U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB/A
(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, 2005
------------------
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.)
255 West 36th Street, Suite 800, New York, N.Y. 10018
-----------------------------------------------------
(Address of Principal Executive Offices)
212-300-2112
------------
(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
--- ---
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
--- ---
The number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
Class Outstanding at November 1, 2005
----- -------------------------------
Common stock - par value $.00001 12,374,248 shares
-------------------------------- -----------------
PART I
FINANCIAL INFORMATION
Item l. Financial Statements.
1
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheet
September 30, December 31,
2005 2004
------------------------------
(Unaudited)
ASSETS
Current:
Cash and cash equivalents $ 79,641 $ 84,408
Accounts receivable, net of allowance for doubtful
accounts of $66,000 in 2005 and $51,000 in 2004 250,541 172,010
Inventory 466,477 260,487
Other current assets 9,642 8,273
------------- -------------
Total current assets 806,301 525,178
Fixed assets, net 315,099 394,509
Intellectual property rights, net 1,312,140 1,361,948
Goodwill 7,285,894 7,285,894
Marketing and distribution agreement 125,000,000
Other assets 21,265
------------- -------------
Total assets $ 134,719,434 9,588,794
============= =============
LIABILITIES
Current:
Accounts payable and accrued expenses $ 2,330,43 $ 1,476,124
Interest payable 250,481 128,050
Short-term credit arrangements -- 191,395
Line of credit -- 19,199
Current portion of notes payable 12,148 17,243
Due to related party 1,282,918 --
Notes and debenture payable 502,455 850,000
10% subordinated notes payable 1,300,000 966,710
12% Debentures payable 100,000 --
Tax assessment payable 7,500 --
Senior secured note payable due to related party 124,649,990
Other notes payable -- 23,330
------------- -------------
Total current liabilities 130,435,926 3,672,051
Notes payable, net of current portion -- 22,059
Deferred grant revenue -- 300,000
------------- -------------
Total liabilities 130,435,926 3,994,110
------------- -------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock 145 134
Common stock 127 121
Paid-in surplus 30,243,169 29,919,185
Accumulated deficit (23,086,833) (21,451,656)
------------- -------------
7,156,608 8,467,784
Less treasury stock, at cost - 1,238,656 shares (2,873,100) (2,873,100)
------------- -------------
Total stockholders' equity 4,283,508 5,594,684
------------- -------------
Total liabilities and stockholders' equity $ 134,719,434 $ 9,588,794
============= =============
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,
------------------------------------------------------------
2005 2004 2005 2004
------------------------------------------------------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Revenues:
Product sales $ 288,628 $ 385,711 $ 801,589 $ 1,279,111
Service fee income 170,327 215,364 522,741 798,017
Internet related income 12,750 41,920 77,703 99,127
------------------------------------------------------------
471,705 642,995 1,402,033 2,176,255
Cost of goods sold 72,298 300,574 400,167 1,085,889
------------------------------------------------------------
Gross profit 399,407 342,421 1,001,866 1,090,366
Other expenses:
Advertising 19,257 5,909 53,542 42,837
Compensation and related costs (65,340) 207,324 335,947 1,028,916
Organizational costs 36,860 36,860
General and administrative 1,759,692 322,507 2,219,384 985,806
Product development 92,904 130,513
Depreciation and amortization 17,269 48,848 114,816 145,204
------------------------------------------------------------
1,767,738 677,492 2,760,549 2,333,276
Loss before other income (expenses) (1,368,331) (335,071) (1,758,683) (1,242,910)
Other income (expenses):
Amortization of debt discount -- (24,963) (33,290) (174,747)
Grant income -- -- 300,000 --
Gain on sale of subsidiary 341 -- 341 --
Interest expense (9,444) (110,757) (143,569) (278,099)
Interest income (67) 277 24 576
------------------------------------------------------------
(9,170) (135,443) 123,506 (452,270)
------------------------------------------------------------
(1,377,501) (470,514) (1,635,177) (1,695,180)
Provision for income taxes -- -- -- --
------------------------------------------------------------
Net loss
$ (1,377,501) $ (470,514) $ (1,635,177) $ (1,695,180)
============================================================
Loss per common share - basic and diluted: $ (0.12) $ (0.04) $ (0.15) $ (0.16)
============================================================
Weighted average number of common
shares outstanding - basic and diluted: 11,640,915 10,640,915 11,263,137 10,349,260
============================================================
See Notes to Consolidated Financial Statements.
3
CNE GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Nine Months Ended September 30,
-------------------------------
2005 2004
-------------------------------
(Unaudited) (Unaudited)
Cash flows from operating activities:
Net loss $(1,635,177) $(1,695,180)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 114,816 145,204
Provision for doubtful accounts 15,000 13,207
Issuance of common stock for services 54,000 50,000
Amortization of debt discount 33,290 174,747
Changes in:
Accounts receivable (93,531) 42,249
Inventory (205,990) (109,439)
Prepaid expenses and other assets 69,704 11,003
Accounts payable, accrued expenses and deferred grant revenue 643,453 346,686
----------------------------
Net cash used in operating activities (1,004,435) (1,021,523)
Cash flows from investing activities:
Purchase of furniture and equipment (35,406) (30,224)
Net cash used in investing activities (35,406) (30,224)
Cash flows from financing activities:
Proceeds from issuance of Series G Preferred Stock 220,000 --
Proceeds from sale of 333,333 shares of restricted common stock 50,000 --
Proceeds from short-term credit arrangements (191,396) 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)
Due to related party 956,470 --
Principal repayments on notes payable - other -- (404,655)
Net cash provided by financing activities 1,035,074 642,617
Increase (decrease) in cash and cash equivalents (4,767) (409,130)
Cash and cash equivalents at beginning of period 84,408 460,832
Cash and cash equivalents at end of period 79,641 51,702
Supplemental disclosures of cash flow information related to continuing
operations:
Cash paid during the period for:
Interest $ 16,666 $ 212,769
============================
Income taxes $ -- $ --
============================
Non-cash investing and financing activities relating to conversion of debt
to preferred stock, and forgiveness of interest indebtedness to an officer
and an employee of the Company:
Interest payable -- 40,000
============================
8% notes payable -- 1,000,000
============================
Issuance of preferred stock, at par -- (10)
============================
Issuance of common stock, at par -- (2)
============================
Paid in surplus -- (1,089,988)
============================
Purchase of marketing and distribution agreement in exchange for senior
secured note payable due to related party:
Marketing and distribution agreement asset $125,000,000.00 $ --
============================
Liability for senior secured note payable $125,000,000.00 $ --
Less: Deferred transaction costs 350,010.00 --
----------------------------
Net senior secured note payable $124,649,990.00 $ --
============================
Advances made by related party and disbursed on behalf of the
Company:
Operating expenses paid by related party $932,908.00 $ --
Deferred transaction costs paid by related party 350,010 --
----------------------------
Amount due to related party $ 1,282,918 $ --
============================
See Notes to Consolidated Financial Statements.
