Research and development expenditures:
Research and development expenditures in connection with the
development of new products are expensed as incurred unless the
costs are related to a contractual arrangement.
[5] Recent accounting pronouncements:
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN
46"), "Consolidation of Variable Interest Entities." In general, a
variable interest entity is a corporation, partnership, trust, or
any other legal structure used for business purposes that either (a)
does not have equity investors with voting rights or (b) has equity
investors that do not provide sufficient financial resources for the
entity to support its activities. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of
the entity if the investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at
risk for the entity to finance its activities without additional
subordinated financial support from other parties. In December 2003
the FASB issued FIN46R which revised certain elements of FIN46. The
consolidation requirements of FIN 46R apply immediately to variable
interest entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or
interim period beginning after December 15, 2003. Certain of the
disclosure requirements apply in all financial statements issued
after January 31, 2003, regardless of when the variable interest
entity was established. The adoption of this statement has had no
effect on the Company's financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities" ("SFAS No.
149"). SFAS No. 149 amends and clarifies
12
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities
under FASB Statement No. 133, "Accounting for Derivative Instruments
and Hedging Activities". This Statement requires that contracts with
comparable characteristics be accounted for consistently as either
derivatives or hybrid instruments. This Statement is effective for
contracts entered into or modified after June 30, 2003, and for
hedging relationships designated after June 30, 2003. The adoption
of this statement has had no effect on the Company's financial
statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity." SFAS No. 150 changes the accounting for certain financial
instruments that under previous guidance issuers could account for
as equity. It requires that those instruments be classified as
liabilities in balance sheets. The guidance in SFAS No. 150 is
generally effective for all financial instruments entered into or
modified after May 31, 2003, and otherwise is effective on July 1,
2003. The adoption of this statement has had no effect on the
Company's financial statements.
NOTE C - CONVERSION OF 8% SUBORDINATED NOTES PAYABLE
On June 10, 2004, the two holders of the Company's 8% Subordinated Notes
Payable, in the aggregate principal amount of $1,000,000, converted their notes
into 1,000,000 shares of the Company's Series AA 8% Cumulative Preferred Stock,
par value $0.00001 per share (the "Series AA Preferred Stock"). The aggregate
liquidating value of the Series AA Preferred Stock acquired by the converting
noteholders, one of whom is an officer and the other an employee of a subsidiary
of the Company, is $1,000,000. Including the aforementioned conversion, the
Company currently has issued and outstanding an aggregate of 2,000,000 shares of
Series AA Preferred Stock, which has a liquidating preference of $2,000,000 over
all other equity of the Company.
NOTE D - PREFERRED STOCK
Preferred Stock consists of the following:
September 30, December 31,
2004 2003
------------- ------------
Par value per share $ 0.00001 $ 0.00001
========== ==========
Authorized number of shares 25,000,000 25,000,000
========== ==========
Issued and outstanding number of shares:
Series AA 2,000,000 1,000,000
Series A 1,697,966 1,697,966
Series B 4,400 4,400
Series C 9,735,875 9,735,875
---------- ----------
Total 13,438,241 12,438,241
========== ==========
The Series AA Preferred Stock has an 8% cumulative dividend, payable in common
stock or cash, and a liquidating preference over all other CNE equity of
$2,000,000. The Series A Preferred Stock has a liquidating preference over all
other CNE equity except the Series AA of $1,697,961. The Series B Preferred
Stock has a liquidating preference over all other CNE equity except the Series
AA and A Preferred Stock of $440,000. The Series C Preferred Stock has no
liquidating preference.
13
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE E - COMMON STOCK
Common Stock consists of the following:
September 30, December 31,
2004 2003
------------- ------------
Par value per share $ 0.00001 $ 0.00001
=========== ===========
Authorized number of shares 40,000,000 40,000,000
=========== ===========
Issued number of shares 12,029,571 10,129,571
Less, Treasury shares (1,238,656) (1,238,656)
----------- -----------
Issued and outstanding number of shares 10,790,915 8,890,915
=========== ===========
NOTE F - WARRANTS
Outstanding warrants to acquire common stock of the Company consists of:
September 30, December 31,
2004 2003
------------- ------------
Type of Exercise
Warrant Exercise Date Expiration Date Price Shares of Common Stock
------- ---------------- -------------- -------- ------------------------------
Class A October 22, 2008 April 22, 2013 $1.00 1,697,966 1,697,966
Class B April 23, 2003 April 30, 2013 $0.50 -- 4,904,800
Class B April 23, 2003 April 30, 2013 $0.40 5,245,200 --
Class B March 12, 2004 April 30, 2013 $0.50 1,708,900 --
Class B July 1, 2004 April 30, 2013 $0.39 153,846 --
Class BB May 10, 2003 May 10, 2006 $0.50 20,000 20,000
Class BB June 10, 2003 June 10, 2006 $0.50 20,000 20,000
Class BB July 10, 2003 July 10, 2006 $0.50 20,000 20,000
Class BB August 10, 2003 August 10, 2006 $0.50 20,000 20,000
Class BB September 10, 2003 September 10, 2006 $0.50 20,000 20,000
Class BB October 10, 2003 October 10, 2006 $0.50 20,000 20,000
Class BB June 10, 2003 June 10, 2006 $2.50 10,000 10,000
Class BB July 10, 2003 July 10, 2006 $3.00 10,000 10,000
Class BB August 10, 2003 August 10, 2006 $4.00 10,000 10,000
Class BB September 10, 2003 September 10, 2006 $4.50 10,000 10,000
Class BB October 10, 2003 October 10, 2006 $5.00 10,000 10,000
Class BB January 21, 2004 February 4, 2009 $0.50 150,000 --
Class BB February 10, 2004 February 10, 2014 $1.00 350,000 --
Class BB August 29, 2004 August 29, 2009 $1.50 25,000 --
Class BB August 29, 2004 August 29, 2009 $2.00 25,000 --
Class BB August 29, 2004 August 29, 2009 $2.50 25,000 --
Class BB August 29, 2004 August 29, 2009 $3.00 25,000 --
Class BB August 29, 2004 August 29, 2009 $3.50 25,000 --
Class BB August 29, 2004 August 29, 2009 $4.00 25,000 --
Class C October 22, 2008 April 22, 2013 $1.00 9,735,875 9,735,875
Class F January 1, 2004 December 31, 2009 $3.00 1,150,000 1,150,000
Class B(1) Immediate March 31, 2005 $6.00 25,000 25,000
Class B(1) Immediate June 28, 2005 $6.00 62,500 62,500
---------- ----------
20,599,287 17,746,141
========== ==========
(1) Class B warrants and Units of a subsidiary of the Company are
exercisable for the Company's common shares.
