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 June 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 July 31, 2004
----- ----------------------------
Common stock - par value $.00001 10,640,915 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 six months ended June
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
June 30, December 31,
2004 2003
------------ ------------
(Unaudited)
ASSETS
Current:
Cash and cash equivalents $ 51,592 $ 460,832
Accounts receivable, net of allowance for doubtful
accounts of $64,707 in 2004 and $51,500 in 2003 280,165 208,358
Inventory 315,132 246,719
Other 10,459 27,840
------------ ------------
Total current assets 657,348 943,749
Fixed assets, net 438,585 447,579
Intellectual property rights, net 1,418,547 1,475,145
Goodwill 7,285,894 7,285,894
Other assets 18,961 18,961
------------ ------------
Total assets $ 9,819,335 $ 10,171,328
============ ============
LIABILITIES
Current:
Accounts payable and accrued expenses $ 1,235,381 $ 1,030,203
Short-term credit arrangements 68,504 210,093
Notes payable 190,422 146,988
Debenture payable 100,000 100,000
------------ ------------
Total current liabilities 1,594,307 1,487,284
Notes payable, net of current portion 331,921 326,045
Subordinated notes payable 916,784 1,767,000
Deferred revenue 22,610 23,620
Deferred grant revenue 300,000 300,000
------------ ------------
Total liabilities 3,165,622 3,903,949
------------ ------------
Commitments and contingencies (Note 1)
STOCKHOLDERS' EQUITY
Preferred stock (Note D) 134 124
Common stock (Note E) 119 101
Paid-in surplus 29,869,187 28,258,215
Accumulated deficit (20,342,627) (19,117,961)
------------ ------------
9,526,813 9,140,479
Less treasury stock, at cost - 1,238,656 shares (2,873,100) (2,873,100)
------------ ------------
Total stockholders' equity 6,653,713 6,267,379
------------ ------------
Total liabilities and stockholders' equity $ 9,819,335 $ 10,171,328
============ ============
See Notes to Consolidated Financial Statements.
2
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Three Months Six Months
Ended June 30, Ended June 30,
------------------------------ ------------------------------
2004 2003 2004 2003
------------ ----------- ------------ -----------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Revenues:
Product sales $ 261,962 $ 356,093 $ 893,400 $ 356,093
Service fee income 262,518 168,519 582,653 168,519
Internet related income 25,838 34,819 57,207 79,858
------------ ----------- ------------ -----------
550,318 559,431 1,533,260 604,470
Cost of goods sold 281,616 278,353 785,315 278,353
------------ ----------- ------------ -----------
Gross profit 268,702 281,078 747,945 326,117
------------ ----------- ------------ -----------
Other expenses:
Advertising 12,208 17,091 36,928 17,091
Compensation and related costs 453,030 313,704 821,592 403,935
General and administrative 363,083 340,419 663,299 438,021
Product development 31,368 -- 37,609 --
Depreciation and amortization 48,857 11,083 96,356 23,270
------------ ----------- ------------ -----------
908,546 682,297 1,655,784 882,317
------------ ----------- ------------ -----------
Loss before other income (expenses) (639,844) (401,219) (907,839) (556,200)
Other income (expenses):
Amortization of debt discount (24,963) (116,500) (149,784) (116,500)
Interest expense (86,460) (148,901) (167,342) (236,843)
Interest income 155 -- 299 --
------------ ----------- ------------ -----------
Loss before provision for income taxes (751,112) (666,620) (1,224,666) (909,543)
Provision for income taxes -- -- -- --
------------ ----------- ------------ -----------
Net loss $ (751,112) $ (666,620) $ (1,224,666) $ (909,543)
============ =========== ============ ===========
Loss per common share - basic and diluted: $ (.07) $ (.10) $ (.12) $ (.15)
============ =========== ============ ===========
Weighted average number of common
shares outstanding - basic and diluted: 10,640,915 6,490,920 10,349,248 6,040,932
============ =========== ============ ===========
See Notes to Consolidated Financial Statements.