4
NOTE A - THE COMPANY
The following consolidated financial statements of CNE Group, Inc. and
subsidiaries (collectively referred to as the "Company or "CNE," 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, 2004, which was filed with the Securities and Exchange
Commission.
The results of operations for the three months ended September 30, 2005 are not
necessarily indicative of the results to be expected for the entire fiscal year.
Business
--------
CNE Group, Inc. is a holding company whose primary operating subsidiaries, as of
September 30, 2005, were SRC Technologies, Inc. ("SRC"), U.S. Commlink, Ltd.
("USCL") and Arrow Resources Development, Ltd. ("Arrow") SRC, also a holding
company, is the parent of Connectivity, Inc. ("Connectivity") and Econo-Comm,
Inc. (d/b/a Mobile Communications) ("ECI"). 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. On
November 3, 2005, the Company sold SRC and USCL pursuant to transactions
described in Note J - Subsequent Events.
Arrow, a development stage enterprise, was incorporated in Bermuda 0n May 20,
2005. It intends to provide marketing and distribution services for lumber
products pursuant to a marketing and distribution agreement with Arrow Pacific
Resources PNG Ltd ("PNG"), an affiliate of Arrow Pacific Resources (s) Pte. Ltd.
("APR"). See Note E below.
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 accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company has incurred substantial
losses, sustained substantial operating cash outflows and has a working capital
deficit at both September 30, 2005 and December 31, 2004. 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. There is no assurance that the Company can obtain
additional financing or achieve profitable operations or generate positive cash
flow. The 2005 and 2004 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.
5
NOTE A - THE COMPANY (CONTINUED)
Private Financings
------------------
1. On or about April 1, 2005, two individuals, both of whom are adult
children of the Company's Chief Executive Officer, purchased 545,000
shares of the Company's Series G Preferred Stock at a price of $0.20
per share. The Series G Preferred Stock is non voting, has no
liquidating preference over the Common Stock and each share is
automatically convertible into two shares of Common Stock when such
conversion has been approved by the Company's Common Stockholders.
2. On or about April 12, 2005, four individuals, three of whom are
adult children or related thereto of the Company's Chief Executive
Officer, purchased 500,000 shares of the Company's Series G
Preferred Stock at a price of $0.20 per share.
3. On or about April 20, 2005, an individual purchased 100,000 shares
of the Company's Series G Preferred Stock at a price of $0.20 per
share.
On November 3, 2005, the Company exchanged all of its Series G Preferred Stock
pursuant to transactions described in Note J - Subsequent Events.
American Stock Exchange Listing
-------------------------------
On August 25, 2005 the Company's common stock was suspended from trading on the
American Stock Exchange and delisted on September 26, 2005. It now trades on the
over the counter Bulletin Board.
6
NOTE A - THE COMPANY (CONTINUED)
At September 30, 2005, our Stockholders' Equity was approximately $4,283,508,
our current assets were $806,301, and our current liabilities were $130,435,926
that primarily included a note payable in the principal amount of $125,000,000
due from our subsidiary, Arrow, to Empire Advisory, LLC. and notes to
noteholders, who include certain of our current and former directors. On
November 2, 2005, we satisfied Arrow's note to Empire by issuing Empire
10,000,000 shares of our Series AAA Preferred Stock and satisfied the other
notes in exchange for shares of our common stock pursuant to transactions
described in Note J - Subsequent Events.
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,
2005 2004
-------- ---------
Raw materials $ 390,669 $ 242,061
Work in progress 73,308 15,926
Finished goods 2,500 2,500
--------- ---------
Total $ 466,477 $ 260,487
========= =========
[2] Fair value of financial instruments:
For financial statement instruments, including cash, accounts and accrued
expenses payable and amounts due to Empire Advisory, LLC. the carrying
amounts approximated fair value because of their short maturity.
[3] Use of estimates:
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
[4] Accounting basis:
The Company uses the accrual basis of accounting for financial statement
reporting. Accordingly revenues are recognized when services are rendered
and expenses realized when the obligation is incurred.
[5] 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
month periods ended September 30, 2005 and 2004. Common Stock equivalents
to purchase Common Stock of the Company that were outstanding at September
30, 2005 and 2004 were not included in the computation of diluted net loss
per share as their effect would have been anti-dilutive.
7
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[6] 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, 2005 and December 31, 2004, the Company had a stock-based
employee compensation plan - the 2003 Plan.
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,
--------------------------
2005 2004
----------- -----------
Net loss, as reported $(1,635,177) $(1,695,180)
----------- -----------
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 $(1,635,177) $(1,941,610)
=========== ===========
Net loss per share - basic and diluted:
As reported $ (0.15) $ (0.16)
=========== ===========
Pro forma $ (0.15) $ (0.18)
=========== ===========
On May 10, 2005, pursuant to a litigation Settlement Agreement the Company
tendered an aggregate of 850,000 shares of the Company's Common Stock to
three former officers and directors in exchange for all of their (i)
incentive stock
8
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
options (1,550,000), (ii) Series AA Preferred Stock (1,000,000), (iii)
Series A Preferred Stock (305,336) and related Class A Warrants (305,336),
and (iv) Series C Preferred Stock (4,867,937) and related Class C Warrants
(4,867,937). On or about July 9, 2005, they delivered those securities
required to be delivered by the settlement agreement to the Company. The
Company subsequently retired these securities.
[7] Recent accounting pronouncements:
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity.
SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as
equity. SFAS No. 150 is effective for financial instruments entered into
or modified after May 31, 2003. The Company adopted this standard during
2003 and the adoption did not have an impact on the Company's consolidated
financial statements in 2004 or 2003.During December 2004, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 153, Exchanges of
Nonmonetary Assets -- An Amendment of APB Opinion No. 29. APB Opinion No.
29, Accounting for Nonmonetary Transactions ("APB 29") required that
nonmonetary exchanges be accounted for at fair value, subject to certain
exceptions. SFAS 153 has removed the exception for nonmonetary exchanges
of similar productive assets, and replaced it with an exception for
exchanges that lack commercial substance. The provisions of SFAS 153 are
effective prospectively for all nonmonetary asset exchanges in fiscal
periods beginning after June 15, 2004. The adoption of this standard did
not have an impact on the Company's consolidated financial statements in
2005 and 2004.