14
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE G - ACQUISITIONS AND RELATED UNAUDITED PRO FORMA FINANCIAL INFORMATION
The purchase price of the acquisition of SRC and ECI was allocated to the assets
and liabilities acquired, both tangible and intangible based on fair values (as
determined by an independent appraiser), with the excess of the purchase price
over the fair value of the net assets acquired of $7,285,894 being recorded as
Goodwill. The fair value of the intellectual property rights, amounting to
$1,550,609, acquired in the related financing was also determined by an
independent appraiser. Due to these acquisitions and related financing, SRC has
acquired intellectual property rights to certain key elements of these products
- specifically, certain communication, data entry and telemetry devices.
The Company's consolidated financial statements include the results of
operations of SRC from its respective acquisition dates. The following unaudited
pro forma information presents a summary of our consolidated results of
operations as if the SRC and ECI acquisitions and the related financing had
taken place on January 1, 2003 for the three and nine-month periods ended
September 30, 2003. The SRC and ECI acquisitions have been recorded in
accordance with SFAS No. 141; therefore, no amortization of goodwill or
intangible assets without determinable lives related to SRC and ECI is reflected
in the prior year amounts. These pro forma results have been prepared for
comparative purposes only and do not purport to be indicative of the results of
operations which actually would have resulted had the acquisitions occurred on
January 1, 2003.
Pro forma
-----------------------------------------
Three Months Ended Nine Months Ended
September 30, 2003 September 30, 2003
------------------ ------------------
(Unaudited) (Unaudited)
Revenues $ 552,596 $ 1,754,529
Expenses 1,358,841 4,053,165
----------- -----------
Pro forma net loss $ (806,245) $(2,298,636)
=========== ===========
Pro forma net loss per share:
Basic and diluted $ (0.11) $ (0.35)
=========== ===========
NOTE H - STOCK OPTION PLANS
At September 30, 2004, the Company had a stock-based employee compensation plan
- the 2003 Stock Incentive Plan. Two of Company's subsidiaries each had separate
stock-based employee compensation plans prior to the acquisition of SRC and ECI.
These subsidiaries' plans were contractually terminated by the Company upon the
acquisition of SRC and ECI on April 23, 2003. Furthermore, on March 14, 2003,
all recipients of options granted pursuant to these terminated plans rescinded
all of their interests.
2003 Stock Incentive Plan
-------------------------
On April 30, 2003, the Board of Directors of the Company approved the 2003 Stock
Incentive Plan, which provided, among other matters, for incentive and
non-qualified stock options to purchase 3,500,000 shares of the Company's common
stock. On November 4, 2003, the 2003 Stock Incentive Plan was amended by the
Board of Directors of the Company, ratified by a majority of the stockholders of
the Company on December 18, 2003, to increase the number of shares of Common
Stock for which the incentive and non-qualified stock options may be granted
from 3,500,00 to 5,000,000. On April 16, 2004, the 2003 Stock Incentive Plan was
further amended by the Board of Directors of the Company, ratified by
15
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE H - STOCK OPTION PLANS (CONTINUED)
a majority of the stockholders of the Company on June 18, 2004, to increase the
number of shares of Common Stock for which the incentive and non-qualified stock
options may be granted from 5,000,00 to 10,000,000. The purpose of the 2003
Stock Incentive Plan is to provide incentives to officers, key employees,
directors, independent contractors and agents whose performance will contribute
to the long-term success and growth of the Company, to strengthen the ability of
the Company to attract and retain officers, key employees, directors,
independent contractors and agents of high competence, to increase the identity
of interests of such people with those of the Company's stockholders and to help
build loyalty to the Company through recognition and the opportunity for stock
ownership. The Plan is administered by the Incentive Compensation Committee of
the Board.
On April 30, 2003, incentive stock options to purchase 1,987,500 shares of the
Company's Common Stock were granted by the Incentive Compensation Committee to
five officers (1,800,000) and one employee (187,500) of the Company at a
weighted average exercise price of $1.32 per share. On November 4, 2003,
incentive stock options to purchase 950,000 shares of the Company's Common Stock
were granted by the Incentive Compensation Committee to three officers of the
Company at a weighted average exercise price of $1.09 per share. On January 21,
2004, incentive stock options to purchase 601,000 shares of the Company's common
stock were granted by the Incentive Compensation Committee of the Board of
Directors to one officer and 18 employees of the Company at a weighted average
exercise price of $0.50 per share. On September 12, 2004, incentive stock
options to purchase 500,000 shares of the Company's common stock were granted by
the Incentive Compensation Committee of the Board of Directors to an officer of
the Company at an exercise price of $0.28 per share. On April 30, 2003
(435,000), November 4, 2003 (220,000), November 21, 2003 (100,000), January 21,
2004 (295,500), and September 12, 2004 (900,000) non-qualified stock options to
purchase an aggregate 1,950,500 shares of the Company's Common Stock were
granted by the Board of Directors to certain independent contractors of the
Company. On June 28, 2004 an officer and employee of a subsidiary relinquished
all their rights to an aggregate 420,000 vested incentive stock options of the
Company for an aggregate payment of $50,000 cash. No options granted have been
exercised.
Stock option activity, for the nine-month period ended September 30, 2004, under
the 2003 Stock Incentive Plan is summarized as follows:
Nine-Month Period Ended September 30, 2004
--------------------------------------------
Incentive Non-Qualified Weighted Average
Shares Shares Exercise Price
--------- ------------- ----------------
Options outstanding at
December 31, 2003 2,937,500 755,000 $1.14
Options granted 1,101,000 1,195,500 $0.37
Options cancelled (420,000) -- $0.50
--------- ---------
Options outstanding
at September 30, 2004 3,618,500 1,950,500 $0.87
========= =========
Options available
at September 30, 2004 4,431,000 $0.88
=========
16
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE H - STOCK OPTION PLANS (CONTINUED)
The following table presents information relating to stock options outstanding
at September 30, 2004 relating to the 2003 Incentive Stock Plan:
Options Outstanding Options Available
--------------------------------------- -------------------------------------
Weighted
Range Weighted Average Weighted
of Average Remaining Average
Exercise Exercise Life in Exercise
Price Shares Price Years Shares Price
-------- --------- -------- --------- --------- --------
$0.15 - $3.00 5,569,000 $ .87 7.70 4,431,000 $ 0.88
NOTE I - LITIGATION
On August 19, 2004, two of the Company's officers, who are also directors,
informed the Company that their employment contracts may have been breached. On
August 27, 2004 these officers filed suit against the Company in the United
States District Court, Southern District of Florida, alleging that (i) their
employment contracts have been breached and (ii) certain future compensation
relating thereto to be paid to them amounting up to an aggregate of $1,003,000
has been accelerated. The Company does not believe that it has committed any
breach of these agreements and, accordingly, has not incurred the claims that
these officers are alleging. In addition, the Company believes that these
officers have committed violations of their employment agreements and have taken
other actions that have damaged the Company. The Company has filed a defense to
this action and asserted appropriate counterclaims. This litigation is ongoing
and no amounts have been accrued as of September 30, 2004 related to this
matter. Since the institution of this litigation these two officers have been
terminated as officers, directors and employees of the Company's subsidiaries
and as officers and employees of the Company, and have been removed as members
of the Company's Executive Committee. They currently remain as directors of the
Company.
