UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-K

(Mark One)

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the fiscal year ended July 31, 2004

 

 

or

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from          to

 

Commission File Number 000-26399

eOn Communications Corporation
(Exact name of registrant as specified in its charter)

DELAWARE

 

62-1482176

(State of incorporation)

 

(I.R.S. Employer Identification No.)

 

4105 Royal Drive NW, Suite 100, Kennesaw, Georgia 30144

(Address of principal executive offices)

 

(770) 423-2200

(Telephone number)

 

Securities registered pursuant to Section 12(b) of the Act:  None

 

Securities registered pursuant to Section 12(g) of the Act:

 

Common Stock, $0.001 par value per share
(Title of each class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES
x NO o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes o  No x

The aggregate market value of the shares of common stock held by non-affiliates of the registrant was approximately $14,138,000 based upon the closing sale price as reported by the Nasdaq Stock Market on September 30, 2004.  The number of outstanding shares of the registrant’s $0.001 par value common stock was 12,830,152 shares as of that date.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the registrant’s Proxy Statement for the 2004 Annual Meeting of Shareholders are incorporated by reference in Part III.



TABLE OF CONTENTS

 

 

 

Page

 

 

 


PART I

 

 

 

 

Item 1.

Business

2

 

 

Executive Officers

12

 

Item 2.

Properties

12

 

Item 3.

Legal Proceedings

13

 

Item 4.

Submission of Matters to a Vote of Security Holders

13

 

 

PART II

 

 

 

 

Item 5.

Market for Registrant’s Common Equity and Related Stockholder Matters, And Issuer Purchases of Equity Securities

14

 

Item 6.

Selected Financial Data

14

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

 

Item 7a.

Quantitative and Qualitative Disclosures About Market Risk.

26

 

Item 8.

Financial Statements and Supplementary Data

27

 

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

50

 

Item 9a.

Controls and Procedures

50

 

Item 9b.

Other Information

52

 

 

PART III

 

 

 

 

Item 10

Directors and Executive Officers of the Registrant.

53

 

Item 11

Executive Compensation

53

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management And Related Stockholder Mattes

53

 

Item 13

Certain Relationships and Related Transactions

53

 

Item 14.

Principal Accountant Fees and Services

53

 

 

PART IV

 

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

54

 

 

SIGNATURES

55

1



PART 1

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements within the meaning of the federal securities laws. Forward-looking statements are those that express management’s views of future events, developments, and trends. In some cases, these statements may be identified by terminology such as “may,” “will,” “should,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of such terms and other comparable expressions. Forward-looking statements include statements regarding our anticipated or projected operating performance, financial results, liquidity and capital resources. These statements are based on management’s beliefs, assumptions, and expectations, which in turn are based on the information currently available to management. Information contained in these forward-looking statements is inherently uncertain, and our actual operating performance, financial results, liquidity, and capital resources may differ materially due to a number of factors, most of which are beyond our ability to predict or control. Factors that may cause or contribute to such differences include, but are not limited to, eOn’s ability to compete successfully in its industry and to continue to develop products for new and rapidly changing markets. We also direct your attention to the risk factors affecting our business that are discussed elsewhere in Item 7. eOn disclaims any obligation to update any of the forward-looking statements contained in this report to reflect any future events or developments. The following discussions should be read in conjunction with our consolidated financial statements and the notes included thereto in Item 8.

ITEM 1.  BUSINESS.

INTRODUCTION

eOn Communications Corporation(“eOn” or the “Company”) designs, develops and markets unified voice, email and Web-based communications systems and software for customer contact centers and general business applications. Our primary business focus is to provide multi-media contact center solutions that help businesses communicate more effectively and efficiently with their customers using all forms of voice, messaging and Internet based interactions. Through such products eOn enables companies to improve customer service and loyalty, increase agent productivity and lower the cost of ownership.  For small and medium-sized general business applications we also offer integrated communication systems such as private branch exchanges (PBX’s), voice mail and unified messaging solutions.

In 1997, eOn was one of the first companies to develop a communications server using the open standards-based Linux™ operating system.  In 2000, eOn became one of the first companies to deliver a single queuing multi-media contact center solution.  Since then we have won numerous industry awards for product innovation and service, and we have successfully competed for and won the business of our customers.  With more than 8,000 customers worldwide, eOn has a proven line of products that enable businesses to improve communications, convert inquiries into sales, and increase customer satisfaction and loyalty.

On June 1, 2004 eOn purchased, through a wholly-owned subsidiary, a controlling interest in Cortelco Shanghai Telecom Equipment Company (“Cortelco Shanghai”).  Cortelco Shanghai is an established telecommunications company with a significant customer base throughout China that provides telecommunications products in China.  These products include fiber optic transmission equipment, data communications systems, and network management software.

The Company’s principal executive offices are located at 4105 Royal Drive NW, Suite 100, Kennesaw, Georgia 30144. The telephone number at that address is (770) 423-2200. The Company was incorporated in Delaware in July 1991, and in 1993 we became a subsidiary of Cortelco Systems Holding Corporation (“CSHC”). In March 1997, our subsidiary in the automatic call distribution products business was spun off to the CSHC stockholders, merged with Business Communications Systems, Inc., and renamed BCS Technologies, Inc. (“BCS”). In April 1999, CSHC distributed its shares of eOn in a spin-off transaction, we acquired Cortelco Systems Puerto Rico, Inc. (“CSPR”), another subsidiary of CSHC, and we acquired BCS.

2



DISCONTINUED OPERATIONS

Through CSPR, we distributed communications systems and cellular phones and resold cellular airtime on the island of Puerto Rico and throughout the Caribbean and Latin America. In August 2001, the Board of Directors approved a plan to spin-off this subsidiary as a separate entity to the stockholders of eOn. This spin-off was effective via a stock distribution on July 31, 2002 to eOn shareholders of record on July 22, 2002. The remainder of the discussion in Item 1 will focus on our continuing operations.

BACKGROUND AND GENERAL DEVELOPMENT OF BUSINESS

eOn continues to focus resources on developing and marketing products that help businesses communicate more effectively and efficiently with their customers.   The demand for consistent and personalized experiences across all forms of interactions – voice, email, and the Web – puts customers in the driver’s seat and at the forefront of a new era in customer interaction management.  eOn understands the relationship between customer satisfaction and company success and has created solutions that embrace the customer driven environment by providing companies the capability to deliver seamless customer experiences across all types of media.

The award-winning eQueue® Multi-Media Contact Center is our flagship product for delivering a proven solution to customers who are looking to evolve from being a traditional call center company to a multimedia contact center.  Unlike traditional telecom solutions, the eQueue System is designed to replace proprietary communication devices such as Private Branch Exchanges (PBX), Automatic Call Distributors (ACD), Interactive Voice Response (IVR) systems, recording systems, workforce management systems, voice mail systems, and Computer Telephony Integration (CTI) middleware systems with an all-in-one, fully blended communications system. Because the eQueue platform is built on an “open” unified architecture, organizations can eliminate the need for complex communications systems integration while reducing start-up and maintenance costs, simplifying administration, and increasing ease of customization.  In addition, the eQueue can distribute and manage email and web-based interactions, making this a true multi-media contact center solution. The eQueue enables enterprises to communicate more effectively with customers, lowers operational costs and increases agent productivity.

eOn Millennium® Digital Communications Platform is a proven solution for small and medium-sized installations requiring general business communication.  Blending voice, data, wireless and CTI technology into one diverse telephony server platform, the Millennium's adaptability and flexibility make it ideal for multi-site networks such as school systems, multi-tenant services, professional offices, distribution facilities, and retail stores.  The Millennium provides integrated voice mail, unified messaging, fax messaging and an array of capabilities to help employees work more efficiently, access information more easily, and serve customers better.

 eQueue Multi-Media Contact Center Solution

The eOn eQueue solution offers many advantages in the complex and competitive customer interaction management marketplace. 