During December 2004, FASB issued SFAS No. 123 (Revised 2004), Share-Based
Payment ("SFAS 123R"). SFAS 123R replaces SFAS No. 123, Accounting for
Stock-Based Compensation (SFAS 123), and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. SFAS 123R requires companies to
recognize the compensation cost related to share-based
9
NOTE B - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
payment transactions with employees in the financial statements. The
compensation cost is measured based upon the fair value of the instrument
issued. Share-based compensation transactions with employees covered
within SFAS 123R include share options, restricted share plans,
performance-based awards, share appreciation rights, and employee share
purchase plans. SFAS 123 included a fair-value-based method of accounting
for share-based payment transactions with employees, but allowed companies
to continue to apply the guidance in APB 25 provided that they disclose in
the footnotes to the financial statements the pro forma net income if the
fair-value-based method been applied. The Company is currently reporting
share-based payment transactions with employees in accordance with APB 25
and provides the required disclosures. SFAS 123R will be effective for the
Company beginning January 1, 2006.
In implementing SFAS 123R the Company will apply the modified prospective
application transition method. The modified prospective application
transition method requires the application of this standard to:
o All new awards issued after the effective date;
o All modifications, repurchased or cancellations of existing
awards after the effective date; and
o Unvested awards at the effective date.
For unvested awards, the compensation cost related to the remaining
"requisite service' that has not been rendered at the effective date will
be determined by the compensation cost calculated currently for either
recognition or pro forma disclosures under SFAS 123. The Company will be
adopting the modified prospective application of SFAS 123R.
NOTE C - RESTRUCTURING OF CERTAIN NOTES PAYABLE
As of September 30, 2005, the Company's (i) 10% Subordinated Notes amounting to
$1,000,000, (ii) 18% Promissory Note amounting to $300,000, (iii) 10% Secured
Note amounting to $150,000, and (iv) 24% Secured Notes amounting to $150,000,
were all due and payable. Unpaid interest relating to these notes amounting to
approximately $220,000 was also due and payable. On November 2, 2005, we
satisfied these notes in exchange for shares of our common stock pursuant to
transactions described in Note J - Subsequent Events.
NOTE D - LITIGATION
The Company is a party to various vendor related litigations. Management has
accrued a liability of approximately $100,000 and, accordingly, this liability
has been reflected in accounts payable and accrued expenses.
NOTE E - AGREEMENT AND PLAN OF MERGER BETWEEN ARROW RESOURCES DEVELOPMENT, LTD.
AND CNE GROUP, INC.
On August 1, 2005, the Company entered into an agreement (the "Merger
Agreement") with PNG and Arrow, pursuant to which, among other things, the
Company would merge with Arrow and issue non-voting shares of Series AAA
Preferred Stock to PNG. This stock would automatically convert into an aggregate
of 624 million shares of the Company's Common Stock, which would equal 96% of
the Company's outstanding shares of Common Stock when the Company's stockholders
approved the conversion and an increase in the number of shares of Common Stock
the Company is authorized to issue so that the conversion could be effected.
10
Arrow had initially been formed by the Company in anticipation of issuing 97% of
its stock to PNG in consideration for the execution of a marketing and
distribution agreement (the "Marketing Agreement") between Arrow and PNG and its
affiliated companies, and distributing the 3% balance of Arrow's stock to the
Company's stockholders. Pursuant to the Marketing Agreement, the term of which
would extend through July 31, 2103, PNG would retain Arrow to act as the
exclusive worldwide marketer and distributor for all of its timber and
derivative products. It would provide for Arrow to retain 10% of the gross sales
generated by all plantation operations from all resources and all derivative
products, such as paper, pulp and chips.
On or about July 12, 2005, the Company began discussions with representatives of
PNG and APR, the parent of PNG, to modify the transaction with PNG, APR and
their affiliates so that Arrow would merge directly into the Company. These
discussions led to the execution of the Merger Agreement.
On August 1, 2005, Arrow entered into the Marketing Agreement with APR and its
subsidiaries in consideration for Arrow issuing a non-interest bearing note (the
"Note") in the principal amount of $125,000,000 to Empire Advisory, LLC,
("Empire"), due on or before December 31, 2005. Empire is APR's merchant banker.
The Note permitted the Company, as Arrow's sole stockholder, to cause Arrow to
repay it in cash or with 10,000,000 shares of the Company's non-voting Series
AAA Preferred Stock.
After the Merger Agreement was executed the parties determined to change the
form but not the substance of the transaction. Rather than merging the Company
and Arrow, the parties agreed that, subject to the Company receiving an
independent valuation of the Marketing Agreement and audited financial
statements of Arrow acceptable to it, the Company, instead of merging with
Arrow, would satisfy the Note by issuing to Empire 10 million shares of voting,
instead of non-voting, Series AAA Preferred Stock. Each share of this stock
would grant the holder thereof the right to cast 62.4 votes, which, together
with all other shares of Series AAA Preferred Stock, would constitute an
aggregate of 96% of all votes on all matters brought before the Company's
stockholders for a vote. The Company received the valuation and the financial
statements and, on November 2, 2005, satisfied Arrow's $125,000,000 note to
Empire by issuing Empire 10 million shares of Series AAA Preferred Stock.
NOTE F - DEFERRED TRANSACTION COSTS
Arrow has incurred certain transactional costs in connection with the
transaction noted above in Note E. As of September 30, 2005, Arrow had totaling
$350,010 of deferred transaction costs. These costs include legal fees incurred
by both Arrow and the Company in contemplation of the planned transaction and
other offering costs incurred to Empire. As of September 30, 2005, these
deferred transaction costs have been offset against the transitional senior
notes payable by Arrow to Empire, since these costs will be deducted from the
proceeds received from the issuance of convertible preferred stock upon
successful consummation of the transaction described in Note E.
NOTE G - MARKETING AND DISTRIBUTION AGREEMENT AND RELATED TRANSACTIONAL SENIOR
NOTE PAYABLE DUE TO EMPIRE ADVISORY, LLC
11
As already discussed in August 2005, Arrow executed the Marketing Agreement.
This Agreement was valued at fair value as determined based on an independent
appraisal, which approximates the market value of 96% of the CNE's public stock
to be issued in the transaction.
The Marketing Agreement will be amortized over 99 years (the life of the
Agreement) once Arrow commences operations. As of September 30, 2005, the
Company had recorded a $125,000,000 amortizable intangible asset for this
agreement and a corresponding credit to the liability for the senior secured
note payable to Empire in the same amount (see Note E) pending success of the
transaction. No amortization of the agreement was taken during the period from
Arrow's inception (May 20, 2005) to September 30, 2005, as the relevant
operations had not yet commenced. Operations are expected to commence no later
than the first quarter of 2006.
The senior secured note payable is non-interest bearing and could be repaid in
cash or in the form of the Preferred Stock (See Note E). It was due on the
earlier of December 31, 2005 without further notice or on events of default as
defined therein. The senior secured note payable and any Preferred Stock issued
there under are considered restricted as to the sale thereof under SEC Rule 144
as unregistered securities. As noted above, the note was repaid by CNE issuing
10 million shares of its Series AAA Preferred Stock to Empire.