On October 5, 2004, an officer of one of the Company's subsidiaries, who is also
a former director of the Company, instituted a suit against the subsidiary in
the Circuit Court, 17th Judicial Circuit, Broward County, Florida, charging a
breach of her employment agreement with the subsidiary and claiming that certain
future compensation relating thereto to be paid to her from the subsidiary
amounting up to an aggregate of $274,000 has been accelerated. Since the
institution of this litigation this officer has been terminated. The Company
does not believe that its subsidiary has committed any breach of this agreement
and, accordingly, has not incurred the claims that this officer is alleging. The
Company has named this officer as a counterclaim defendant in the litigation
pending in federal court referred to in the previous paragraph and has asserted
certain claims against her in that action. The subsidiary has filed an answer to
this action. This litigation is ongoing and no amounts have been accrued as of
September 30, 2004 related to this matter.
NOTE J - DISCONTINUED OPERATIONS
On August 15, 2003 the Company, for a nominal amount, sold all the stock of one
of the subsidiaries whose remaining assets and liabilities were transferred to a
trust for the benefit of its creditors and recognized a gain amounting to
approximately $533,634.
17
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE K - SUBSEQUENT EVENTS
1. 80% of the holders of the Company's 10% subordinated notes agreed to defer
$20,000 of interest due July 1, 2004 to October 1, 2004. As of October 1,
2004, 75% of the holders of the Company's 10% subordinated notes agreed to
further defer $18,750 of interest from October 1, 2004 to January 1, 2005
in consideration of the Company issuing to them an additional 170,455
Class B Warrants of the Company, each to give the holder thereof the right
to purchase a share of common stock at $0.33 per share. The noteholders
include two officers of the Company.
2. As of October 1, 2004, 75% of the holders of the Company's 10%
subordinated notes agreed to defer $18,750 of interest due on such date to
January 1, 2005 in consideration of the Company issuing to them 170,455
Class B Warrants of the Company, each to give the holder thereof the right
to purchase a share of common stock at $0.33 per share. The noteholders
include two officers of the Company.
3. In October 2004, the Company and USCL entered into a two-year Project
Financing Agreement with an institutional lender relating to USCL's
anticipated participation in the "Cellular Call Box Upgrade and
Maintenance Service" projects for numerous Service Authority for Freeway
Emergencies ("SAFE") programs within the state of California. These call
box programs operate over 17,000 motorist aid analog call boxes that will
require upgrades to digital cellular technology available through USCL.
This agreement provides the Company with finished goods and accounts
receivable financing of up to $2,000,000 relating to these potential
aforementioned projects. The effective interest rate is approximately 3%
per month on the outstanding balance of the amount financed. The finished
goods and accounts receivable to be financed, as well as all the other
assets of the Company not previously pledged, will secure the borrowings
under this agreement.
4. On October 1, 2004, 100% of the holders of the Company's 24% Secured Notes
issued in July 2004 agreed to defer $5,786 of interest due on such date to
January 1, 2005 in consideration of the Company issuing to them 76,712
Class B Warrants of the Company, each to give the holder thereof the right
to purchase a share of common stock at $0.33 per share. The warrants
expire on April 30, 2013.
5. In October and November 2004, the Company issued (i) $125,000 of its 10%
Convertible Subordinated Notes due June 30, 2005 and (ii) 787,500 Class B
Warrants of the Company, each to give the holder thereof the right to
purchase a share of common stock at $0.50 per share. The notes were sold
to the wife of the Chief Executive Officer of the Company and other
accredited investors and are convertible by the holder, at any time, into
common stock of the Company at $0.50 per share. The warrants expire on
April 30, 2013. Interest on the notes is payable monthly in arrears.
18
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
General
-------
CNE Group, Inc. (the "Company," "CNE" or "we") is a holding company
whose primary operating subsidiaries are SRC Technologies, Inc.
("SRC") and U.S. Commlink, Ltd. ("USCL"). SRC, also a holding
company, is the parent of Connectivity, Inc. ("Connectivity") and
SRC-ECI, Inc. ("ECI"). These companies, which we acquired on April
23, 2003, market, manufacture, repair and maintain remote radio and
cellular-based emergency response products to a variety of federal,
state and local government agencies as well as other vertical
markets located throughout the United States. In addition, we engage
in the business of e-recruiting through our subsidiary,
CareerEngine, Inc. The e-recruiting business does not generate a
significant part of our revenue, and is not significant to the
operations of the Company.
Acquisition of all of the outstanding stock of SRC and ECI
----------------------------------------------------------
On April 23, 2003, we issued (i) 899,971 shares of our common stock,
(ii) 1,697,966 shares of our non-voting Series A Preferred Stock and
an equal number of ten year Class A Warrants, (iii) 4,400 shares of
our Series B Preferred Stock, and (iv) 9,735,875 shares of our
non-voting Series C Preferred Stock and a like number of ten year
Class C Warrants, for 100% ownership of SRC which at that time
included USCL, and ECI. On August 19, 2004, we transferred all the
stock of USCL to CNE and USCL became a wholly-owned subsidiary of
CNE. In addition, ECI's sellers retained certain of ECI's trade
receivables aggregating approximately $100,000. We also acquired a
patent related to the operation of ECI's business in exchange for
notes aggregating $2,000,000 bearing 8% interest. The consolidated
financial statements include the operating results of SRC and ECI
from the date of acquisition. The details of the foregoing
transactions are set forth below.
SRC
---
On April 23, 2003, we issued to Michael J. and Carol L. Gutowski,
the former principal common stockholders of SRC and former executive
officers of the Company, an aggregate of 4,867,937 shares of its
non-voting Series C Preferred Stock and a like number of ten year
Class C Warrants, each to purchase one share of its Common Stock at
$1.00 per share. The Class C Warrants are not exercisable or
detachable from the Series C Preferred Stock prior to 66 months
after their issuance. Mr. Gutowski is also a current director of the
Company.
We issued to the other former common stockholders of SRC, including
Larry M. Reid, currently one of the Company's directors and a former
executive officer of the Company, an aggregate of 899,971 shares of
its Common Stock, 1,697,966 shares of its non-voting Series A
Preferred Stock and a like number of ten year non-detachable Class A
Warrants, each to purchase one share of its Common
19
Stock at $1.00 per share. The Class A Warrants are not exercisable
or detachable from the Series A Preferred Stock prior to 66 months
after their issuance.
We issued an aggregate of 4,400 shares of our Series B Preferred
Stock to the former holders of the SRC Series B Preferred Stock.