Universal Queue

 

 

 

The eQueue’s universal queue approach enables contact centers to more efficiently interact with their customers regardless of the media. The capability not only provides customers with consistent interaction management across all media, but also includes extensive skills-based routing for all contacts that can match the most appropriate resource to a customer’s need. 

 

 

Comprehensive

 

 

 

The eQueue offers comprehensive applications including ACD with skills based routing, PBX with Voice over Internet Protocol (VoIP) capabilities, email and web chat applications with an integrated knowledge base, integrated voice response, voice mail with unified messaging, quality assurance recording, workforce management and a complete range of desktop devices and applications.

3




Open

 

 

 

The eQueue is an open standards-based solution based on the Linux™ operating system. Using an open solution not only provides for ease of integration, but also provides the contact center with support for evolving future needs.

 

 

Modular

 

 

 

The eQueue provides the flexibility to add, combine and customize important features and functions to meet the individual needs of a contact center.  The eQueue is compatible with most third party systems, allowing companies the ability to integrate other applications.

 

 

Scalable

 

 

 

For contact centers with as few as 10 agents to those with over 1000 agents, the eQueue provides the functionality required.

 

 

Proven

 

 

 

With a quarter century of contact center expertise, eOn serves over 8,000 customers in a variety of markets including Multi-Media Contact Centers, Traditional Call Centers, General Business Applications, Service Providers and Emergency 911 Centers. The eQueue is a fully redundant solution designed to perform in a mission-critical environment.

Benefits of an eQueue Solution

The benefits of using an eQueue include improved customer satisfaction, retention and loyalty, increased agent productivity and lower total cost of ownership.

Improved Customer Satisfaction, Retention & Loyalty

 

 

 

 

Outstanding customer service is the primary goal of most companies. Attaining this goal is often the direct result of how effectively voice calls, emails and web-based communications are routed and managed within the contact center. The eQueue provides a universal queue together with a common management interface for all types of customer contacts. This, combined with powerful skills-based routing capabilities, ensures that contact centers can match the best possible resource to meet a customer’s need consistently across all media types.  Additionally, the eQueue’s open platform provides ease of integration with customer relationship management (“CRM”) and other enterprise applications, allowing a high level of business-driven management of all customer interactions.  This enables improved customer satisfaction and retention with consistent service delivery across all contact channels.

 

 

 

Increased Productivity

 

 

 

 

Multi–media contact blending is one way to significantly improve productivity. In traditional call centers, individual agents can only handle one contact type, such as voice calls.  Therefore, different pools of agents must be created to manage different forms of media. To cover peak demand times, each unique agent pool must be staffed to maximum capacity.  With the eQueue, however, all agents can effectively handle all types of contacts, coverage is more flexible, fewer agents can handle the same demand, and idle agents can be minimized.  Agent productivity is also increased through the use of. Agent productivity will also be increased through the use of features such as skills-based routing, remote agent support, unified reporting for all media types, quality monitoring and dynamic supervisory control. 

 

 

 

Lower Total Cost of Ownership

 

 

 

 

The eQueue solution offers an overall total lower cost of ownership – lower capital costs and lower operating costs, which equates to a higher return on investment. Integration costs are kept to a minimum with eQueue’s comprehensive applications and open platform.  Because the eQueue architecture is open and modular, the contact center is also prepared for future growth.

4



STRATEGY

eOn will continue to work towards being the recognized global leader in providing comprehensive contact center solutions.  Key elements of our strategy for future growth are as follows:

Grow Our eQueue Business

 

 

 

 

We believe our best opportunities lie with our eQueue Multi-Media Contact Center Solution. We believe we have an architectural advantage over other companies that will enable eOn to respond quickly to opportunities with our eQueue solution. We will also broaden our core routing and voice services applications by offering products such as workforce management and Voice over IP. eOn will not only gain new opportunities for revenue generation with these additional offerings, but we will also enhance our ability to win competitive bids.  Moreover, providing next-generation capabilities such as universal queuing, workforce optimization, and IP-enablement demonstrates that eOn will be able to meet its client’s current and future needs.  Today, eOn owns one of the most comprehensive solutions available, and we will continue to broaden our product line to maintain this competitive advantage.

 

 

 

Differentiate with Enhanced Professional Services

 

 

 

 

We have already positioned the company as a total solution provider, as we have the software, hardware and the services required to deliver the most advanced products and services in the industry.  However, we believe that enhancing our professional services capabilities will serve as a key point of differentiation in the contact center market.  Providing enhanced services such as customization, system integration and business process consulting are ways to demonstrate to users that eOn truly understands and is able to address their business challenges.  eOn has the call center expertise and reference base to offer the types of services necessary to succeed in this area. 

 

 

 

Adopt Customer Migration Programs to Encourage IP Adoption

 

 

 

 

Customers that currently purchase contact center solutions require that they be able to support more IP based applications in the future. Since the eQueue has a hybrid architecture that supports traditional TDM switching infrastructure and IP-based technology, eOn is able to provide a solution that allows users to migrate to IP at their own pace and ultimately reap the cost savings and business performance enhancement benefits of converged networks.  eOn plans to implement a customer migration program to encourage IP adoption, while preserving a customer’s existing investment in the eQueue system. We believe this will lead to both short-term and long-term growth.

 

 

 

Leverage Attractive Price/Performance Ratio

 

 

 

 

eOn is in a very unique position today as we possess a comprehensive contact center solution that is offered at an attractive price when compared to our competitors. Our all-in-one approach reduces costs and implementation time, which we believe has positioned eOn as the value leader in the call center industry. In the current climate of reduced capital spending and lengthened sales cycles, we plan to focus on demonstrating the Return On Investment (ROI) value of our solution and plan to accomplish this with sales tools that emphasize operational efficiency, agent productivity, and improved customer service. Key metrics such as average speed to answer, average first call resolution rates, and abandon rates will also be emphasized. eOn has proven customer success stories that can demonstrate hard ROI.

 

 

 

Expand Internationally

 

 

 

 

eOn had success during FY2004 in penetrating international markets and creating new revenue streams. The international market creates an opportunity for eOn to realize rapid revenue growth.  Asia/Pacific has been the focus of eOn and that will continue in FY2005.  eOn’s strategy is to develop strategic alliances in Asia that will allow for rapid distribution and deployment of products and services.  eOn’s strategy is to build partnerships with resellers, outsource companies, and sales agents to achieve these goals. On June 1, 2004 eOn purchased, through a wholly-owned subsidiary, a controlling interest in Cortelco Shanghai.  Cortelco Shanghai is an established telecommunications company with a significant customer base throughout China that provides telecommunications products in China.  These products include fiber optic transmission equipment, data communications systems, and network management software.

5




Opportunistically Manage  the Millennium Business

 

 

 

 

While we promote and grow our eQueue business we will also strive to opportunistically manage the Millennium business. We will continue to support our Millennium dealer channel and will maintain profitability for our Millennium business.  We believe the anticipated growth in the eQueue business will offset the anticipated decline in the Millennium business during Fiscal 2005.

PRODUCTS AND PRODUCTS UNDER DEVELOPMENT

We have already established a reputation for product innovation.  In 1997, eOn was one of the first companies to develop a communications server using the open standards-based Linux™ operating system, and in 2000, we became one of the first companies to deliver a single queuing multi-media contact center solution.  Since then we have won numerous industry awards for product innovation and service, and we have successfully competed for and won the business of prestigious and demanding customers. We will continue to enhance this reputation as we believe that we have a unique opportunity to gain new customers among companies that wish to acquire a comprehensive and proven contact center solution. We believe our extensive experience in voice communications and call center systems provides us with a strategic advantage for offering an integrated voice and Internet communications product line.