3
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Six Months Ended June 30,
-----------------------------
2004 2003
----------- -----------
(Unaudited) (Unaudited)
Cash flows from operating activities:
Net loss $(1,224,666) $ (909,543)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 96,356 23,270
Provision for doubtful accounts 13,207
Issuance of common stock for services -- 81,250
Amortization of debt discount 149,784 116,500
Changes in:
Accounts receivable (85,014) 42,727
Inventory (68,413) 8,600
Prepaid expenses and other assets 17,381 (10,584)
Accounts payable, accrued expenses and other liabilities 247,404 8,642
----------- -----------
Net cash used in operating activities (853,961) (639,138)
----------- -----------
Cash flows from investing activities:
Purchase of furniture and equipment (30,764) (17,013)
----------- -----------
Net cash used in investing activities (30,764) (17,013)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of 10% subordinated notes payable -- 1,000,000
Net proceeds from issuance of 1,750,000 shares of common stock 571,000 --
Proceeds from issuance of 10% notes payable - other 150,000 --
Principal repayments on notes payable - other (245,515) (110,000)
Payment of accounts receivable due Sellers of Econo-Comm, Inc. -- (100,000)
----------- -----------
Net cash provided by financing activities 475,485 790,000
----------- -----------
Increase (decrease) in cash and cash equivalents (409,240) 133,849
Cash and cash equivalents at beginning of period 460,832 183,200
----------- -----------
Cash and cash equivalents at end of period $ 51,592 $ 317,049
=========== ===========
See Notes to Consolidated Financial Statements.
4
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, continued
Six Months Ended June 30,
-----------------------------
2004 2003
----------- -----------
(Unaudited) (Unaudited)
Supplemental disclosures of cash flow information related to
continuing operations:
Cash paid during the period for:
Interest $ 137,861 $ 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, and forgiveness of interest indebtedness to an officer and an employee of
the Company:
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 (9)
Paid in surplus (1,039,990) (6,048,075)
See Notes to Consolidated Financial Statements.
5
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 subsidiary is SRC Technologies, Inc. ("SRC"). SRC, also a holding
company, is the parent of Connectivity, Inc. ("Connectivity"), Econo-Comm, Inc.
("ECI") (d/b/a Mobile Communications), and U.S. Commlink, Ltd. ("USCL").
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. SRC 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 June 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 June 30, 2004, management believes that the working
capital deficit, losses and negative cash flow will ultimately be improved by
(i) the acquisitions of SRC and ECI and (ii) cost reduction strategies initiated
in January 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
6
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 is using 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 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.
6. 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 which is included in compensation and related costs
7
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE A - THE COMPANY (CONTINUED)
7. 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. The noteholders included two officers of the
Company.
8. 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. The accompanying financial statements include
the accrued salaries owed to these officers for the amounts so
deferred.
The Company is using the funds obtained from these financings primarily
for working capital purposes as well as to pay certain ECI notes payable.
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:
June 30, December 31,
2004 2003
-------- ------------
Raw materials $286,632 $158,347
Work in progress 28,500 3,089
Finished goods -- 85,283
-------- --------
Total $315,132 $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
six month periods ended June 30, 2004 and 2003, respectively. Common stock
equivalents to purchase common stock of the Company that were outstanding
at June 30, 2004 and June 30, 2003 were not included in the computation of
diluted net loss per share as their effect would have been anti-dilutive.
[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
8
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 June 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.
Six Month Period
Ended June 30,
-----------------------------
2004 2003
----------- -----------
Net loss, as reported $(1,224,666) $ (909,543)
Less, Total stock-based employee compensation
expense determined under fair value-based method for
all awards, net of related tax effects (168,280) --
----------- -----------
Pro forma net loss $(1,392,946) $ (909,543)
=========== ===========
Net loss per share - basic and diluted:
As reported $ (0.12) $ (0.15)
=========== ===========
Pro forma $ (0.13) $ (0.15)
=========== ===========
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
9
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 April 30, 2003 (435,000), November 4, 2003 (220,000), November
21, 2003 (100,000) and January 21, 2004 (295,500), non-qualified stock
options to purchase an aggregate 1,050,500 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 FIN 46R which revised certain elements of
FIN 46. 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 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.
10
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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:
June 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.
11
CNE GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE E - COMMON STOCK
Common Stock consists of the following:
June 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 11,879,571 10,129,571
Less, Treasury shares (1,238,656) (1,238,656)
----------- -----------
Issued and outstanding number of shares 10,640,915 8,890,915
=========== ===========
NOTE F - WARRANTS
Outstanding warrants to acquire common stock of the Company consists of:
June 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 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 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
---------- ----------
20,295,441 17,746,141
========== ==========
(1) Class B warrants and Units of a subsidiary of the Company are exercisable
for the Company's common shares.