NOTE H - RELATED PARTY TRANSACTIONS
[1] Management Agreement with Empire Advisory, LLC
Effective August 1, 2005, Arrow entered into a Management Agreement with
Empire under which Empire provides chief executive officer and
administrative services to Arrow in exchange for a) an annual fee of
$300,000 for overhead expenses, b)$25,000 per month for rent, c)
$1,000,000 per annum (subject to increases in subsequent years) for
executive services, and d) a one-time fee of $150,000 for execution of the
proposed transaction.
As of September 30, 2005, Arrow had short-term borrowings of $1,282,918
due to Empire, consisting of working capital raised by Empire on behalf of
Arrow. These amounts are non-interest bearing and due on demand.
Peter Frugone is a member of Arrow's Board of Directors and is the owner
of Empire. It is anticipated that on November 22, 2005 he will become the
Company's Chief Executive Officer and a member of the Company's Board of
Directors.
"Consulting fees and services" charged in the "Statement of Operations"
for the period from inception (May 20, 2005) to September 30, 2005
incurred to Empire totaled $641,666.
[2] Engagement and Management Agreements entered into with individuals
affiliated with APR.
"Consulting fees and services" charged in the "Statement of Operations"
for the period from Arrow's inception (May 20, 2005) to September 30, 2005
incurred to Hans Karundeng and Rudolph Karundeng under "Engagement and
Management Agreements" totaled $532,877. In addition, as of September 30,
2005 Arrow owed them a total of $452,876. These agreements are discussed
in detail in Note I.
NOTE I - COMMITMENTS AND OTHER MATTERS
12
[1] Engagement and Management Agreements entered into with individuals
affiliated with APR.
Effective as of May 20, 2005, Arrow entered into an Engagement Agreement
with Hans Karundeng for business and financial consulting services for
fees of $1,000,000 per annum. The term of the agreement is five years.
Hans Karundeng is also a 43% owner of APR.
Effective as of August 1, 2005, Arrow entered into an Employment Agreement
with Rudolph Karundeng for his services as Chairman of the Board of Arrow
for fees of $1,000,000 per annum. The term of the agreement is five years.
Rudolph Karundeng is a son of Hans Karundeng. It is anticipated that on
November 22, 2005 he will the Company's Chief Operating Officer and a
member of the Company's Board of Directors
[2] Management Agreement with Empire Advisory, LLC
See Note H above.
-CONSULTING AGREEMENT
On May 11, 2005 the Company entered into a consulting Agreement with an
individual that included the issuance of 300,000 shares of its restricted
Common Stock and three-year warrants to purchase an aggregate of 250,000
shares at $0.46 per share, subject to appropriate anti-dilution
provisions. The individual has since returned the warrants to the Company
and they have been cancelled.
[3] 5 Year Table of obligations under [1] and [2] above:
The minimum future obligations for consulting fees and services under
agreements outlined in [1] and [2] are as follows:
Years Ending
September 30, Amounts
------------- -------
2006 $ 3,041,667
2007 3,302,083
2008 3,627,604
2009 4,034,505
2010 3,506,755
-----------
$17,512,614
===========
The Company also engages certain consultants to provide services including
management of the corporate citizenship program and investor relations services.
These agreements contain cancellation clauses with notice with periods ranging
from zero to sixty days.
NOTE J - SUBSEQUENT EVENTS
Background of the Transaction and Change in Control
13
On November 2, 2005, we issued 10,000,000 shares of our Series AAA
Preferred Stock to Empire in payment for the note in the principal amount of
$125,000,000 issued by Arrow. In connection therewith, Empire has agreed to pay
certain of our expenses, including expenses relating to this transaction,
aggregating approximately $350,000, of which approximately $70,000 has been paid
as of November 2, 2005, and the balance will be paid on or about November 22,
2005. George W. Benoit, our Chief Executive Officer, will be paid $60,000 of
this amount. Also on November 22, 2005, our current directors plan to resign and
appoint designees of the Preferred Stockholders to be the Company's directors.
Subsequent to September 30, 2005, we:
(i) exchanged all of our 1,392,630 shares of Series A Preferred Stock
for our common stock at the rate of one share of Preferred Stock for
one share of common stock and thereafter retired this Preferred
Stock;
(ii) purchased all of our 4,400 shares of Series B Preferred Stock for an
aggregate price of $20,000 and thereafter retired this Preferred
Stock;
(iii) exchanged all of our 1,145,000 Series G Preferred Stock at the rate
of one share of Preferred Stock for two shares of common stock and
thereafter retired this Preferred Stock;
(iv) exchanged all of our outstanding debt, exclusive of accrued but
unpaid salaries, directors' and professional fees and expenses, and
exclusive of the debt cancelled pursuant to a transaction described
below relating to the sale of one of SRC, in the aggregate amount of
approximately $1,370,000 for an aggregate of 2,837,533 shares of
common stock;
(v) issued 373,277 shares of common stock to independent contractors for
services they rendered to us;
(vi) except for the warrants and options referred to in the transaction
relating to the sale of our subsidiary, exchanged all of our
warrants and options for an aggregate of 6,275,772 shares of common
stock; and
(vii) executed mutual general releases with certain of our creditors
including, among others, our officers and directors, pursuant to
which all of our accrued but unpaid salaries, directors' and
professional fees and expenses in the aggregate amount of
approximately $1,350,000 were released.
Subsequent to September 30, 2005, we obtained releases from our current
directors and a former director, pursuant to which, for nominal consideration,
they have each released us from our obligation to pay him any accrued but unpaid
compensation, directors fees and/or advances, as the case may be, that we may
owe him. We have also released them from all actions we may have against them
except for those prohibited by applicable law. The following table sets for the
amounts that they have released:
Name Amount Released
---- ---------------
Joseph G. Anastasi $ 30,000
George W. Benoit $ 1,307,050
Anthony S. Conigliaro $ 223,333
Charles W. Currie $ 28,000
David W. Dube $ 35,000
Subsequent to September 30, 2005, we also entered into agreements with
Messrs. Anastasi, Benoit, Conigliaro, Currie and Dube, members of Mr. Benoit's
family, and Grace C. Lindblom and Frank Ciolli, each a beneficial owner of more
14
than 10% of our outstanding common stock at the time of the agreements, pursuant
to which we issued them our common stock in exchange for debt owed by us, Series
G Preferred Stock and/or options or warrants, each to purchase one share of our
common stock at various prices. We were paid $0.20 per share for the Series G
Preferred Stock. The following table sets forth certain information relating to
these transactions:
Name Consideration Exchanged Number of Shares Issued
---- ------------------------ -----------------------
Joseph G. Anastasi 25,000 options and $26,667 debt 116,894
George W. Benoit (1)(2)(4) 600,000 options 479,887
Maureen Benoit (1) 3,007,903 options and $515,000 debt 2,656,326
George W. Benoit, Jr. (2) 49,600 shares of preferred stock 496,000
Kevin J. Benoit (2)(3) 59,400 shares of preferred stock,
514,277 options and $56,667 debt 712,750
Frank Ciolli (3) 1,542,833 options and $181,625 debt 377,324
Anthony S. Conigliaro 1,314,277 warrants and
options and $56,667 debt 1,857,538
Charles W. Currie 25,000 options and $26,667 debt 112,639
David W. Dube 100,000 options 72,117
Grace C. Lindblom (3) 2,081,550 options and $250,000 debt 545,167
Anne B. Mullen (2) 22,913 shares of preferred stock 228,930
Michael Mullen (4) 8,000 shares of preferred stock 80,000
Nancy C. Zucco (2) 43,003 shares of preferred stock 430,230
---------------------------------
(1) Maureen Benoit is George W. Benoit's wife.