Our products and products under development include a broad line of next-generation communications servers and software.

eQueue Multi-Media Contact Center Solution

The eQueue Multi-Media Contact Center Solution is designed for mission-critical contact center environments and has won numerous industry awards during previous years.  The eQueue incorporates a comprehensive range of applications including:

eQueue ACD

 

 

 

We built the eQueue from the platform up with an understanding of the critical nature of call center operations, and the eQueue ACD application is at the core of the eQueue solution. Our redundant, reliable, fault-tolerant system platform is used to deploy mission-critical business communications. The eQueue has a single robust routing engine for all contact types and is designed with comprehensive and flexible routing capabilities.  The eQueue gives contact centers several key routing differentiators, including a single multi-media queue for all contact types, powerful skills based routing across all media types, real-time supervision, and virtual agent groups. Effective customer service is a direct result of contact centers routing customers to the right agents quickly and efficiently.  Enhancements to eQueue ACD are incorporated into our development initiatives.

 

 

eQueue PBX

 

 

 

The eQueue comes complete with a rich set of telephony features, telephony grade reliability, comprehensive PBX capabilities, multi-featured phones, PC phones, and networking interfaces. The eQueue has a hybrid architecture that supports traditional TDM switching infrastructure and IP-based technology, including the support of VoIP capabilities.  Enhancements to eQueue PBX capabilities, including new multi-feature phones, additional VoIP functionality and redundancy enhancements are incorporated into our development initiatives.

6




eQueue Email & Chat

 

 

 

eQueue Email and eQueue Chat applications are options that allow agents to interact with online customers quickly and easily.  Emails and Chat sessions are received in queue with voice calls and then delivered to agents based on defined skill sets and priorities.  Using an intuitive browser-based interface, agents can respond to email contacts and web chat sessions efficiently and can selected automatic responses to FAQ’s from the shared knowledge base.  eQueue Email & Chat integrates with other eQueue applications to offer extensive real-time and historical reporting, secured multi-domain support, dynamic routing, instant messaging and more.  Enhancements to eQueue Email & Chat Application are incorporated into our development initiatives.

 

 

eQueue IVR

 

 

 

The eQueue Interactive Voice Response (IVR) provides contact centers with a customer self-service option by providing unlimited voice announcements, customized greetings, variable delay messages, and interactive multi-level menu selections.  With advanced scripting, thousands of customized voice files can be selected and combined so callers hear promotional, call status, and informational updates.  Additionally, the eQueue IVR offers features that give contact centers an advantage in servicing their customers, such as real-time statistics, whisper announce, automated paging, callback and web callback. Enhancements to eQueue IVR are incorporated into our development initiatives.

 

 

eQueue Recording

 

 

 

eQueue Recording is an application that allows agent and/or customer interactions to be recorded and stored for later review.  eQueue Recording supports two distinct recording types: On-Demand Recording and Quality Assurance Recording.  Agents can initiate an On-Demand Recording session at any time during the call by simply pressing a button on their phone or screen.  Quality Assurance Recording sessions, on the other hand, are automatically activated based on the agent’s group, type of call, number of calls previously recorded for the agent and number of calls previously recorded for the group.  A client application provided with this feature allows supervisors to schedule, maintain and administer all recordings from their desktop. Enhancements to eQueue Recording are incorporated into our development initiatives.

 

 

eQueue Messaging

 

 

 

In addition to voice mail capabilities, eQueue Messaging brings unified messaging to the contact center.  In particular eQueue Messaging enables a customer service department to handle and access fax correspondence using the same business processes that handle voice and email inquiries.  eQueue Messaging offers an array of features from one intuitive user-friendly interface. eQueue Voice Mail is an integrated voice communications system that offers a wide range of voice messaging options for all users.  Within contact centers, eQueue Voice Mail gives callers the option of leaving a voice message instead of waiting in queue, thereby empowering the caller and enhancing the customer contact experience.

 

 

eQueue Reporting

 

 

 

eQueue Reporting provides flexible standard and custom reports and displays, available in both real-time and historical formats, giving contact centers the information needed in any form to manage contact center efficiency, agent performance, and service delivery levels.  The unified architecture of the eQueue uses a single, standards-based reporting engine to track contact center resources, applications and interactions.  Because of this architecture, eQueue Reporting enables companies to build comprehensive, end-to-end management reports that can also include information from multiple disparate systems.  eQueue Reporting delivers consolidated data for voice, email and Web that is timely, easily accessible and presented in a form that fits the unique needs of a contact center. eOn Supervisor WorkSpace is Java™-based and provides real-time management displays and alerts and can be fully customized for quick and easy identification of customer contact patterns and trends.  With this insight, managers can make more timely and informed decisions about how to enhance service delivery and to improve operational efficiencies. Enhancements to eQueue Reporting are incorporated into our development initiatives.

7




eQueue Interfaces

 

 

 

eQueue Interfaces, including industry-standard CTI, gives companies the extensibility and integration tools necessary to customize the eQueue solution to meet the specific needs of the enterprise.  The eQueue can be tightly integrated with other enterprise applications - including CRM, knowledge bases, self-service applications and e-commerce systems.

 

 

eQueue WorkForce

 

 

 

In February 2002 eOn entered into a software licensing agreement with GMT Corporation (GMT),  to offer GMT's workforce management application as eQueue Workforce. Through this initiative, eOn and GMT will provide an integrated workforce scheduling and forecasting solution that will allow customers to have the ability to improve the quality of customer interactions, more closely adhere to service level goals, and lower their contact center workforce costs.

 

Millennium Voice Switching Platform

The Millennium voice-switching platform is a fully featured private branch exchange with basic customer contact center and computer telephony integration features.  It can be expanded in a modular manner from 32 to 1,024 communication ports and provides enterprises with the ability to increase the number of ports and add new features through the simple installation of add-in cards and software.

The Millennium supports the voice switching needs of enterprises with small to medium-sized installations and includes such features as voice mail, interactive voice response and caller identification. The Millennium also offers an advanced voice processing system with unified messaging that integrates email, voice mail and fax on a personal computer connected to a Millennium port; Auto Attendant, which is an automated answering and routing service; and PC Attendant Console, which provides customized computer telephony integration features that support the needs of various vertical markets.

The Millennium can be used for multi-site networking by connecting Millennium platforms in multiple locations, thereby creating a private communications network that operates as if all sites were on a single system. The Millennium may also be networked with our eQueue communications server for a range of virtual private network applications.

SALES AND MARKETING

Our marketing objectives are focused on building upon the accomplishments in fiscal year 2004, especially in the areas of lead generation, sales tool creation, and increasing brand awareness. Our goal is to position eOn as the leader in offering multi-media contact center solutions, but our target customer base continues to be customers that are looking to replace their ACD systems with the next generation multi-media contact center solutions. Our strategy will be to continue to promote solutions within our industry, but we will also promote our solution to selected vertical and horizontal markets. During FY2004 we launched many marketing initiatives and programs that began to gain traction and contributed to the growth in eQueue sales during the past year, including:

 

Lead Generation Program

 

eOn Partner Network  Program

 

eOn Consulting Services  Program

 

Investment Guarantee and Trade Out Promotions

 

Event Marketing Program

8



We sell, install, maintain and support our eQueue Multi-Media Contact Center in the United States through our direct sales force and through selected value added resellers. For overseas sales of our eQueue product, we utilize value-added resellers for sales, installation, and maintenance. In addition we are in the process of training and educating Cortelco Shanghai on our product suite to assist in the sales and installation process. We also sell the Millennium domestically through our network of dealers and value added resellers.

Net revenues in quarters ending January 31 usually decline from the previous quarter, reflecting seasonal factors that affect some of our customers. U.S. government customers typically make substantial purchases during the quarters ending October 31, the last quarter of the government’s fiscal year, and these purchases decline significantly in the following quarter. Customers in such markets as contact centers, education, and retail also have seasonal buying patterns and do not purchase substantial amounts of equipment during the quarters ending January 31.