ECI
---
On April 23, 2003, the Company issued to Thomas Sullivan and Gary
Eichsteadt, the former stockholders of ECI and currently,
respectively, an executive officer and employee of the Company, an
aggregate of 4,867,938 shares of its Series C Preferred Stock and a
like number of Class C Warrants. In addition, Messrs. Eichsteadt and
Sullivan retained certain of ECI's trade receivables aggregating
approximately $100,000. We also acquired a patent ("ECI Patent)
related to the operation of ECI's business from Mr. Eichsteadt for
notes in the aggregate principal amount of $2,000,000, bearing
interest at the annual rate of 8%, payable quarterly, and due on
October 31, 2008. The notes were secured by a certain Pledge
Agreement. Mr. Sullivan remained an executive officer ECI. On July
31, 2003, we transferred all the stock of ECI to SRC and ECI became
a wholly-owned subsidiary of SRC.
On May 19, 2003, Mr. Eichsteadt assigned $1,500,000 of the
aforementioned 8% notes equally to Mr. Sullivan, Mr. Gutowski and
Mrs. Gutowski. On August 31, 2003, Mr. and Mrs. Gutowski converted
their notes aggregating $1,000,000 into 1,000,000 shares of the
Company's Series AA Preferred Stock. On June 28, 2004, Messrs.
Sullivan and Eichsteadt converted their notes aggregating $1,000,000
into 1,000,000 shares of the Company's Series AA Preferred Stock.
The Series AA Preferred Stock has an 8% cumulative dividend, payable
in common stock or cash, and a liquidating preference over all other
CNE equity of $2,000,000. The Series A Preferred Stock has a
liquidating preference over all other CNE equity except the Series
AA of $1,697,961. The Series B Preferred Stock has a liquidating
preference over all other CNE equity except the Series AA and A
Preferred Stock of $440,000. The Series C Preferred Stock has no
liquidating preference.
The total consideration, including acquisition costs, was allocated
based on the estimated fair values of the net assets acquired on the
acquisition date.
ECI SRC Total
----------- ----------- -----------
Tangible assets $ 588,492 $ 292,979 $ 881,471
Patents 1,379,789 170,820 1,550,609
Goodwill 2,766,233 4,519,661 7,285,894
Liabilities (2,144,771) (857,033) (3,001,804)
----------- ----------- -----------
Net asset value $ 2,589,743 $ 4,126,427 $ 6,716,170
=========== =========== ===========
There were no relationships between us or any of our affiliates and
any of the
20
sellers of the assets we acquired prior to the acquisition
transactions.
Catastrophe of September 11, 2001
---------------------------------
Our headquarters were located at Suite 2112 of Two World Trade
Center in New York City. The catastrophe of September 11, 2001
involved no injury to any of our employees. However, with the
complete destruction of the building, all of our leasehold
improvements, furniture and fixtures, and office and computer
equipment located at this site were also destroyed. Since the attack
through the date of the acquisitions and financing set forth above,
our management had been preoccupied with the relocation and
reestablishment of our businesses, assessing and processing of
insurance claims with the assistance of a risk manager with our
insurers, and seeking sources of financing. The Company received
insurance proceeds in amounts that have exceeded the net carrying
value of the destroyed assets. We also had insurance coverage for
other than assets destroyed. In 2003, we received all outstanding
insurance claims relating to the catastrophe.
In addition, we applied for governmental assistance grants related
to the catastrophe. In 2002 and 2003 we received grants aggregating
$300,000. The grants have a restriction that could require their
repayment, specifically if we were to relocate a substantial portion
our operations outside of New York City before May 1, 2005. Until
such time as this restriction no longer applies, we will classify
the grants as a liability of the Company. We will remove the
liability and record grant income on our financial statements when
these restrictions lapse or are satisfied or, alternatively, repay
such grants if the above condition is not satisfied.
Critical Accounting Policies and Estimates
------------------------------------------
The preparation of financial statements in accordance with U.S.
generally accepted accounting principles requires us to make
estimates and assumptions that affect the reported amounts of assets
and liabilities at the date of the financial statements and the
reported amounts of net revenue and expenses during the reporting
period. On an ongoing basis, we evaluate our estimates, including
those related to our allowance for doubtful accounts, inventory
reserves, goodwill and purchased intangible asset valuations, and
asset impairments. We base our estimates on historical experience
and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and
liabilities. Actual results may differ from these estimates under
different assumptions or conditions.
We believe the following critical accounting policies, among others,
affect the significant judgments and estimates we use in the
preparation of our consolidated financial statements:
21
Revenue Recognition
-------------------
We recognize product revenue when persuasive evidence of an
arrangement exists, the sales price is fixed, the service is
performed or products are shipped to customers, which is when title
and risk of loss transfers to the customers, and collectibility is
reasonably assured.
Allowance for Doubtful Accounts
-------------------------------
We evaluate the collectibility of our accounts receivable based on a
combination of factors. In circumstances where we are aware of a
specific customer's inability to meet its financial obligations to
us, we record a specific allowance to reduce the net receivable to
the amount we reasonably believe will be collected. For all other
customers, we record allowances for doubtful accounts based on the
length of time the receivables are past due, the prevailing business
environment and our historical experience. If the financial
condition of our customers were to deteriorate or if economic
conditions were to worsen, additional allowances may be required in
the future.
At September 30, 2004 our allowance for doubtful accounts was
$64,707 or 29.7% of gross receivables, compared to $51,500 or 19.8%
of gross receivables as of December 31, 2003. The increase in the
reserve as a percentage of gross receivable from prior period is the
result of a decrease in accounts receivable.
Inventory Valuation
-------------------
At each balance sheet date, we evaluate our ending inventories for
excess quantities and obsolescence. This evaluation includes
analyses of sales levels by product and projections of future
demand. If inventories on hand are in excess of forecasted demand,
we provide appropriate reserves for such excess inventory. If we
have previously recorded the value of such inventory determined to
be in excess of projected demand, or if we determine that inventory
is obsolete, we write off these inventories in the period the
determination is made. Remaining inventory balances are adjusted to
approximate the lower of our cost or market value. If future demand
or market conditions are less favorable than our projects,
additional inventory write-downs may be required, and would be
reflected in cost of revenues in the period the revision is made.
Valuation of Goodwill, Purchased Intangible Assets and
------------------------------------------------------
Long-Lived Assets
-----------------
We perform goodwill impairment tests on an annual basis and on an
interim basis if an event or circumstance indicates that it is more
likely than not that impairment has occurred. We assess the
impairment of other amortizable intangible assets and long-lived
assets whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors we consider important
that could trigger an impairment review include significant
22
underperformance to historical or projected operating results,
substantial changes in our business strategy and significant
negative industry or economic trends. If such indicators are
present, we evaluate the fair value of the goodwill. For other
intangible assets and long-lived assets we determine whether the sum
of the estimated undiscounted cash flows attributable to the assets
in question is less than their caring value. If less, we recognize
an impairment loss based on the excess of the carrying amount of the
assets over their respective fair values. Fair value of goodwill is
determined by using a valuation model based on market
capitalization. Fair value of other intangible assets and long-lived
assets is determined by future cash flows, appraisals or other
methods. If the long-lived asset determined to be impaired is to be
held and used, we recognize an impairment charge to the extent the
anticipated net cash flows attributable to the asset are less than
the asset's carrying value. The fair value of the long-lived asset
then becomes the asset's new carrying value, which we depreciate
over the remaining estimated useful life of the asset.