(2) This person is an adult childof George W. Benoit.
(3) This person was a holder of 10% or more of our common stock at the time of
the agreement.
(4) Mr. Mullen is George W. Benoit's son-in-law.
We issued all of our common stock in the transactions referred to in this
Note pursuant to the exemptions from the registration provisions of the
securities Act of 1933 provided by Sections 3(a)(9) and 4(2) thereof.
On November 3, 2005, we entered into an agreement with Gary L.. Eichsteadt, a
former director, Thomas L. Sullivan, a former executive officer, and David B.
Batzer pursuant to which we sold SRC and SRC-ECI, Inc., SRC's wholly-owned
subsidiary, and a patent associated with these businesses, to Messrs. Eichsteadt
and Sullivan in consideration for the cancellation of debt in the aggregate
amount of $50,000 we owed to Messrs. Eichsteadt and Sullivan, the cancellation
of debt in the aggregate amount of approximately $150,000 SRC owed to Mr.
Eichstead, the cancellation of debt in the aggregate amount of approximately
$300,000 SRC owed to Mr. Batzer, and the return to us by Messrs. Eichsteadt and
Sullivan of an aggregate of 1,000,000 shares of our Series AA Preferred Stock
and 4,867,938 shares of our Series C Preferred Stock and the return by Messrs.
Eichsteadt, Sullivan and Batcher of options and warrants to purchase an
aggregate of 486,000 shares of our common stock. We have since retired and/or
canceled all of the securities returned to us pursuant to this agreement. As
part of this transaction Mr. Eichsteadt resigned as a director. All inter
company debt was eliminated prior to closing.
15
On November 3, 2005, we entered into an agreement with USCL and Thomas Leyen
pursuant to which all inter company debt was eliminated prior to closing, and we
transferred USCL and two patents related to that business to Mr. Leyen and will
pay certain of USCL's obligations in the aggregate amount not to exceed $86,000
in consideration for Mr. Leyen canceling Options currently held by him to
purchase an aggregate of 300,000 shares of Common Stock.
16
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
General
-------
We are a holding company whose primary operating subsidiaries, as of
September 30, 2005, were SRC, US Commlink and Arrow Resources
Development, Ltd. SRC, also a holding company, is the parent of
Connectivity and ECI. On November 3, 2005, we sold SRC and US
Commlink. Arrow remains our primary operating subsidiary
On August 1, 2005, Arrow entered into a marketing and distribution
agreement (the "Marketing Agreement") with Arrow Pacific Resources
PNG Ltd. ("PNG"), an affiliate of Arrow Pacific Resources (S) Pte.
Ltd ("APR"). APR and PNG have represented to us that they and their
affiliated companies have initiated the commercial development of
timber resources and a eucalyptus plantation operation in Papua, New
Guinea. Pursuant to the Marketing Agreement Arrow will act as the
exclusive worldwide marketer and distributor for all of APR's timber
and derivative products. This Agreement terminates on July 31, 2103
unless sooner terminated or renewed in accordance with its terms.
APR has been granted a license by the government of Papua, New
Guinea for the development of plantation operations on more than
100,000 hectares of land and has entered into land leases with the
owners of this property. The license terminates in 2098. The
Marketing Agreement provides for Arrow to retain 10% of the gross
sales generated by all plantation operations from all resources and
all derivative products, such as paper, pulp and chips.
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 our operations.
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.
17
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:
Allowance for Doubtful Accounts, Revenue Recognition
----------------------------------------------------
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.
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.
At September 30, 2005, our allowance for doubtful accounts was
$66,000 for 20.8 % of gross receivables, compared to $51,000 or
22.9% of gross receivables as of December 31, 2004. The decrease in
the reserve as a percentage of gross receivables at September 30,
2005 as compared to December 31, 2004 is primarily the result a
decreased requirement for an allowance for doubtful accounts at
September 30, 2005 than at December 31, 2004.
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
------
18
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
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 May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity. SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an
issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). Many of those
instruments were previously classified as equity. SFAS No. 150 is
effective for financial instruments entered into or modified after
May 31, 2003. We adopted this standard during 2003 and the adoption
did not have an impact on our consolidated financial statements in
2005 or 2004.
During December 2004, the Financial Accounting Standards Board
("FASB") issued SFAS No. 153, Exchanges of Nonmonetary Assets -- An
Amendment of APB Opinion No. 29. APB Opinion No. 29, Accounting for
Nonmonetary Transactions ("APB 29") required that nonmonetary
exchanges be accounted for at fair value, subject to certain
exceptions. SFAS 153 has removed the exception for nonmonetary
exchanges of similar productive assets, and replaced it with an
exception for exchanges that lack commercial substance. The
provisions of SFAS 153 are effective prospectively for all
nonmonetary asset exchanges in fiscal periods beginning after June
15, 2004. The adoption of this standard did not have an impact on
our consolidated financial statements in 2005 or 2004.
19
During December 2004, FASB issued SFAS No. 123 (Revised 2004),
Share-Based Payment ("SFAS 123R"). SFAS 123R replaces SFAS No. 123,
Accounting for Stock-Based Compensation (SFAS 123), and supersedes
APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS
123R requires companies to recognize the compensation cost related
to share-based payment transactions with employees in the financial
statements. The compensation cost is measured based upon the fair
value of the instrument issued. Share-based compensation
transactions with employees covered within SFAS 123R include share
options, restricted share plans, performance-based awards, share
appreciation rights, and employee share purchase plans. SFAS 123
included a fair-value-based method of accounting for share-based
payment transactions with employees, but allowed companies to
continue to apply the guidance in APB 25 provided that they disclose
in the footnotes to the financial statements the pro forma net
income if the fair-value-based method been applied. We are currently
reporting share-based payment transactions with employees in
accordance with APB 25 and provides the required disclosures. SFAS
123R will be effective for us beginning January 1, 2006.
In implementing SFAS 123R we will apply the modified prospective
application transition method. The modified prospective application
transition method requires the application of this standard to:
o All new awards issued after the effective date;
o All modifications, repurchased or cancellations of
existing awards after the effective date; and
o Unvested awards at the effective date.