RESEARCH AND DEVELOPMENT

The market for our products is characterized by rapidly changing technology, evolving industry standards and frequent product introductions. We believe that our future success depends in large part upon our ability to continue to enhance the functionality and capabilities of our products. We plan to extend the functionality of our hardware and software technology by continuing to invest in research and development.

Our success depends, in part, on our ability to enhance our existing products and to develop functionality, technology and new products that address the increasingly sophisticated and varied needs of our current and prospective customers.

MANUFACTURING

We currently use two contract manufacturers to produce the Millennium - ACT Electronics, Inc. and Innovative Circuits, Inc. ACT Electronics, Inc., a subsidiary of private investment firm Sun Capital Partners, is comprised of the former U.S. operations of ACT Manufacturing, Inc. ACT Manufacturing filed for bankruptcy in December 2001, and Sun Capital Partners purchased the U.S. operations of ACT Manufacturing in July 2002 through a bankruptcy auction. Both contract manufacturers perform printed circuit board assembly and soldering, in-circuit and functional testing and packaging. We believe that ACT Electronics and Innovative Circuits have sufficient capacity and technical capabilities to respond to foreseeable increases in customer demand and advances in technology. After final assembly by either manufacturer, we inspect and perform quality assurance testing prior to shipment to our dealers or customers.  We make purchases from ACT and Innovative Circuits through purchase orders.

We currently use Clover Electronics, Inc. to perform printed circuit board assembly and soldering, in-circuit and functional testing and packaging of boards for our eQueue product line. We believe that Clover Electronics has sufficient capacity and technical capabilities to respond to foreseeable increases in customer demand and advances in technology.

We depend on sole source suppliers for certain components, digital signal processors and chip sets, and voice processor boards. Interruptions in the availability of components from our key suppliers could result in delays or reductions in product shipments, which could damage our customer relationships and harm our operating results. Finding alternate suppliers or modifying product designs to use alternative components could cause delays and expenses.

COMPETITION

The competitive arena for our products is changing very rapidly. Well-established companies and many emerging companies are developing products to address the PBX, ACD and Multi-Media Contact Center markets.  While the industry remains fragmented, it is rapidly moving toward consolidation, driven by both emerging companies' desires to expand product offerings and established companies' attempts to acquire new technology and reach new market segments. Most established competitors, as well as those emerging companies that have completed initial public offerings, currently have greater resources and market presence than we do.

9



We compete on the basis of providing reliable integrated voice and data communications systems that can be customized and configured rapidly and at a low cost. Although we believe that we compete favorably with respect to these factors, we may not be successful in this rapidly changing and highly competitive market.

Many of our current and potential competitors have significantly greater financial, technical, marketing, customer service and other resources, greater name recognition and a larger installed customer base than we do. Therefore, our competitors may be able to respond to new or emerging technologies and changes faster than we can. They may also be able to devote greater resources to the development, promotion and sale of their products. Actions by our competitors could result in price reductions, reduced margins and loss of market share, any of which would damage our business.

Our current and potential competitors can be grouped into the following categories:

Contact Center Vendors

 

 

 

Our major competitors for the eQueue are the traditional ACD or call center vendors who have large referencable customer bases, brand recognition, reliable scaleable product offerings and have extensive experience with voice applications. However, their contact center solutions often consist of multiple separate technologies with little integration, have proprietary system architectures, and are expensive. These competitors include Avaya, Nortel Networks, Aspect Communications, and Concerto. We also face competition from other contact center competitors that feature integrated applications (all-in-one products) that are built on Intel hardware platforms. These competitors have reduced the need for systems integration and are often aggressively priced, but also lack brand recognition and do not have the depth of telephony capability of the traditional vendors. These vendors include Interactive Intelligence and Concerto.

 

 

Data Communications Equipment Suppliers

 

 

 

Many data communications equipment suppliers have a strategic objective of penetrating the voice communications and customer interaction management market, thereby substantially expanding their total served market.  Foremost of these data-centric companies pursuing this strategy is Cisco Systems. Although data communications companies generally do not have substantial experience with voice communications systems, these companies can be expected to compete intensely in this market.

 

 

Email Management and Web Center Software Suppliers

 

 

 

There are many competitors that supply software for managing the rapidly increasing volumes of web and email communications for e-commerce. These competitors' products and services manage inbound and outbound email and web-based communications, while facilitating the delivery of specific and personalized information to each customer. They strive to enable e-businesses to enhance customer relationships, generate additional revenue opportunities, and reduce the cost of online communications. Email and Web center software competitors include eGain, Kana Communications, and Live Person. We intend to compete in the web center software and services market by providing integrated voice and data communications in a contact center environment or providing a direct upgrade path from a Web center to an integrated contact center.

 

 

Application Solution or Hosted Solution Providers

 

 

 

An emerging area for eQueue competitors are firms that deliver contact center functionality from a web based platform. Telephony @ Work, Five9, and UCN are examples of companies offering this model in the market place. Advantages typically promoted are investment flexibility with monthly or transaction based licensing, immediate access to technology upgrades, and disaster recovery options.  Business issues that must be considered include IP voice quality, system and application scalability, and limitations in system management and control.

 

 

Voice Communications Equipment Suppliers

 

 

 

Our major competitors for the Millennium are the companies that provide products for the traditional voice communications market. These products include PBXs, voicemail systems and related products that have generally been based on proprietary hardware and software. These companies are expanding beyond traditional voice based communications into IP based voice & data communications. These companies include Nortel Networks, Avaya, Mitel, NEC, Toshiba, and Siemens.

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INTELLECTUAL PROPERTY

We rely on patent, trademark, copyright, trade secret protection and confidentiality and license agreements with our employees, clients, partners and others to protect our proprietary rights. We currently have 17 patents issued in the United States and 1 additional patent pending. There can be no assurance that any of our patent application pending will result in the additional patent being issued.

Our patent position, and that of technology companies in general, involves complex legal and factual questions and, therefore, the validity and enforceability of our patents cannot be predicted with certainty. The steps we have taken to protect our proprietary rights might not be adequate. Third parties might infringe or misappropriate our patents, trade secrets, trademarks and similar proprietary rights. Furthermore, others might independently develop or duplicate technologies similar to ours.

If we fail to protect our intellectual property, our business, financial condition and results of operations could be harmed. In addition, we may have to litigate to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of management and technical resources, which could harm our business, financial condition and results of operations.

“eOn,” “eQueue,” “Millennium” & “WorkSpace” are trademarks of eOn.

EMPLOYEES

As of July 31, 2004, we employed 174 people. We had 65 employees in the United States and 109 in Asia. The mix of employees was 26 in sales and marketing, 103 in research, development, and professional services, and 45 in finance and administration.  We also employ independent contractors and temporary employees. None of our employees are represented by a labor union, and we consider our employee relations to be good.

11



EXECUTIVE OFFICERS

The following table sets forth information about our executive officers:

Name

 

Age

 

Position


 


 


 

David E. Lee

 

67

 

Chairman and Chief Executive Officer

 

Stephen R. Bowling

 

62

 

Chief Financial Officer

 

Mitch C. Gilstrap

 

43

 

Chief Operating Officer

DAVID S. LEE, became the Chairman of the Board of eOn in 1991 and became President and Chief Executive Officer in November 2003.  Previously Mr. Lee served as Chief Executive Officer from May 2000 through August 2001. Mr. Lee is a director of ESS Technology, Inc., a provider of semiconductor and software solutions for multimedia applications; iBasis, Inc., a telecommunications company; and Linear Technology Corporation, a semiconductor company. Mr. Lee is also a Regent of the University of California. From 1985 to 1988, Mr. Lee was President and Chairman of Data Technology Corporation, a computer peripheral company. Prior to 1985, he was Group Executive and Chairman of the Business Information Systems Group of ITT Corporation, a diversified company, and President of ITT Qume, formerly Qume Corporation, a computer systems peripherals company. In 1973, Mr. Lee co-founded Qume Corporation and was its Executive Vice President until the company was acquired by ITT Corporation in 1978. Mr. Lee received an M.S. from North Dakota State University and a B.S. and an honorary doctorate from Montana State University.