Recent Accounting Pronouncements
--------------------------------
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN
46"), "Consolidation of Variable Interest Entities." In general, a
variable interest entity is a corporation, partnership, trust, or
any other legal structure used for business purposes that either (a)
does not have equity investors with voting rights or (b) has equity
investors that do not provide sufficient financial resources for the
entity to support its activities. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of
the entity if the investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at
risk for the entity to finance its activities without additional
subordinated financial support from other parties. The consolidation
requirements of FIN 46 apply immediately to variable interest
entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or
interim period beginning after December 15, 2003. Certain of the
disclosure requirements apply in all financial statements issued
after January 31, 2003, regardless of when the variable interest
entity was established. The adoption of this statement has had no
effect on the Company's financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities" ("SFAS No.
149"). SFAS No. 149 amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under FASB Statement No.
133, Accounting for Derivative Instruments and Hedging Activities.
This Statement requires that contracts with comparable
characteristics be accounted for consistently as either derivatives
or hybrid instruments. This Statement is effective for contracts
entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. The adoption of this
statement has had no effect on our financial statements.
23
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity." SFAS No. 150 changes the accounting for certain financial
instruments that under previous guidance issuers could account for
as equity. It requires that those instruments be classified as
liabilities in balance sheets. The guidance in SFAS No. 150 is
generally effective for all financial instruments entered into or
modified after May 31, 2003, and otherwise is effective on July 1,
2003. The adoption of this statement has had no effect on our
financial statements.
A. Results of Operations:
----------------------
Three-Month Period Ended September 30, 2004 Compared to the
-----------------------------------------------------------
Three-Month Period Ended September 30, 2003
-------------------------------------------
Revenues
Total revenues increased to $642,995 for the three-month period
ended September 30, 2004 from $552,596 for the three-month period
ended September 30, 2003 due to an increase in the dollar amount of
the awarded contracts to USCL and SRC and its subsidiaries.
Product sales income increased to $385,711 for the three-month
period ended September 30, 2004 from $268,591 for the three-month
period ended September 30, 2003 due to an increase in the dollar
amount of the awarded contracts to USCL and SRC and its
subsidiaries.
Service fee income decreased to $215,364 for the three-month period
ended September 30, 2004 from $244,413 for the three-month period
ended September 30, 2003 due to the loss of certain maintenance
contracts by ECI.
Internet related income increased to $41,920 for the three-month
period ended September 30, 2004 from $39,592 for the three-month
period ended September 30, 2003 as the operations of our subsidiary,
CareerEngine, Inc. have appeared to stabilized although we have
relatively small operations within the e-recruiting industry.
Cost of Goods Sold
Costs of goods sold, which relates to product sales and related
service fee income increased for the three-month period ended
September 30, 2004 ($300,574) as compared to the three-month period
ended September 30, 2003 ($294,863) due to the increase in related
revenues.
24
Other Expenses
Total other expenses decreased to $677,492 for the three-month
period ended September 30, 2004 from $805,908 for the three-month
period ended September 30, 2003 as certain cost reduction
initiatives were instituted in the three-month period ended
September 31, 2004 that were not instituted in the three month
period ended September 30, 2003.
Advertising expenses modestly decreased to $5,909 for the
three-month period ended September 30, 2004 from $6,591 for the
three-month period ended September 30, 2003 as we decreased our
attendance at industry trade shows. These expenditures relate to the
acquired operations of USCL and SRC and its subsidiaries.
Compensation and related costs decreased to $207,324 for the
three-month period ended September 30, 2004 from $387,467 for the
three-month period ended September 30, 2003 as we instituted certain
payroll reduction initiatives in 2004 and certain payroll related
accruals were reversed as they were deemed unnecessary due to the
termination of certain officers in September, 2004.
General and administrative expenses decreased to $322,507 for the
three-month period ended September 30, 2004 from $341,657 for the
three-month period ended September 30, 2003 due to the decreased use
of professional services in the operations of the Company.
Product development expenses increased to $92,904 for the
three-month period ended September 30, 2004 from nil for the
three-month period ended September 30, 2003 due to certain
initiatives commenced by USCL and SRC and its subsidiaries to
develop products to meet our customers' future requirements.
Depreciation and amortization expenses decreased to $48,848 for the
three-month period ended September 30, 2004 from $70,193 for the
three-month period ended September 30, 2003, due to the net effect
of the depreciation and amortization expense relating to the
relatively long-life fixed assets and intellectual property rights
associated with the acquisition of SRC and its subsidiaries in the
three-month period ended September 30, 2004, and the depreciation of
certain short-life assets of the Company that remained in the
three-month period ended September 30, 2003.
Other Items
Amortization of debt discount decreased to $24,963 for the
three-month period ended September 30, 2004 from $175,750 for the
three-month period ended September 30, 2003 due to the change in the
monthly rate of amortization of the debt discount ($699,000) related
to the 10% subordinated notes issued on April 23, 2003 from $58,250
to $8,321. The change in the amortization rate was caused
25
by the extension of the maturity date of the notes from April 30,
2004 to April 30, 2005.
Interest expense increased to $110,757 for the three-month period
ended September 30, 2004 from $82,320 for the three-month period
ended September 30, 2003 due primarily to the use, by SRC and its
subsidiaries of accounts receivable financing commonly referred to
as factoring. Factoring when utilized has a annual interest rate in
excess of 36%.
Tax Settlement adjustment of $895,622 relates to the 2003 accepted
and paid Offer in Compromise with the Internal Revenue Service
($50,000) pertaining to a $945,000 tax liability of a subsidiary of
the Company.
Operating Loss
On a pre-tax basis, we had a loss from continuing operations of
$470,514 for the three-month period ended September 30, 2004
compared with income from continuing operations of $89,377 for the
three-month period ended September 30, 2003. This change is due to
the effect of the tax settlement adjustment in 2003 offset by
start-up expenses associated with the acquisition of SRC
Technologies, Inc. and its subsidiaries and the related private
financings in 2003.
Our loss from continuing operations for the three-month period ended
September 30, 2004 was $470,514 compared with income from continuing
operations of $89,377 for the three-month period ended September 30,
2003. This change is due to the effect of the tax settlement
adjustment in 2003 offset by start-up expenses associated with the
acquisition of SRC Technologies, Inc. and its subsidiaries and the
related private financings in 2003. For the three-month period ended
September 30, 2004, loss per common share from continuing
operations, basic and diluted, was $.04 per share. For the
three-month period ended September 30, 2003, income per common share
from continuing operations, basic and diluted, was $.01 per share.
Our income from discontinued operations for the three-month period
ended September 30, 2004 was nil compared with income of $533,634
from discontinued operations for the three-month period ended
September 30, 2003 due to a gain on the sale of a subsidiary of the
Company. For the three-month period ended September 30, 2003, income
per common share from discontinued operations, basic and diluted,
was $.07 per share.