12
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 six-month periods ended June
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 Six Months Ended
June 30, 2003 June 30, 2003
------------------ ----------------
Unaudited Unaudited
Revenues $ 673,251 $ 1,201,933
Expenses 1,522,113 2,694,324
----------- -----------
Pro forma net loss $ (848,862) $(1,492,391)
=========== ===========
Pro forma net loss per share:
Basic and diluted $ (0.13) $ (0.15)
=========== ===========
NOTE H - STOCK OPTION PLANS
At June 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
13
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, 2003, 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 April 30, 2003 (435,000), November 4, 2003
(220,000), November 21, 2003 (100,000) and January 21, 2004 (295,500),
non-qualified stock options to purchase an aggregate 1,050,500 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 six-month period ended June 30, 2004, under the
2003 Stock Incentive Plan is summarized as follows:
Six-Month Period Ended June 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 601,000 295,500 $ 0.50
Options cancelled (420,000) -- $ 0.50
--------- ---------
Options outstanding
at June 30, 2004 3,118,500 1,050,500 $ .97
========= =========
Options available
at June 30, 2004 5,831,000 $ 1.09
=========
14
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 June 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 4,169,000 $ .97 8.31 5,831,000 $ 1.09
Note I - CONTINGENCIES
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
which could cause the acceleration of certain future compensation relating
thereto amounting up to an aggregate of $1,003,000. The Company does not believe
that it has committed any breach of these agreements and, accordingly, has not
incurred the claims that these officers may be asserting.
15
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 subsidiary is SRC. SRC, also a holding company, is the parent
of Connectivity, ECI, and US Commlink. 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 and ECI.
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 such 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 each currently an executive officer 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 executive officers, 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 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.
16
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
sellers of the assets we acquired prior to the acquisition transactions.
17
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:
18
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 June 30, 2004 our allowance for doubtful accounts was $64,707 or 18.8% of
gross receivables, compared to $51,500 or 19.8% of gross receivables as of
December 31, 2003. The decrease in the reserve as a percentage of gross
receivable from prior period is the result of a increase in accounts receivable
and a decrease in the need for an allowance for doubtful accounts.
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
19
we consider important that could trigger an impairment review include
significant 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.
20
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 June 30, 2004 Compared to the Three-Month Period
Ended June 30, 2003
Revenues
Total revenues decreased to $550,318 for the three-month period ended June
30, 2004 from $559,431 for the three-month period ended June 30, 2003 due
to a reduction of the contracts awarded to SRC and its subsidiaries.
Product sales income decreased to $261,962 for the three-month period
ended June 30, 2004 from $356,093 for the three-month period ended June
30, 2003 due to a reduction of the contracts awarded to SRC and its
subsidiaries.
Service fee income increased to $262,518 for the three-month period ended
June 30, 2004 from $168,519 for the three-month period ended June 30, 2003
as we had we had three months of activity of SRC and its subsidiaries in
the six months ended June 30, 2004 compared to only two months of activity
of SRC and its subsidiaries in the six months ended June 30, 2003.
Internet related income decreased to $25,838 for the three-month period
ended June 30, 2004 from $34,819 for the three-month period ended June 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 did not change substantially for the three-month period ended
June 30, 2004 ($281,616) as compared to the three-month period ended June
30, 2003 ($278,353).
21
Other Expenses
Total other expenses increased to $908,546 for the three-month period
ended June 30, 2004 from $682,297 for the three-month period ended June
30, 2003 as we had we had three months of activity of SRC and its
subsidiaries in the six months ended June 30, 2004 compared to only two
months of activity of SRC and its subsidiaries in the six months ended
June 30, 2003.
Advertising expenses modestly decreased to $12,208 for the three-month
period ended June 30, 2004 from $17,091 for the three-month period ended
June 30, 2003 as we decreased our attendance at industry trade shows.
These expenditures relate to the acquired operations of SRC and its
subsidiaries.