STEPHEN R. BOWLING, became a director of eOn in 1993 and Chief Financial Officer in November 2003. From 1994 to 1997, he was the President of eOn and, from 1994 to 1998, he was the Chief Executive Officer of eOn. In 1993, Mr. Bowling became a director of Cortelco Systems Holding Corporation.  He was the President and Chief Executive Officer of Cortelco Systems Holding Corporation from 1993 to April 2004. He was the President and Chief Executive Officer of eManage.com, an internet web site service company in 1999 and 2000. eManage.com filed for Chapter 11 bankruptcy in November 2000. Mr. Bowling received an M.B.A. from Stanford University and a B.A. from Williams College.

MITCH C. GILSTRAP, Chief Operating Officer, leads eOn's U.S. operations and sales teams. Mr. Gilstrap is responsible for sales and sales support, professional services, technical support, engineering, information technology and manufacturing. Joining eOn in February 2001, Mr. Gilstrap drove the product marketing efforts for eOn's contact center solution within the product management group, and most recently led eOn's professional services team, including custom application development, installation and delivery, training, maintenance, consulting and project management services. Prior to joining eOn, he served as General Manager of Fusion Point Technologies as well as Vice President of Product Marketing at Syntellect, a provider of contact center self-service solutions. With more than eighteen years experience, Mr. Gilstrap has held positions in senior product marketing and development in the contact center and telecommunications industries for such companies as Sprint and Hitachi. Mr. Gilstrap holds a Bachelor's degree in Engineering from Georgia Institute of Technology.

ITEM 2.  PROPERTIES.

The Company leases property as detailed in the following table.

LOCATION

 

APPROXIMATE
SIZE

 

LEASE EXPIRATION
DATE

 

INTENDED USE


 


 


 


Kennesaw, Georgia

 

40,000 sq. ft.

 

March 2007

 

Office

Shanghai, China

 

35,000 sq. ft.

 

August 2005

 

Office

Beijing, China

 

2,000 sq. ft.

 

Monthly

 

Office

Seoul, Korea

 

2,000 sq. ft.

 

Monthly

 

Office


Aggregate monthly rental payments for the Company’s facilities are approximately $38,000. The Company’s current facilities are generally adequate for anticipated needs over the next 12 to 24 months. The Company does not own any real property.

12



ITEM 3.  LEGAL PROCEEDINGS.

From time to time, we may be a party to legal proceedings incidental to our business. We do not believe that any of these proceedings will have a material adverse effect on our business or financial condition.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

13



PART II

ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

PRICE RANGE OF COMMON STOCK AND DIVIDENDS

Our common stock began trading on the Nasdaq Stock Market under the symbol EONC on February 4, 2000. Prior to that date, there was no public market for the common stock. The following table sets forth, for the fiscal quarters indicated, the high and low sales prices of our common stock as reported by the Nasdaq Stock Market.

QUARTER ENDED

 

HIGH

 

LOW

 


 


 


 

July 31, 2004

 

$

2.50

 

$

1.10

 

April 30, 2004

 

$

4.17

 

$

2.09

 

January 31, 2004

 

$

4.57

 

$

2.36

 

October 31, 2003

 

$

3.70

 

$

1.70

 

 

 

 

 

 

 

 

 

July 31, 2003

 

$

2.35

 

$

0.47

 

April 30, 2003

 

$

0.81

 

$

0.30

 

January 31, 2003

 

$

0.55

 

$

0.25

 

October 31, 2002

 

$

0.60

 

$

0.21

 

The prices in the table above represent interdealer prices, without retail mark-up, mark-down or commission and may not reflect actual transactions.

As of  September 30, 2004, there were 218 shareholders of record of our common stock and, to the best of our knowledge, approximately 5,000 beneficial owners whose shares of common stock were held in the names of brokers, dealers, and clearing agencies.

During fiscal 2004, we did not declare any cash dividends on our capital stock.  We currently intend to retain any earnings to finance the operation and expansion of our business and, therefore, do not expect to pay cash dividends on our common stock in the foreseeable future.

On July 31, 2002, we distributed our entire ownership in Cortelco Systems Puerto Rico to the shareholders of eOn via a stock distribution.

Information set forth under the caption “Securities Authorized for Issuance under Equity Compensation Plans” in the Company’s definitive Proxy Statement for the 2004 Annual Meeting of Shareholders to be held on November 30, 2004 (the “Proxy Statement”), which will be filed with the Securities and Exchange Commission not later than 120 days after July 31, 2004, are incorporated herein by reference.

ITEM 6.  SELECTED FINANCIAL DATA.

The selected consolidated financial data represent the results from continuing operations of eOn and its subsidiaries, which exclude the results of Cortelco Systems Puerto Rico, Inc., as the results of this subsidiary’s operations are presented separately on a retroactive basis as a discontinued operation (see Footnote 4 to the consolidated financial statements).  The statement of operations data set forth below for each of the fiscal years ended July 31, 2004 and 2003, and the selected balance sheet data at July 31, 2004 and 2003, are derived from consolidated financial statements included in Item 8, which have been audited by Grant Thornton LLP as of July 31, 2004 and 2003 and for the years then ended and by Deloitte & Touche LLP as of July 31, 2002 and for the year then ended. These reports of the independent registered public accounting firms also appear in Item 8. The consolidated statement of operations data for the years ended July 31, 2001, and 2000, and the consolidated balance sheet data at July 31, 2001, and 2000, are derived from audited consolidated financial statements not included in this report. This data should be read in conjunction with the consolidated financial statements, including the notes thereto, appearing in Item 8 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.

14




 

 

Year Ended July 31,

 

 

 


 

 

 

2004(2)

 

2003

 

2002

 

2001

 

2000

 

 

 


 


 


 


 


 

 

 

(in thousands, except per share data)

 

Consolidated Statement of
   Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

17,950

 

$

17,457

 

$

15,046

 

$

20,184

 

$

29,705

 

Cost of revenues

 

 

8,507

 

 

7,478

 

 

6,706

 

 

9,111

 

 

14,027

 

Special charges (1)

 

 

-

 

 

-

 

 

752

 

 

1,985

 

 

-

 

 

 



 



 



 



 



 

          Gross profit

 

 

9,443

 

 

9,979

 

 

7,588

 

 

9,088

 

 

15,678

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Selling, general and
          administrative

 

 

7,087

 

 

8,667

 

 

9,538

 

 

14,380

 

 

15,283

 

     Research and development

 

 

3,106

 

 

2,859

 

 

2,959

 

 

4,340

 

 

3,914

 

     Goodwill amortization

 

 

-

 

 

-

 

 

-

 

 

586

 

 

586

 

     Special charges (1)

 

 

-

 

 

(63

)

 

970

 

 

4,714

 

 

-

 

 

 



 



 



 



 



 

          Total operating expenses

 

 

10,193

 

 

11,463

 

 

13,467

 

 

24,020

 

 

19,783

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations 

 

 

(750

)

 

(1,484

)

 

(5,879

)

 

(14,932

)

 

(4,105

)

Interest income

 

 

(79

)

 

(99

)

 

(287

)

 

(783

)

 

(759

)

Interest expense

 

 

29

 

 

35

 

 

6

 

 

-

 

 

211

 

Other (income) expense, net

 

 

167

 

 

84

 

 

210

 

 

214

 

 

971

 

 

 



 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing
   operations before income taxes
   and minority interest

 

 

(867

)

 

(1,504

)

 

(5,808

)

 

(14,363

)

 

(4,528

)

Income tax expense(benefit)

 

 

24

 

 

-

 

 

(121

)

 

(45

)