Our net loss for the three-month period ended September 30, 2004 was
$470,514 compared with net income of $623,011 for the three-month
period ended September 30, 2003. For the three-month period ended
September 30, 2004, net loss per common share, basic and diluted,
was $.04 per share. For the three-month period ended September 30,
2003, net income per common share, basic and diluted, was $.08 per
share.
26
Nine-Month Period Ended September 30, 2004 Compared to the
----------------------------------------------------------
Nine-Month Period Ended September 30, 2003
------------------------------------------
Revenues
Total revenues increased to $2,176,255 for the nine-month period
ended September 30, 2004 from $1,157,066 for the nine-month period
ended September 30, 2003 as we had nine months of activity and an
increase in the dollar amount of contracts awarded to USCL and SRC
and its subsidiaries in the nine months ended September 30, 2004
compared to only five months of activity of USCL and SRC and its
subsidiaries in the nine months ended September 30, 2003.
Product sales income increased to $1,279,111 for the nine-month
period ended September 30, 2004 from $624,684 for the nine-month
period ended September 30, 2003 as we had nine months of activity of
USCL and SRC and its subsidiaries in the nine months ended September
30, 2004 compared to only five months of activity of USCL and SRC
and its subsidiaries in the nine months ended September 30, 2003.
Service fee income increased to $798,017 for the nine-month period
ended September 30, 2004 from $412,932 for the nine-month period
ended September 30, 2003 as we had nine months of activity of USCL
and SRC and its subsidiaries in the nine months ended September 30,
2004 compared to only five months of activity of USCL and SRC and
its subsidiaries in the nine months ended September 30, 2003.
Internet related income decreased to $99,127 for the nine-month
period ended September 30, 2004 from $119,450 for the nine-month
period ended September 30, 2003 as the operations of our subsidiary,
CareerEngine, Inc. have continued to decline due to our relatively
small size in the e-recruiting industry.
Cost of Goods Sold
Costs of goods sold, which relates to product sales and related
service fee income increased to $1,085,889 for the nine-month period
ended September 30, 2004 from $573,216 for the nine-month period
ended September 30, 2003 as we had nine months of activity of SRC
and its subsidiaries in the nine months ended September 30, 2004
compared to only five months of activity of SRC and its subsidiaries
in the six months ended September 30, 2003.
Other Expenses
Total other expenses increased to $2,333,276 for the nine-month
period ended September 30, 2004 from $1,688,225 for the nine-month
period ended September 30, 2003 as we had nine months of activity of
USCL and SRC and its subsidiaries in the nine months ended September
30, 2004 compared to only five months of activity of USCL and SRC
and its subsidiaries in the nine months ended September 30, 2003.
27
Advertising expenses increased to $42,837 for the nine-month period
ended September 30, 2004 from $23,682 for the nine-month period
ended September 30, 2003 as we had nine months of activity of USCL
and SRC and its subsidiaries in the nine months ended September 30,
2004 compared to only five months of activity of USCL and SRC and
its subsidiaries in the nine months ended June 30, 2003.
Compensation and related costs increased to $1,028,916 for the
nine-month period ended September 30, 2004 from $791,402 for the
nine-month period ended September 30, 2003 as we had nine months of
activity of USCL and SRC and its subsidiaries in the nine months
ended September 30, 2004 compared to only five months of activity of
USCL and SRC and its subsidiaries in the nine months ended September
30, 2003.
General and administrative expenses increased to $985,806 for the
nine-month period ended September 30, 2004 from $779,678 for the
nine-month period ended September 30, 2003 due to the costs
associated with the acquisition and related operations of USCL and
SRC and its subsidiaries, and the professional fees associated the
significantly increased operations of the Company.
Product development expenses increased to $130,513 for the
nine-month period ended September 30, 2004 from nil for the
nine-month period ended September 30, 2003 due to certain
initiatives commenced by USCL and SRC and its subsidiaries to
develop products to meet our customers' future requirements.
Depreciation and amortization expenses increased to $145,204 for the
nine-month period ended September 30, 2004 from $93,463 for the
nine-month period ended September 30, 2003, due to the net effect of
the depreciation and amortization expense relating to the relatively
long-life fixed assets and intellectual property rights associated
with the acquisition of USCL and SRC and its subsidiaries in the
nine-month period ended September 30, 2004, and the depreciation of
certain short-life assets of the Company that remained in the
nine-month period ended September 30, 2003.
Other Items
Amortization of debt discount decreased to $174,747 for the
nine-month period ended September 30, 2004 from $292,250 for the
nine-month period ended September 30, 2003 due the combined effect
of (i) an increase in the amortization period to nine months in the
nine-month period ended September 30, 2004 from five months in the
nine-month period ended September 30, 2003 as the notes were issued
in late April 2003, and (ii) the decrease in the rate of
amortization in the nine-month period ended September 30, 2004 as
compared to the rate of amortization utilized in the nine-month
period ended September 30, 2003 when the notes were extended for an
additional year in March 2004 .
28
Interest expense decreased to $278,099 for the nine-month period
ended September 30, 2004 from $319,163 for the nine-month period
ended September 30, 2003 due primarily to the combined effect of the
issuance of the Company's 10% and 8% subordinated notes in April
2003, the cessation of interest expense on a subsidiary's 12%
Debentures Payable and Tax Assessment Payable in July and August
2003, and the conversion of $1,000,000 of 8% Promissory Notes to
preferred stock in July, 2003.
Tax Settlement adjustment of $895,622 relates to the accepted and
paid Offer in Compromise with the Internal Revenue Service ($50,000)
pertaining to a $945,000 tax liability of a subsidiary of the
Company.
Operating Loss
On a pre-tax basis, we had a loss from continuing operations of
$1,695,180 for the nine-month period ended September 30, 2004
compared with a loss from continuing operations of $820,166 for the
nine-month period ended September 30, 2003. This change is due to
the effect of the tax settlement adjustment in 2003 offset by
start-up expenses associated with the acquisition of SRC
Technologies, Inc. and its subsidiaries and the related private
financings in 2003.
Our loss from continuing operations for the nine-month period ended
September 30, 2004 was $1,695,180 compared with our loss from
continuing operations of $820,166 for the nine-month period ended
September 30, 2003. This change is due to the effect of the tax
settlement adjustment in 2003 offset by start-up expenses associated
with the acquisition of SRC Technologies, Inc. and its subsidiaries
and the related private financings in 2003. For the nine-month
period ended September 30, 2004, loss per common share from
continuing operations, basic and diluted, was $.16 per share. For
the nine-month period ended September 30, 2003, loss per common
share from continuing operations, basic and diluted, was $.12 per
share.
Our income from discontinued operations for the nine-month period
ended September 30, 2004 was nil compared with income of $533,634
from discontinued operations for the nine-month period ended
September 30, 2003 due to a gain on the sale of a subsidiary of the
Company. For the nine-month period ended September 30, 2003, income
per common share from discontinued operations, basic and diluted,
was $.08 per share.