Compensation and related costs increased to $453,030 for the three-month
period ended June 30, 2004 from $313,704 for the three-month period ended
June 30, 2003 as we had we had three months of activity of SRC and its
subsidiaries in the six months ended June 30, 2004 compared to only two
months of activity of SRC and its subsidiaries in the six months ended
June 30, 2003.
General and administrative expenses increased to $363,083 for the
three-month period ended June 30, 2004 from $340,419 for the three-month
period ended June 30, 2003 due to the costs associated with the
acquisition and related operations of SRC and its subsidiaries, and the
professional fees associated the significantly increased operations of the
Company.
Product development expenses increased to $31,368 for the three-month
period ended June 30, 2004 from nil for the three-month period ended June
30, 2003 due to certain initiatives commenced by SRC and its subsidiaries
to develop products to meet our customers' future requirements.
Depreciation and amortization expenses increased to $48,857 for the
three-month period ended June 30, 2004 from $11,083 for the three-month
period ended June 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 June 30, 2004, and the
depreciation of certain short-life assets of the Company that remained in
the three-month period ended June 30, 2003.
Other Items
Amortization of debt discount decreased to $24,963 for the three-month
period ended June 30, 2004 from $116,500 for the three-month period ended
June 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 by the extension of the maturity date of the notes from April
30, 2004 to April 30, 2005.
22
Interest expense decreased to $86,460 for the three-month period ended
June 30, 2004 from $148,901 for the three-month period ended June 30, 2003
due primarily to the net effect of the issuance of the Company's 10% and
8% subordinated notes in April 2003 and the cessation of interest expense
on a subsidiary's 12% Debentures Payable and Tax Assessment Payable in
July and August 2003.
Operating Loss
On a pre-tax basis, we had a net loss before income taxes of $751,112 for
the three-month period ended June 30, 2004 compared with a net loss before
income taxes of $666,620 for the three-month period ended June 30, 2003.
Our net loss for the three-month period ended June 30, 2004 was $751,112
compared with a net loss of $666,620 for the three-month period ended June
30, 2003. For the three-month period ended June 30, 2004, net loss per
common share, basic and diluted, was $0.07 per share. For the three-month
period ended June 30, 2003, net loss per common share, basic and diluted,
was $0.10 per share.
Six-Month Period Ended June 30, 2004 Compared to the Six-Month Period
Ended June 30, 2003
Revenues
Total revenues increased to $1,533,260 for the six-month period ended June
30, 2004 from $604,470 for the six-month period ended June 30, 2003 as we
had six months of activity of SRC and its subsidiaries in the six months
ended June 30, 2004 compared to only two months of activity of SRC and its
subsidiaries in the six months ended June 30, 2003.
Product sales income increased to $893,400 for the six-month period ended
June 30, 2004 from $356,093 for the six-month period ended June 30, 2003
as we had six months of activity of SRC and its subsidiaries in the six
months ended June 30, 2004 compared to only two months of activity of SRC
and its subsidiaries in the six months ended June 30, 2003.
Service fee income increased to $582,653 for the six-month period ended
June 30, 2004 from $168,519 for the six-month period ended June 30, 2003
as we had six months of activity of SRC and its subsidiaries in the six
months ended June 30, 2004 compared to only two months of activity of SRC
and its subsidiaries in the six months ended June 30, 2003.
Internet related income decreased to $57,207 for the six-month period
ended June 30, 2004 from $79,858 for the six-month period ended June 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.
23
Cost of Goods Sold
Costs of goods sold, which relates to product sales and related service
fee income increased to $785,315 for the six-month period ended June 30,
2004 from $278,353 for the six-month period ended June 30, 2003 as we had
six months of activity of SRC and its subsidiaries in the six months ended
June 30, 2004 compared to only two months of activity of SRC and its
subsidiaries in the six months ended June 30, 2003.
Other Expenses
Total other expenses increased to $1,655,784 for the six-month period
ended June 30, 2004 from $882,317 for the six-month period ended June 30,
2003 as we had six months of activity of SRC and its subsidiaries in the
six months ended June 30, 2004 compared to only two months of activity of
SRC and its subsidiaries in the six months ended June 30, 2003.
Advertising expenses increased to $36,928 for the six-month period ended
June 30, 2004 from $17,091 for the six-month period ended June 30, 2003 as
we had six months of activity of SRC and its subsidiaries in the six
months ended June 30, 2004 compared to only two months of activity of SRC
and its subsidiaries in the six months ended June 30, 2003.