 

(1,193

)

 

 



 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing
   operations before minority
   Interest

 

$

(891

)

$

(1,504

)

$

(5,687

)

$

(14,318

)

$

(3,335

)

Minority Interest

 

 

(37

)

 

-

 

 

-

 

 

-

 

 

-

 

 

 



 



 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (Loss) from continuing
Operations

 

$

(928

)

$

(1,504

)

$

(5,687

)

$

(14,318

)

$

(3,335

)

 

 



 



 



 



 



 

Income (loss) from continuing
   operations per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

          Basic

 

$

(0.07

)

$

(0.12

)

$

(0.47

)

$

(1.19

)

$

(0.34

)

          Diluted

 

$

(0.07

)

$

(0.12

)

$

(0.47

)

$

(1.19

)

$

(0.34

)

Weighted average shares
   outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

          Basic

 

 

12,522

 

 

12,091

 

 

12,013

 

 

12,040

 

 

9,885

 

          Diluted

 

 

12,522

 

 

12,091

 

 

12,013

 

 

12,040

 

 

9,885

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends per common share,
   basic and diluted

 

$

0.00

 

$

0.00

 

$

0.00

 

$

0.00

 

$

0.00

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

4,679

 

$

3,221

 

$

2,682

 

$

3,590

 

$

1,829

 

Marketable securities

 

 

4,200

 

 

4,200

 

 

6,610

 

 

8,850

 

 

16,337

 

Working capital

 

 

9,715

 

 

8,313

 

 

9,855

 

 

20,591

 

 

35,882

 

Goodwill, net

 

 

-

 

 

-

 

 

-

 

 

10,375

 

 

10,961

 

Total assets

 

 

22,295

 

 

13,717

 

 

15,970

 

 

39,914

 

 

55,320

 

Long-term debt

 

 

-

 

 

-

 

 

613

 

 

-

 

 

-

 

Total stockholders’ equity

 

 

9,459

 

 

9,464

 

 

10,900

 

 

34,077

 

 

50,002

 

15




 

(1)

In fiscal year 2001, the Company entered into a restructuring plan that resulted in the write-down of inventory, termination of employees, impairment of assets, and accrual of expected costs associated with excess space. An additional charge was recorded in fiscal year 2002, primarily to reflect the financial impact of the sublease termination agreement for the facilities in Memphis, Tennessee and a noncash valuation charge for excess inventory. In FY 2003, a special charge expense reversal was recorded upon the favorable settlement of all outstanding property tax liabilities associated with the former facility in Memphis, Tennessee (see Footnote 6 to the consolidated financial statements).

 

 

 

 

(2)

On June 1, 2004 we acquired a controlling interest in Cortelco Shanghai Telecom Equipment Company.  Cortelco Shanghai’s results of operations have been included with our results of operations since the acquisition date.


ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

OVERVIEW

We design, develop and market next-generation communications servers and software which integrate and manage voice, email and Internet communications for customer contact centers and other applications. We also offer a traditional voice-switching platform for small and medium-sized installations.

Net revenues in quarters ending January 31 usually decline from the previous quarter, reflecting seasonal factors that affect some of our customers. U.S. government customers typically make substantial purchases during the quarters ending October 31, the last quarter of the government’s fiscal year, and these purchases decline significantly in the following quarter. Customers in such markets as contact centers, education, and retail also have seasonal buying patterns and do not purchase substantial amounts of equipment during the quarters ending January 31.

On June 1, 2004 eOn purchased a controlling interest in Cortelco Shanghai Telecom Equipment Company (“Cortelco Shanghai”).  Cortelco Shanghai is an established telecommunications company with a significant customer base throughout China that provides telecommunications products in China.  These products include fiber optic transmission equipment, data communications systems, and network management software.

CRITICAL ACCOUNTING POLICIES

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties and that could potentially result in materially different results under different assumptions and conditions. We believe that our critical accounting policies are limited to those described below. For a detailed description of our accounting policies, see Footnote 3, “Summary of Significant Accounting Policies,” in the notes to the consolidated financial statements.

 

Revenue Recognition – Revenues from our Millennium and eQueue products are recognized only when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price to the customer is fixed or determinable, and collectibility is reasonably assured. Generally, revenue is recognized (1) upon shipment for equipment and software, (2) as work is performed for professional services, and (3) in equal periodic amounts over the term of the contract for software and hardware maintenance.  The Company’s revenue recognition policies are in accordance with Staff Accounting Bulletin No. 104, “Revenue Recognition,” and Statement of Position No. 97-2, “Software Revenue Recognition”

 

 

 

Product Warranties – We provide our customers with standard product warranties from the date of purchase. The costs of satisfying warranty claims have historically been comprised of materials and direct labor costs. We estimate the costs of satisfying warranty claims based on analysis of past claims experience. We perform quarterly evaluations of these estimates, and any changes in estimate, which could potentially be significant, are included in earnings in the period in which the evaluations are completed.

 

 

 

Inventory Obsolescence – We carry inventories at the lower of cost or market. This policy depends on the timely identification of those items included in inventory whose market price may have declined below carrying value, such as slow-moving or obsolete items, and we record any necessary valuation reserves. We perform an analysis of slow-moving or obsolete inventory on a quarterly basis, and any necessary valuation reserves, which could potentially be significant, are included in earnings in the period in which the evaluations are completed.

16




 

Allowance for Uncollectible Accounts Receivable – We typically grant standard credit terms to customers in good credit standing. As a result, we must estimate the portion of our accounts receivable that are uncollectible and record any necessary valuation reserves. We generally reserve for estimated uncollectible accounts on a customer-by-customer basis, which requires us to make judgments about each individual customer’s ability and intention to fully pay balances payable to us. We make these judgments based on our knowledge of and relationships with our customers, and we update our estimates on a monthly basis. Any changes in estimate, which can be significant, are included in earnings in the period in which the change in estimate occurs.

 

 

 

Deferred Taxes – We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Because of substantial losses in prior years, primarily during the years 2000 through 2002, the Company has available net operating loss (“NOL”) carryforwards of $18.8 million.

 

 

 

Accounting principles generally accepted in the United States of America require the recording of a valuation allowance against the net deferred tax asset associated with this NOL and other timing differences if it is “more likely than not” that the Company will not be able to utilize the NOL to offset future taxes. Due to the size of the NOL carryforward in relation to the Company’s taxable income in recent years and to the continuing uncertainties surrounding future earnings, management has not recognized any of its net deferred tax asset. Because this asset has been offset by a valuation allowance, the Company currently provides for income taxes only to the extent of expected cash payments of taxes, primarily state income taxes, for current income.

 

 

 

Should the Company’s earnings trend cause management to conclude that it is more likely than not the Company will realize all or a material portion of the NOL carryforward, management would record the estimated net realizable value of its deferred tax asset at that time. The Company would then provide for income taxes at a rate equal to its combined federal and state effective rates, which would approximate 39% under current tax rates. Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause the provision for income taxes to vary significantly from period to period, although the Company’s cash tax payments would remain unaffected until the benefit of the NOL is utilized.