Our net loss for the nine-month period ended September 30, 2004 was
$1,695,180 compared with our net loss of $286,532 for the nine-month
period ended September 30, 2003. For the nine-month period ended
September 30, 2004, net loss per common share, basic and diluted,
was $.16 per share. For the nine-month period ended September 30,
2003, our net loss per common share, basic and diluted, was $.04 per
share.
B. Liquidity and Capital Resources
-------------------------------
29
The Company has incurred substantial losses, sustained substantial
cash outflows from operating activities and had a working capital
deficit at September 30, 2004 and December 31, 2003. The above
factors raise substantial doubt about the Company's ability to
continue as a going concern. The Company's continued existence
depends on its ability to obtain additional equity and/or debt
financing to fund its operations, financial obligations as they
become due, and ultimately to achieve profitable operations. The
Company is continuously in the process of raising additional
financing and has initiated a cost reduction strategy. At September
30, 2004 and December 31, 2003, management believed that the working
capital deficit, losses and negative cash flow will ultimately be
improved by (i) the acquisition and increased operations of SRC and
ECI, (ii) cost reduction strategies initiated in January and June
2004, and (iii) additional equity and debt financing activities in
addition to those set forth in the financial statements. On January
2, 2004, the Company received a notice dated December 31, 2003 from
the American Stock Exchange indicating that the Company had
demonstrated compliance with the requirement for continued listing
on the Exchange. As is the case for all listed issuers, the
Company's continued listing eligibility will be assessed on an
ongoing basis; however, during the year ending December 31, 2004,
the Company will be subject to additional scrutiny (as set forth in
Section 1009(h) of the AMEX Company Guide) as is the case for any
listed company that has regained compliance. There is no assurance
that the Company can obtain additional financing or achieve
profitable operations or generate positive cash flow.
Off-Balance Sheet Arrangements
------------------------------
At September 30, 2004 and December 31, 2003, the Company had no
off-balance sheet arrangements.
Operating Activities
--------------------
We utilized $1,021,523 of cash in operating activities during the
nine-month period ended September 30, 2004. We had a net loss of
1,695,180 during this period, which included an aggregate of
$383,158 of non-cash items, including depreciation and amortization,
amortization of debt discount, allowance for doubtful accounts and a
charge for the issuance of common stock of the Company for services.
In addition to the impact of non-cash items, our operating
activities for the nine-month period ended September 30, 2004 also
reflected an increase in inventory and accounts payable, accrued
expenses and other liabilities, and a decrease in accounts
receivable and other assets.
We utilized $1,114,894 of cash in operating activities during the
nine-month period ended September 30, 2003. We had a net loss of
$286,532 during this period which included depreciation and
amortization, non-cash items, amounting to $93,463. In addition to
the impact of non-cash items, our operating activities for the
nine-month period ended September 30, 2003 also reflected an
increase in deferred grant revenue and a decrease in accounts
receivable, inventory, prepaid expenses, and accounts payable,
accrued expenses and other liabilities.
30
On January 21, 2004, we took several initiatives to address our
operating cash deficiency, which included, but were not limited to,
the reduction and/or elimination of certain executive salaries,
waiving of certain interest payments due officers and/or directors,
waiving of certain accounts receivable due an officer and employee,
and the reduction of certain administrative costs. In addition, we
raised (a) gross proceeds of $700,000 (net cash proceeds of
$571,000) in February 2004 from the sale of our common stock (see
"Financing Activities" below), (b) restructured (i) certain
short-term credit arrangements into a $300,000 Note payable due in
February 2005 (see Note A to our Consolidated Financial Statements)
and (ii) a certain line of credit into a $150,000 secured note
payable, (c) raised $150,000 through the issuance of our 25% Secured
Notes in July and August 2004, and (d) raised $150,000 through the
issuance of our 10% Convertible Subordinated Notes and related Class
C warrants in October 2004.
Financing Activities
--------------------
On April 23, 2003, we issued $1,000,000 in principal amount of our
10% Subordinated Notes due April 30, 2004 to investors for a 15%
non-dilutive interest in the Company in the form of 4,165,800
cashless Class B Warrants, each to purchase one share of Common
Stock at $0.50 per share. We had the option to extend the maturity
date of the notes to April 30, 2005 in consideration for issuing the
noteholders an additional 4% non-dilutive interest in the Company.
The notes also require prepayment in an amount equal to 100% of any
net financing proceeds obtained by us after the issuance of the
notes. The noteholders waived this provision to the extent of
$2,000,000 through April 15, 2004, of which $1,200,000 was raised.
The investors included two of our officers. Interest is payable, in
arrears, calendar quarterly. We valued the Warrants, utilizing the
Black-Scholes Pricing Model, at $699,000, which is being accounted
for as debt discount and is being amortized ratably over the initial
one-year term of the Notes.
On March 12, 2004, we notified the Class B Warrant holders that, to
satisfy the 15% non-dilutive provisions of their Warrants, these
Warrants were now exercisable for an aggregate of 5,245,200 shares
of our common stock at approximately $0.40 per share. On this date,
we also exercised our option to extend the maturity date of the
notes to April 30, 2005 and satisfied the requirement for the
additional 4% non-dilutive interest in the Company by issuing to the
noteholders Class B Warrants to purchase an additional 1,708,900
shares of our common stock at $0.50 per share. The non-dilutive
provisions of the Warrants terminate when all of the notes have been
paid in full.
In addition, on September 17, 2003, we sold 1,250,000 shares of our
common stock at $0.40 per share to an existing noteholder and
stockholder of the Company.
31
On February 10, 2004, the Company sold 1,750,000 shares of our
common stock at $0.40 per share in consideration of $700,000 cash
(net cash proceeds of $571,000).
In June 2004, in an effort to conserve the financial resources of
the Company, the Board of Directors of the Company deferred 100% of
the salaries of four officers of the Company until such time as the
Board deems otherwise. In September 2004, three of the
aforementioned officers were terminated by the Company.
On June 28, 2004 the Company repaid, in full, one of its outstanding
lines of credit amounting to approximately $146,000. On the same
date the Company issued a secured note payable to an officer and
employee of a subsidiary of the Company in the amount of $150,000.
The note is secured by the equipment of a subsidiary of the Company.
The note bears interest at 10% per annum and the principal and all
interest thereon is due September 28, 2004. The Company is currently
negotiating new terms with regard to this note.
As of July 1, 2004, 80% of the holders of the Company's 10%
subordinated notes agreed to defer $20,000 of interest due on such
date to October 1, 2004 in consideration of the Company issuing to
them 153,846 Class B Warrants of the Company, each to give the
holder thereof the right to purchase a share of common stock at
$0.39 per share. As of October 1, 2004, 75% of the holders of the
Company's 10% subordinated notes agreed to defer $18,750 of interest
deferred to October 1, 2004 to January 1, 2005 in consideration of
the Company issuing to them an additional 170,455 Class B Warrants
of the Company, each to give the holder thereof the right to
purchase a share of common stock at $0.33 per share. The noteholders
include two officers of the Company.