Compensation and related costs increased to $821,592 for the six-month
period ended June 30, 2004 from $403,935 for the six-month period ended
June 30, 2003 as we had six months of activity of SRC and its subsidiaries
in the six months ended June 30, 2004 compared to only two months of
activity of SRC and its subsidiaries in the six months ended June 30,
2003.
General and administrative expenses increased to $663,299 for the
six-month period ended June 30, 2004 from $438,021 for the six-month
period ended June 30, 2003 due to the costs associated with the
acquisition and related operations of SRC and its subsidiaries, and the
professional fees associated the significantly increased operations of the
Company.
Product development expenses increased to $37,609 for the six-month period
ended June 30, 2004 from nil for the six-month period ended June 30, 2003
due to certain initiatives commenced by SRC and its subsidiaries to
develop products to meet our customers' future requirements.
Depreciation and amortization expenses increased to $96,356 for the
six-month period ended June 30, 2004 from $23,270 for the six-month period
ended June 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 six-month period ended June 30, 2004, and the
depreciation of certain short-life assets of the Company that remained in
the six-month period ended June 30, 2003.
24
Other Items
Amortization of debt discount increased to $149,784 for the six-month
period ended June 30, 2004 from $116,500 for the six-month period ended
June 30, 2003 due the combined effect of an increased period of time that
the amortization of the debt discount ($699,000), relating to the 10%
subordinated notes issued in April 2003, pertained and the change in the
rate of amortization when the notes were extended for an additional year
in March 2004.
Interest expense decreased to $167,342 for the six-month period ended June
30, 2004 from $236,843 for the six-month period ended June 30, 2003 due
primarily to the net effect of the issuance of the Company's 10% and 8%
subordinated notes in April 2003 and the cessation of interest expense on
a subsidiary's 12% Debentures Payable and Tax Assessment Payable in July
and August 2003.
Operating Loss
On a pre-tax basis, we had a net loss before income taxes of $1,224,666
for the six-month period ended June 30, 2004 compared with a net loss
before income taxes of $909,543 for the six-month period ended June 30,
2003.
Our net loss for the six-month period ended June 30, 2004 was $1,224,666
compared with a net loss of $909,543 for the six-month period ended June
30, 2003. For the six-month period ended June 30, 2004, net loss per
common share, basic and diluted, was $0.12 per share. For the six-month
period ended June 30, 2003, net loss per common share, basic and diluted,
was $0.15 per share.
B. Liquidity and Capital Resources
The Company has incurred substantial losses, sustained substantial cash
outflows from operating activities and had a working capital deficit at
June 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 June 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 acquisitions of
SRC and ECI, (ii) cost reduction strategies initiated in January 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
25
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 June 30, 2004 and December 31, 2003, the Company had no off-balance
sheet arrangements.
Operating Activities
We utilized $853,961 of cash in operating activities during the six-month
period ended June 30, 2004. We had a net loss of $1,224,666 during this
period, which included an aggregate of $172,347 of non-cash items,
including depreciation and amortization, amortization of debt discount and
allowance for doubtful accounts. In addition to the impact of non-cash
items, our operating activities for the six-month period ended June 30,
2004 also reflected an increase in accounts receivable, inventory, and
accrued expenses and other liabilities, and a decrease in prepaid expenses
and other assets.
We utilized $639,138 of cash in operating activities during the six-month
period ended June 30, 2003. We had a net loss of $909,543 during this
period which included depreciation, a non-cash item, amounting to $23,270.
In addition to the impact of non-cash items, our operating activities for
the six-month period ended June 30, 2003 also reflected an increase in
accounts receivable and inventory, and a decrease in prepaid expenses and
other assets, and accrued expenses and other liabilities.
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 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), and 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.
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
26
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.
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).
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
June 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.
27
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.
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 and a report on
Form 8-K on July 9, 2004.
28
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: August 14, 2004 George W. Benoit, Chairman of the Board
of Directors, and Chief Executive
Officer
/s/ Anthony S. Conigliaro
-----------------------------------------
Date: August 14, 2004 Anthony S. Conigliaro, Vice President and
Chief Financial Officer
29