RESULTS OF OPERATIONS

The following table presents our operating ratios for fiscal years 2004, 2003, and 2002:

 

 

Year Ended July 31,

 

 

 

 


 

 

 

 

2004

 

2003

 

2002

 

 

 

 


 


 


 

 

Net revenues

 

 

100.0

%

 

100.0

%

 

100.0

%

 

Cost of revenues

 

 

47.4

%

 

42.8

%

 

44.6

%

 

Special charges

 

 

0.0

%

 

0.0

%

 

5.0

%

 

 

 



 



 



 

 

Gross margin

 

 

52.6

%

 

57.2

%

 

50.4

%

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

     Selling, general, and administrative

 

 

39.5

%

 

49.7

%

 

63.4

%

 

     Research and development

 

 

17.3

%

 

16.4

%

 

19.7

%

 

     Special charges

 

 

0.0

%

 

(0.4

)%

 

6.4

%

 

 

 



 



 



 

 

Total operating expenses

 

 

56.8

%

 

65.7

%

 

89.5

%

 

 

 



 



 



 

 

Loss from operations

 

 

(4.2

)%

 

(8.5

)%

 

(39.1

)%

 

Interest (income) expense, net

 

 

(0.2

)%

 

(0.4

)%

 

(1.9

)%

 

Other (income) expense, net

 

 

0.9

%

 

0.5

%

 

1.4

%

 

 

 



 



 



 

 

Loss from continuing operations before income taxes and
        minority interest

 

 

(4.8

)%

 

(8.6

)%

 

(38.6

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense(benefit)

 

 

0.1

%

 

(0.0

) %

 

(0.8

)%

 

 

 



 



 



 

 

Loss from continuing operations before minority interest.

 

 

(5.0

)%

 

(8.6

)%

 

(37.8

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

Minority Interest

 

 

0.2

%

 

0.0

%

 

0.0

%

 

 

 



 



 



 

 

Loss before discontinued operations and cumulative
        effect of change in accounting principle

 

 

(5.2

)%

 

(8.6

)%

 

(37.8

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from discontinued operations, net of tax ..

 

 

0.0

%

 

0.0

%

 

(17.5%

)

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative effect of change in accounting principle,
        net of tax

 

 

0.0

%

 

(0.0

)%

 

(69.0

)%

 

 

 



 



 



 

 

Net loss ....

 

 

(5.2

)%

 

(8.6

)%

 

(124.3

)%

 

 

 



 



 



 

 

17



The following discussion provides information about the Company’s continuing operations, which excludes the results of Cortelco Systems Puerto Rico, Inc. (see Footnote 4 – Discontinued Operations in the notes to the consolidated financial statements).

NET REVENUES

Our overall net revenues increased 2.8% to $18.0 million in fiscal 2004 from $17.5 million in fiscal 2003. The increase resulted primarily from the additional revenue received by the acquisition of Cortelco Shanghai partially offset by a decrease in revenues from our eQueue products. Fiscal 2003 net revenues represented a 16.0% increase from $15.0 million in fiscal 2002. The increase was primarily due to an increase in eQueue revenues of $2.8 million, offset by a decline in Millennium revenues of $0.4 million.

COST OF REVENUES AND GROSS PROFIT

Cost of revenues consists primarily of purchases from our contract manufacturers and other suppliers and costs incurred for final assembly of our systems. Gross profit decreased 5.4% to $9.4 million for the year ended July 31, 2004 from $10.0 million in fiscal 2003. The decrease was primarily due to a decrease in revenue for our higher margined eQueue products. Fiscal 2003 represented an increase in gross profit of 31.5% from $7.6 million in fiscal 2002. The increase in gross profit in 2003 was primarily due to increased revenues from our eQueue products. Our gross margins, excluding any special charges, were 52.6%, 57.2%, and 55.4% for fiscal years 2004, 2003, and 2002, respectively. The change in gross margin from year-to-year is primarily the function of changes in product mix, rather than changes in pricing and/or costs.

SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE

Selling, general and administrative expenses were $7.1 million in fiscal 2004, a decrease of 18.2% from $8.7 million in fiscal 2003.  The decrease was a result of cost cutting measures implemented by management.  Fiscal 2003 represented a 9.1% decrease from $9.5 million in fiscal 2002. The decrease in fiscal year 2003 resulted from a decrease in personnel and fixed costs from the implementation of our restructuring plan (see the Special Charges section).

RESEARCH AND DEVELOPMENT EXPENSE

Research and development expenses consist primarily of personnel and related expenses for our engineering staff. The majority of our research and development efforts are currently concentrated on enhancements for our eQueue product line. Research and development expenses were $3.1 million in fiscal 2004 which represents an 8.6% increase from $2.9 million in fiscal 2003.  The increase was primarily due to increased development on our eQueue product. Fiscal 2003 expenses were relatively unchanged from $3.0 million in fiscal 2002.

18



AMORTIZATION OF GOODWILL AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE

On August 1, 2001, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” which changed the method of evaluating goodwill for impairment from a recoverability test based upon undiscounted cash flows to a fair value approach, which is stipulated in SFAS No. 142. In addition, the new standard eliminated the periodic amortization of goodwill; consequently, no goodwill amortization was recorded in the current year.

As a result of the adoption of SFAS No. 142 on August 1, 2001, the Company recorded goodwill impairment in the amount of $10,375,000, which is reflected as a cumulative effect of change in accounting principle in the financial statements for the year ended July 31, 2002. The income tax effect of this change in accounting principle was $0.

SPECIAL CHARGES

To reduce costs and improve productivity, the Company adopted a restructuring plan during the second quarter of  fiscal year 2001, which included headcount reductions and office space consolidation and resulted in charges of $2,199,000. During the fourth quarter of 2001, the Company made the decision to consolidate the majority of functions to its Atlanta headquarters, which resulted in additional charges of $4,500,000. In fiscal 2002, the Company recorded additional special charges to reflect the impact of a lease termination agreement for its former facility in Memphis, Tennessee and to properly value excess inventories on hand at July 31, 2002. In fiscal 2003, the company settled all remaining property tax liabilities associated with the former facility in Memphis, Tennessee and recorded an expense reversal of $63,000 to reflect this favorable settlement and close out the restructuring accrual.

Major components of the restructuring plan included corporate management changes; the relocation and concentration of management and strategic functions at the Company’s headquarters in Atlanta, Georgia; site closures; outsourcing initiatives for the assembly, repair, and manufacturing of our products; and workforce reductions of approximately 40%. The majority of the restructuring plan was completed by July 31, 2002.

As a result of the adoption of the restructuring plan, the Company recognized special charges  in operating expenses of ($63,000) and $970,000 in 2003 and 2002, respectively.In 2002, the Company terminated 5 employees in the sales and field service functions for a charge of $58,000.

The special charge in operating expenses also included ($63,000) and $970,000 in fiscal 2003 and 2002, respectively, for the expected costs associated with excess space at the Company’s locations in Memphis, Tennessee; Englewood, Colorado; and Guelph, Ontario. The excess space resulted from the Company’s relocation of personnel and certain functions to the Atlanta headquarters and the corresponding reductions in our workforce.

The Company also recognized special charges of $752,000 in cost of revenues during 2002. The 2002 noncash charge was recorded  to properly value excess inventories in light of then-current economic conditions.

The following tables summarize the activity relating to the special charges during fiscal years 2003 and the associated liabilities at July 31, 2003 and 2002:

 

 

July 31, 2002
Liability
Balance

 

Charges

 

Expenditures

 

Other
Adjustments

 

July 31, 2003
Liability
Balance

 

 

 


 


 


 


 


 

Termination benefits

 

 

 

61

 

 

 

 

-

 

 

 

 

(61

)

 

 

 

-

 

 

 

 

-

 

 

Excess facilities cost

 

 

 

173

 

 

 

 

(63)

(1)

 

 

 

(110

)

 

 

 

-

 

 

 

 

-

 

 

 

 

 



 

 

 



 

 

 



 

 

 



 

 

 



 

 

Total

 

 

$

234

 

 

 

$

(63

)

 

 

$

(171

)

 

 

$

-

 

 

 

$

-

 

 

 

 

 



 

 

 



 

 

 



 

 

 



 

 

 



 

 


(1)

Reflects favorable settlement of all property tax liabilities for the Company’s former facility in Memphis, Tennessee and the resulting closure of the accrued restructuring liability.

19



INTEREST INCOME AND EXPENSE

Interest expense was $29,000, $35,000 and $6,000 in fiscal years 2004, 2003 and 2002, respectively. The interest expense was primarily due to the imputation of interest on the note payable associated with the termination of the lease on the Memphis facility.