In July and August 2004, the Company issued $150,000 of its 24%
Secured Notes due April 30, 2005 to the wife of the Chief Executive
Officer and an existing 10% subordinated noteholder of the Company.
Interest on the notes is payable quarterly in arrears. The notes are
secured by (i) all the stock of SRC and USCL, and (ii) the pledge of
Patent Nos. 6,060,979, 6,047,173 and 5,701,338 -all owned by the
Company. On October 1, 2004, 100% of the holders of the Company's
24% Secured Notes agreed to defer $5,786 of interest due on such
date to January 1, 2005 in consideration of the Company issuing to
them 76,712 Class B Warrants of the Company, each to give the holder
thereof the right to purchase a share of common stock at $0.33 per
share.
As of October 1, 2004, 75% of the holders of the Company's 10%
subordinated notes agreed to defer $18,750 of interest due on such
date to January 1, 2005 in consideration of the Company issuing to
them 170,455 Class B Warrants of the Company, each to give the
holder thereof the right to purchase a share of common stock at
$0.33 per share. The noteholders include two officers of the
Company.
In October 2004, the Company and USCL entered into a two-year
Project Financing Agreement with an institutional lender relating to
USCL's anticipated participation in the "Cellular Call Box Upgrade
and Maintenance Service"
32
projects for numerous Service Authority for Freeway Emergencies
("SAFE") programs within the state of California. These call box
programs operate over 17,000 motorist aid analog call boxes that
will require upgrades to digital cellular technology available
through USCL. This agreement provides the Company with finished
goods and accounts receivable financing of up to $2,000,000 relating
to these potential aforementioned projects. The effective interest
rate is approximately 3% per month on the outstanding balance of the
amount financed. The finished goods and accounts receivable to be
financed, as well as all the other assets of the Company not
previously pledged, will secure the borrowings under this agreement.
In October and November 2004, the Company issued (i) $125,000 of its
10% Convertible Subordinated Notes due June 30, 2005 and (ii)
787,500 Class C Warrants of the Company, each to give the holder
thereof the right to purchase a share of common stock at $0.50 per
share. The notes were sold to the wife of the Chief Executive
Officer of the Company and other accredited investors and are
convertible by the holder, at any time, into common stock of the
Company at $0.50 per share. The warrants expire on April 30, 2013.
Interest on the notes is payable monthly in arrears.
We are using the funds obtained from these financings to pay certain
ECI notes payable and for working capital. The financings were
effected pursuant to the exemption from the registration provisions
of the Securities Act of 1993 provided by Section 4(2) thereof.
We did not have any material commitments for capital expenditures as
of September 30, 2004.
C. Inflation
---------
Due to the nature of our business, inflation does not significantly
impact the Company's operations.
Item 3. Controls and Procedures
The Chief Executive Officer and Chief Financial Officer of the
Company have conducted an evaluation of the effectiveness of
disclosure controls and procedures pursuant to Rule 13a-14 of the
Exchange Act. Based on that evaluation, they have concluded that the
Company's disclosure controls and procedures are effective in
ensuring that all material information required to be filed in this
Quarterly Report on Form 10-QSB has been made known to them in a
timely fashion. There have been no significant changes in internal
controls, or in other factors that could significantly affect
internal controls, subsequent to the date they completed their
evaluation.
33
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is a party to various vendor related litigations. Based
on the opinion of management and legal counsel, the Company has
accrued an estimated liability of approximately $100,000.
On August 19, 2004, Michael J. Gutowski, then the Company's
President and Chief Operating Officer and a director, and Larry M.
Reid, then the Company's Executive Vice President and a director,
informed the Company that their employment contracts may have been
breached. On August 27, 2004, Messrs. Gutowski and Reid filed suit
against the Company in the United States District Court, Southern
District of Florida, alleging that (i) their employment contracts
have been breached and (ii) certain future compensation relating
thereto to be paid to them amounting up to an aggregate of
$1,003,000 has been accelerated. The name of the case is Michael J.
Gutowski and Larry M. Reid v. CNE Group, Inc., Case Number 04-61125.
The Company does not believe that it has committed any breach of
these agreements and, accordingly, has not incurred the claims that
these officers are alleging. In addition, the Company believes that
Messrs. Gutowski and Reid have committed violations of their
employment agreements and have taken other actions that have damaged
the Company. The Company has filed a defense to this action and
asserted appropriate counterclaims. This litigation is ongoing and
no amounts have been accrued as of September 30, 2004 related to
this matter. Since the institution of this litigation Messrs.
Gutowski and Reid have been terminated as officers, directors and
employees of the Company's subsidiaries and as officers and
employees of the Company, and have been removed as members of the
Company's Executive Committee. They currently remain as directors of
the Company.
On October 5, 2004, Carol L. Gutowski, then an officer of one of the
Company's subsidiaries and a former director of the Company,
instituted a suit against the subsidiary in the Circuit Court, 17th
Judicial Circuit, Broward County, Florida, charging a breach of her
employment agreement with the subsidiary and claiming that certain
future compensation relating thereto to be paid to her from the
subsidiary amounting up to an aggregate of $274,000 has been
accelerated. Since the institution of this litigation Ms. Gutowski
has been terminated as an officer and director of the subsidiary.
The Company does not believe that its subsidiary has committed any
breach of this agreement and, accordingly, has not incurred the
claims that Ms. Gutowski is alleging. The Company has named Ms.
Gutowski as a counterclaim defendant in the litigation pending in
federal court referred to above and has asserted certain claims
against her in that action. The subsidiary has filed an answer to
this action. This litigation is ongoing and no amounts have been
accrued as of September 30, 2004 related to this matter.
34
Item 5. Other Information.
On April 28, 2004, the Company's Board of Directors approved the
Company's Code of Business Conduct and Ethics for the Directors,
Officers and Employees of CNE Group, Inc. (the "Code"). The Company
has posted the Code on its corporate website: www.cnegroupinc.com.
--------------------
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
31.1 Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 from the Company's Chief
Executive Officer
31.2 Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 from the Company's Chief
Financial Officer
32.1 Certification of the Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
A statement regarding the computation of per share
earnings is omitted because the computation is described
in Note B of the Notes to Consolidated Financial
Statements (Unaudited) in this Form 10-QSB.
(b) Reports on Form 8-K:
The Company filed a report on Form 8-K on February 10, 2004
and two reports on Form 8-K on June 14, 2004, a report on Form
8-K on July 9, 2004 and a report on Form 8-K on September 13,
2004.
35
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CNE GROUP, INC.
/s/ George W. Benoit
Date: November 22, 2004 -----------------------------------------
George W. Benoit, Chairman of the Board
of Directors, and Chief Executive
Officer
/s/ Anthony S. Conigliaro
-----------------------------------------
Date: November 22, 2004 Anthony S. Conigliaro, Vice President and
Chief Financial Officer
36