For unvested awards, the compensation cost related to the remaining
"requisite service' that has not been rendered at the effective date
will be determined by the compensation cost calculated currently for
either recognition or pro forma disclosures under SFAS 123. We will
be adopting the modified prospective application of SFAS 123R.
A. Results of Operations:
---------------------
Three-Month Period Ended September 30, 2005 Compared to the
--------------------------------------------------------------------
Three-Month Period Ended September 30, 2004
-------------------------------------------
Revenues
Total revenues were $471,705 for the three-month period ended
September 30, 2005 decreased from $642,995 for the three-month
period ended September 30, 2004 primarily due to a decrease of the
contracts awarded to Connectivity, ECI and Commlink.
20
Product sales income decreased to $288,628 for the three-month
period ended September 30, 2005 from $385,711 for the three-month
period ended September 30, 2004 primarily due to a reduction of the
contracts awarded to Connectivity, ECI and Commlink.
Service fee income decreased to $170,327 for the three-month period
ended September 30, 2005 from $215,364 for the three-month period
ended September 30, 2004 primarily due to a reduction of the
contracts awarded to Connectivity, ECI and Commlink.
Internet related income decreased to $12,750 for the three-month
period ended September 30, 2005 from $41,920 for the three-month
period ended September 30, 2004 as the operations of our subsidiary,
Career Engine, 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 decreased to $72,298 for the three-month period
ended September 30, 2005 from $300,574 for the three-month period
ended September 30, 2004 due to the related decrease in revenues.
Other Expenses
Total other expenses increased to $1,767,738 for the three-month
period ended September 30, 2005 from $677,497 for the three-month
period ended on September 30, 2004 due primarily to the activity of
our subsidiary, Arrow, a development stage company.
Advertising expenses increased to $19,257 for the three-month period
ended September 30, 2005 from $5,909 for the three-month period
ended September 30, 2004.
Compensation and related costs decreased to $65,340 for the
three-month period ended September 30, 2005 from $207,32 for the
three-month period ended September 30, 2004. We instituted certain
payroll reduction initiatives, primarily, the third quarter of 2004,
including the reduction of our executive personnel and the reversal
of previous accrued salaries.
General and administrative expenses increased to $1,759,692 for the
three-month period ended September 30, 2005 from $322,507 for the
three-month period ended September 30, 2004 due to the activity of
our subsidiary, Arrow.
Product development expenses decreased to nil for the three-month
period ended September 30, 2005 from $92,904 for the three-month
period ended September 30, 2004 due to the cessation of certain
initiatives commenced by Commlink and SRC and its subsidiaries to
develop products to meet our customers' future requirements.
21
Depreciation and amortization expenses decreased to $17,269 for the
three-month period ended September 30, 2005 from $48,857 for the
three-month period ended September 30, 2004
Other Items
Amortization of debt discount decreased to nil for the three-month
period ended September 30, 2005 from $24,963 for the three-month
period ended September 30, 2004 as the debt discount was fully
amortized at April 30, 2005. There was no amortization in the
three-month period September 30, 2005 as compared to the three-month
period ended September 30, 2004.
Interest expense decreased to $9,444 for the three-month period
ended September 30, 2005 from $110,751 for the three-month period
ended September 30, 2004 due primarily to a decrease in the use, by
SRC and its subsidiaries, of accounts receivable financing commonly
referred to as factoring. Factoring, when utilized, has an annual
interest rate in excess of 36%.
Operating Loss
On a pre-tax basis, we had a net loss before income taxes of
$1,377,501 for the three-month period ended September 30, 2005
compared with a net loss before income taxes of $470,514 for the
three-month period ended September 30, 2004.
Our net loss for the three-month period ended September 30, 2005 was
$1,377,501 compared with a net loss of $470,514 for the three-month
period ended September 30, 2004. For the three-month period ended
September 30, 2005, net loss per common share, basic and diluted,
was $0.12 per share. For the three-month period ended September 30,
2004, net loss per common share, basic and diluted, was $0.04 per
share.
Nine-Month Period Ended September 30, 2005 Compared to the
--------------------------------------------------------------------
Nine-Month Period Ended September 30, 2004
------------------------------------------
Revenues
Total revenues decreased to $1,402,033 for the nine-month period
ended September 30, 2005 from $2,176,205 for the month period ended
September 30, 2004 primarily due to a decrease in the dollar amount
of the contracts awarded to Connectivity, ECI and Commlink.
Product sales income decreased to $801,589 for the nine-month period
ended September 30, 2005 from $1,279,111 for the nine-month period
ended September 30, 2004 primarily due to a decrease in the dollar
amount of the contracts awarded to Connectivity, ECI and Commlink.
22
Service fee income decreased to $522,741 for the nine-month period
ended September 30, 2005 from $798,017 for the nine-month period
ended September 30, 2004 primarily due to a decrease in the dollar
amount of the contracts awarded to Connectivity, ECI and Commlink I.
Internet related income decreased to $77,703 for the nine-month
period ended September 30, 2005 from $99,127 for the month period
ended September 30, 2004 as the operations of our subsidiary,
CareerEngine, Inc., as the operations of our subsidiary, Career
Engine, 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 decreased to $400,167 for the nine-month period
ended September 30, 2005 from $1,085,889 for the nine-month period
ended September 30, 2004 due to the related decrease in revenues.
Other Expenses
Total other expenses increased to $2,760,549 for the nine-month
period ended September 30, 2005 from $2,333,276 for the month period
ended September 30, 2004 due primarily to the activity of our
subsidiary, Arrow.
Advertising expenses increased to $53,542 for the nine-month period
ended September 30, 2005 from $42,837 for the nine-month period
ended September 30, 2004. These expenditures relate to the
operations of Commlink and SRC and its subsidiaries.
Compensation and related costs decreased to $335,947 for the
nine-month period ended September 30, 2005 from $1,028,916 for the
nine-month period ended September 30, 2004. We instituted certain
payroll reduction initiatives, primarily, the third quarter of 2004,
including the reduction of our executive personnel.
Organization cost increased for the nine-month period ended
September 30, 2005 to $36,860 from nil for the nine-month period
ended September 30, 2004 due to the amortization related to our
subsidiary, Arrow.
General and administrative expenses increased to $2,219,386 for the
nine-month period ended September 30, 2005 from $985,806 for the
nine-month period ended September 30, 2004 due to activity of our
subsidiary, Arrow.
23
Product development expenses decreased to nil for the month period
ended September 30, 2005 from $130,513 for the nine-month period
ended September 30, 2004 due to the cessation of certain initiatives
commenced by Commlink, Conectivity and ECI to develop products to
meet our customers' future requirements.
Depreciation and amortization expenses decreased to $114,816 for the
nine-month period ended September 30, 2005 from $145,204 for the
nine-month period ended September 30, 2004.
Other Items
Amortization of debt discount decreased to $33,290 for the
nine-month period ended September 30, 2005 from $174,747 for the
nine-month period ended September 30, 2004 due the combined effect
of a decreased 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.
The debt discount was fully amortized on April 30, 2005.
Interest expense decreased to $143,569 for the nine-month period
ended September 30, 2005 from $278,099 for the nine-month period
ended September 30, 2004 due primarily to a decrease in the use, by
SRC and its subsidiaries, of accounts receivable financing commonly
referred to as factoring. Factoring, when utilized, has an annual
interest rate in excess of 36%.
Grant income increased to $300,000 for the nine-month period ended
September 30, 2005 from nil for the nine-month period ended
September 30, 2004 as the restrictions set forth in the grant have
expired.
Operating Loss
On a pre-tax basis, we had a net loss before income taxes of
$1,635,177 for the nine-month period ended September 30, 2005
compared with a net loss before income taxes of $1,695,180 for the
nine-month period ended September 30, 2004.
Our net loss for the nine-month period ended September 30, 2005 was
$1,635,177 compared with a net loss of $1,635,177 for the nine-month
period ended September 30, 2004. For the nine-month period ended
September 30, 2005, net loss per common share, basic and diluted,
was $0.15 per share. For the nine-month period ended September 30,
2004, net loss per common share, basic and diluted, was $0.16 per
share.
B. Liquidity and Capital Resources
-------------------------------
24
We have incurred substantial losses, sustained substantial cash
outflows from operating activities and had a working capital deficit
at September 30, 2005 and December 31, 2004. The above factors raise
substantial doubt about our ability to continue as a going concern.
Our continued existence depends on our ability to obtain additional
equity and/or debt financing to fund our operations, financial
obligations as they become due, and ultimately to achieve profitable
operations. There is no assurance that we can obtain additional
financing or achieve profitable operations or generate positive cash
flow. Our 2005 and 2004 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 ongoing
concern uncertainty..
On August 25, 2005, our common stock was suspended from trading on
the American Stock Exchange and delisted on September 26, 2005. It
now trades on the over the counter Bulletin Board.
At September 30, 2005, our Stockholders' Equity was approximately
$4,283,508, our current assets were $806,301, and our current
liabilities were $130,435,926 that primarily included a note payable
in the principal amount of $125,000,000 due from Arrow to Empire
Advisory, LLC. ("Empire") and notes to noteholders, who included
certain of our directors and officers. On November 2, 2005, we
satisfied Arrow's note to Empire by issuing Empire 10,000,000 shares
of our Series AAA Preferred Stock and we satisfied the other notes
by exchanging them for shares of our common stock pursuant to
transactions described below.
On August 1, 2005, we entered into an agreement (the "Merger
Agreement") with PNG and Arrow, pursuant to which, among other
things, we would merge with Arrow and issue non-voting shares of
Series AAA Preferred Stock to PNG. This stock would automatically
convert into an aggregate of 624 million shares of our Common Stock,
which would equal 96% of our outstanding shares of Common Stock when
our stockholders approved the conversion and an increase in the
number of shares of Common Stock we are authorized to issue so that
the conversion could be effected.
We had initially formed Arrow as a Bermuda corporation on May 20,
2005, in anticipation of issuing 97% of Arrow's stock to PNG in
consideration for the execution of the Marketing Agreement, and
distributing the 3% balance of Arrow's stock to our stockholders. On
or about July 12, 2005, we began discussions with representatives of
PNG and APR to modify the transaction with PNG, APR and their
affiliates so that we would merge directly with Arrow. These
discussions led to the execution of the Merger Agreement.
On August 1, 2005, Arrow entered into the Marketing Agreement with
APR and its subsidiaries in consideration for Arrow issuing a
non-interest bearing note (the "Note") in the principal amount of
$125,000,000 to Empire, due on or before December 31, 2005. Empire
is APR's merchant banker. The Note permitted us, as Arrow's sole
stockholder, to cause Arrow to repay it in cash or with 10,000,000
shares of the Company's non-voting Series AAA Preferred Stock.
25
After the Merger Agreement was executed the parties determined to
change the form but not the substance of the transaction. Rather
than merging us and Arrow, the parties agreed that, subject to our
receiving an independent valuation of the Marketing Agreement and
audited financial statements of Arrow acceptable to us, instead of
merging with Arrow, we would satisfy the Note by issuing to Empire,
on behalf of APR, 10 million shares of voting, instead of
non-voting, Series AAA Preferred Stock. Each share of this stock
would grant the holder thereof the right to cast 62.4 votes, which,
together with all other shares of Series AAA Preferred Stock, would
constitute an aggregate of 96% of all votes on all matters brought
before our stockholders for a vote. We received the valuation and
the financial statements and, on November 2, 2005, satisfied Arrow's
$125,000,000 note to Empire by issuing Empire 10 million shares of
Series AAA Preferred Stock. In connection therewith, Empire has
agreed to pay certain of our expenses, including expenses relating
to this transaction, aggregating approximately $350,000, of which
approximately $70,000 has been paid as of November 2, 2005, and the
balance will be paid on or about November 22, 2005. George W.
Benoit, our Chief Executive Officer, will be paid $60,000 of this
amount. Also on November 22, 2005, our current directors plan to
resign and appoint designees of the Preferred Stockholders to be the
Company's directors.
Off-Balance Sheet Arrangements
------------------------------
At September 30, 2005 and December 31, 2004, we had no off-balance
sheet arrangements.
Operating Activities
--------------------
We utilized $1,004,435 of cash in operating activities during the
nine-month period ended September 30, 2005. We had a net loss of
$1,635,177 during this period, which included an aggregate of
$207,106 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 nine-month period ended September 30, 2005 also
reflected an increase in accounts receivable, inventory, and
accounts payable, accrued expenses, and deferred grant revenue, and
a decrease in prepaid expenses and other assets.
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
$383,518 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 nine-month period ended September 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.
26
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 in February 2004 from the sale of
our Common Stock, and restructured certain short-term credit
arrangements into a $300,000 note payable due in February 2005.
Furthermore, in July through December 2004 we restructured and
issued approximately $450,000 of our debt securities. The note
payable and debt securities have been satisfied subsequent to
September 30, 2005 pursuant to transactions described below. See
Subsequent Events.
Subsequent Events.
------------------
On November 3, 2005, we entered into an agreement with Gary L.
Eichsteadt, a former director, Thomas L. Sullivan, a former
executive officer, and David B. Batzer pursuant to which we sold
SRC, its subsidiary and a patent associated with these businesses,
to Messrs. Eichsteadt and Sullivan in consideration for the
cancellation of debt in the aggregate amount of $50,000 we owed to
Messrs. Eichsteadt and Sullivan, the cancellation of debt in the
aggregate amount of approximately $150,000 SRC owed to Mr.
Eichstead, the cancellation of debt in the aggregate amount of
approximately $300,000 SRC owed to Mr. Batzer, and the return to us
by Messrs. Eichsteadt and Sullivan of an aggregate of 1,000,000
shares of our Series AA Preferred Stock and 4,867,938 shares of our
Series C Preferred Stock and the return by Messrs. Eichsteadt,
Sullivan and Batcher of options and warrants to purchase an
aggregate of 486,000 shares of our Common Stock. We have since
retired and/or canceled all of the securities returned to us
pursuant to this agreement. As part of this transaction Mr.
Eichsteadt resigned as a director. All inter company debt was
eliminated prior to closing.
On November 3, 2005, we entered into an agreement with, U.S.
Commlink, Ltd. ("Commlink"), our wholly owned subsidiary, and Thomas
Leyen pursuant to which all inter company debt was eliminated prior
to closing, and we transferred Commlink and two patents related to
that business to Mr. Leyen and will pay certain of Commlink's
obligations in the aggregate amount not to exceed $86,000 in
consideration for Mr. Leyen canceling Options currently held by him
to purchase an aggregate of 300,000 shares of our Common Stock.
Subsequent to September 30, 2005, we:
(i) exchanged all of our 1,392,630 shares of Series A
Preferred Stock for our common stock at the rate of one
share of Preferred Stock for one share of common stock
and thereafter retired this Preferred Stock;
27
(ii) purchased all of our 4,400 shares of Series B Preferred
Stock for an aggregate price of $20,000.00 and
thereafter retired this Preferred Stock;
(iii) exchanged all of our 1,145,000 Series G Preferred Stock
at the rate of one share of Preferred Stock for two
shares of common stock and thereafter retired this
Preferred Stock
(iv) exchanged all of our outstanding debt, exclusive of
accrued but unpaid salaries, directors' and professional
fees and expenses, and exclusive of the debt cancelled
pursuant to the transaction described above relating to
the sale of SRC, in the aggregate amount of
approximately $1,370,000 for an aggregate of 2,837,533
shares of common stock;
(v) issued 373,277 shares of common stock to independent
contractors for services they rendered to us; (vi)
except for the warrants and options referred to in the
transaction relating to the sale of our subsidiary,
exchanged all of our warrants and options for an
aggregate of 6,275,772 shares of common stock; and
(vii)executed mutual general releases with certain of
our creditors including, among others, our officers and
directors, pursuant to which all of our accrued but
unpaid salaries, directors' and professional fees and
expenses in the aggregate amount of approximately
$1,350,000 were released.
Subsequent to September 30, 2005, we obtained releases from our
current directors and a former director, pursuant to which, for
nominal consideration, they have each released us from our
obligation to pay him any accrued but unpaid compensation,
directors' fees and/or advances, as the case may be, that we may owe
him. We have also released them from all actions we may have against
them except for those prohibited by applicable law. The following
table sets for the amounts that they have released:
Name Amount Released
---- ---------------
Joseph G. Anastasi $ 30,000
George W. Benoit $ 1,307,050
Anthony S. Conigliaro $ 223,333
Charles W. Currie $ 28,000
David W. Dube $ 35,000
Subsequent to September 30, 2005, we also entered into agreements
with Messrs. Anastasi, Benoit, Conigliaro, Currie and Dube, members
of Mr. Benoit's family, and Grace C. Lindblom and Frank Ciolli, each
a beneficial owner of more than 10% of our outstanding Common Stock
at the time of the agreements, pursuant to which we issued them our
Common Stock
28
in exchange for debt owed by us, Series G Preferred Stock and/or
options or warrants, each to purchase one share of our Common Stock
at various prices. We were paid $0.20 per share for the Series G
Preferred Stock. The following table sets forth certain information
relating to these transactions:
Name Consideration Exchanged Number of Shares Issued
---- ------------------------ -----------------------
Joseph G. Anastasi 25,000 options and $26,667 debt 116,894
George W. Benoit (1)(2)(4) 600,000 options 479,887
Maureen Benoit (1) 3,007,903 options and $515,000 debt 2,656,326
George W. Benoit, Jr. (2) 49,600 shares of preferred stock 496,000
Kevin J. Benoit (2)(3) 59,400 shares of preferred stock,
514,277 options and $56,667 debt 712,750
Frank Ciolli (3) 1,542,833 options and $181,625 debt 377,324
Anthony S. Conigliaro 1,314,277 warrants and
options and $56,667 debt 1,857,538
Charles W. Currie 25,000 options and $26,667 debt 112,639
David W. Dube 100,000 options 72,117
Grace C. Lindblom (3) 2,081,550 options and $250,000 debt 545,167
Anne B. Mullen (2) 22,913 shares of preferred stock 228,930
Michael Mullen (4) 8,000 shares of preferred stock 80,000
Nancy C. Zucco (2) 43,003 shares of preferred stock 430,230
(1) Maureen Benoit is George W. Benoit's wife.
(2) This person is an adult child of George W. Benoit.
(3) This person was a holder of 10% or more of our common stock at
the time of the agreement.
(4) Mr. Mullen is George W. Benoit's son-in-law.
We issued all of our Common Stock in the transactions referred to
above pursuant to the exemptions from the registration provisions of
the securities Act of 1933 provided by Sections 3(a)(9) and 4(2)
thereof.
C. Inflation
---------
Due to the nature of our business, inflation does not significantly
impact our operations.
29
Item 3. Controls and Procedures
Our Chief Executive Officer, who is also acting as our Chief
Financial Officer, has conducted an evaluation of the effectiveness
of disclosure controls and procedures pursuant to Rule 13a-14 of the
Exchange Act. Based on that evaluation, he has concluded that our
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 him 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 his
evaluation.
30
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
We are a party to various vendor related litigations. Based on the
opinion of management, we have accrued an estimated liability of
approximately $100,000.
Item 5. Other Information.
None
Item 6. Exhibits and Reports on Form 8-K.
Exhibit 4.1 was mislisted as Exhibit 2.1 and Exhibit 31.2 was inadvertently left
out of the filing. Exhibit 4.1 is being correctly listed and Exhibit 31.2 is
herewith being filed.
(a) Exhibits:
4.1 Designations of Rights and Preferences of Series
AAA Preferred Stock.
31.2 Certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 from the Company's
Chief Financial Officer
(b) Reports on Form 8-K:
The Company filed a report on Form 8-K on August 18,
2005, a report on Form 8-K on September 6, 2005, a
report on Form 8-K/A on October 24, 2005, a report on
Form 8-K/A November 8, 2005 and a report on Form 8-K on
November 9, 2005.
31
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this amended report to be signed on its behalf by the undersigned, thereunto
duly authorized.
CNE GROUP, INC.
/s/ George W. Benoit
---------------------------------------
Date: November 21, 2005 George W. Benoit, Chairman of the Board
of Directors, Chief Executive
Officer and Chief Financial Officer
32