Interest income in fiscal 2004 of $0.08 million decreased 20.0% from $0.10 million in fiscal 2003. Interest income was  $0.29 million in fiscal 2002. The decrease in fiscal years 2004 and 2003 reflected significantly lower interest rates and a lower level of investments in marketable securities.

OTHER INCOME AND EXPENSE, NET

Other expense was $0.2 million in fiscal 2004 compared to $0.1 million in fiscal 2003 and $0.2 million in fiscal 2002.  The increase was primarily due to a reserve established for a bankruptcy judgment that occurred in 2001.

INCOME TAX EXPENSE (BENEFIT)

Income tax expense was $24,000 for fiscal 2004 as a result of the acquisition of Cortelco Shanghai. The income tax benefit was  $0.0 million and $0.12 million in fiscal years 2003 and 2002, respectively. The income tax benefit for fiscal year 2002 resulted from the carryback of previous years’ operating losses to the preceding five years under the Job Creation and Worker Assistance Act of 2002, versus two years under previous tax laws.

SUPPLEMENTAL PRO FORMA INFORMATION (UNAUDITED)

We are providing unaudited pro forma information regarding the acquisition of Cortelco Shanghai. These pro forma results assume that the acquisition had been completed as of August 1, 2001 and therefore presents revenues and net income of us and all our subsidiaries for each fiscal year.

 

 

Fiscal Year Ended July 31,

 

 

 

 

 

 

 

2004

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

 

Net Revenue

 

$

24,336

 

$

28,295

 

$

32,310

 

Net income (loss) before extraordinary items

 

 

(805

)

 

(1,215

)

 

(5,381

)

Net income (loss) before cumulative effect of
accounting change

 

 

(805

)

 

(1,215

)

 

(8,014

)

Net income (loss)

 

 

(805

)

 

(1,215

)

 

(18,389

)

 

 

 

 

 

 

 

 

 

 

 

Earnings per share

 

 

(0.06

)

 

(0.10

)

 

(1.53

)

LIQUIDITY AND CAPITAL RESOURCES

As of July 31, 2004, we had cash and cash equivalents of $4.7 million, $4.2 million in short term investments, and a working capital balance of $9.7 million. Our short term investments are primarily invested in taxable auction rate securities with frequent rate resets and high grade corporate obligations with maturities less than one year.

Our operating activities resulted in net cash outflows of $1.3 million, $1.1 million, and $2.1 million for fiscal years 2004, 2003, and 2002, respectively. The net operating cash for the current year was primarily the result of our operating loss (adjusted for  non-cash items) and an increase in accounts receivable, which was partially offset by a reduction in accounts payable. The net operating cash outflow for fiscal year 2003 was primarily the result of our operating loss (adjusted for  non-cash items) and an increase in accounts receivable, which were partially offset by a reduction in inventories. The net operating cash outflow for fiscal 2002 resulted primarily from our operating loss (adjusted for non-cash items), and expenditures for accrued special charges, which were partially offset by increased collections and a reduction in inventories.

20



Our investing activities resulted in cash inflows of $2.9 million, $2.2 million, and $1.8 million in fiscal years 2004, 2003, and 2002, respectively. Cash provided by investing activities in the current year consisted primarily of $3.8 million in cash acquired with the acquisition of Cortelco Shanghai offset by the purchase of property and equipment. Cash provided by investing activities in 2003 consisted primarily of $2.4 million in net sales of marketable securities. Cash provided by investing activities in fiscal year 2002 consisted primarily of $2.1 million in net sales of marketable securities.

Our financing activities have resulted in cash outflows of  $0.1 million, $0.6 million and $0.2 million in fiscal years 2004, 2003, and 2002, respectively. Cash used in financing activities in fiscal 2004 and fiscal 2003 consisted primarily of payments against the note payable issued in connection with the lease termination agreement for our former facility in Memphis, Tennessee. Cash used in financing activities in fiscal 2002 consisted primarily of repurchases of common stock and payments against the note payable issued in connection with the lease termination agreement for our former facility in Memphis, Tennessee.

We believe that our available funds will satisfy our projected working capital and capital expenditure requirements for at least the next twelve months. To the extent future revenues are not realized or we grow more rapidly than expected, we may need additional cash to finance our operating activities and capital expenditures. Should we need financing, there can be no assurances that financing will be available to us on economically acceptable terms.

COMMITMENTS AND CONTINGENCIES

At July 31, 2004, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $1,518,000.

During fiscal 2002, the Company entered into a lease termination agreement for its former facility in Memphis, Tennessee. A $1,400,000 declining balance letter of credit was issued to secure payments under the termination agreement. The balance of the letter of credit as of July 31, 2004 was $175,000. 

The Company is involved in various matters of litigation, claims, and assessments arising in the ordinary course of business.  In the opinion of management, the eventual disposition of these matters will not have a material adverse effect on the financial statements.

ADDITIONAL RISK FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS

The following risk factors and other information contained in this report should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that are not currently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occurs, our business, financial condition, and operating results could be materially adversely affected.

In addition to the other information included in this report, the following factors should be considered in evaluating our business and future prospects.

Fluctuations in our quarterly operating results could cause our stock price to decline.

Future operating results are likely to fluctuate significantly from quarter to quarter. Factors that could affect our quarterly operating results include:

delays or difficulties in introducing new products;

increasing expenses without commensurate revenue increases;

variations in the mix of products sold;

variations in the timing or size of orders from our customers;

declining market for traditional private branch exchange (PBX) equipment;

delayed deliveries from suppliers; and

price decreases and other actions by our competitors.

21



Our quarterly operating results are also likely to fluctuate due to seasonal factors. Some of our vertical markets, such as the U.S. government, educational and retail buyers, follow seasonal buying patterns and do not make substantial purchases during the quarters ending January 31. Thus, revenues in the quarters ending January 31 are often lower than in the previous quarters. Because of these and other factors, our operating results may not meet expectations in some future quarters, which could cause our stock price to decline.

Our communications servers face intense competition from many companies that have targeted our markets.

The competitive arena for our products is changing very rapidly and we face intense competition in our markets. Well-established companies and many emerging companies are scrambling to develop products to improve customer service in e-commerce. While the industry remains fragmented, it is rapidly moving toward consolidation, driven by both emerging companies’ desires to expand product offerings and resources and established companies’ attempts to acquire new technology and reach new market segments. A number of emerging companies have completed initial public offerings, while many more remain private. More established competitors, as well as those emerging companies that have completed initial public offerings, currently have greater resources and market presence than we do. Additionally, a number of our current and potential competitors have recently been acquired by larger companies who seek to enter our markets.

We expect competition to intensify as competitors develop new products, new competitors enter the market, and companies with complementary products enter into strategic alliances.

Our current and potential competitors can be grouped into the following categories:

contact center vendors, such as Avaya, Nortel Networks, Aspect Communications, and Rockwell;

data communication equipment suppliers, such as Cisco Systems and 3COM;

email management and web center software suppliers, such as eGain, Kana Communications, and Live Person;

and voice communications equipment suppliers, such as Nortel Networks, Avaya, Mitel, NEC, Toshiba, and Siemens.

Many of our current and potential competitors have significantly greater financial, technical, marketing, customer service and other resources, greater name and brand recognition and a larger installed customer base than we do. Therefore, our competitors may be able to respond to new or emerging technologies and changes faster than we can. They may also be able to devote greater resources to the development, promotion and sale of their products.

Actions by our competitors could result in price reductions, reduced margins and loss of market share, any of which would damage our business. We cannot assure you that we will be able to compete successfully against these competitors.

If we cannot expand our indirect sales channel to sell our eQueue products, our ability to generate revenue would be harmed.

We sell our eQueue communications servers both directly and indirectly through dealers and value added resellers that have experience in data as well as voice communications. We may not be able to expand this indirect sales channel. In addition, new distribution partners may devote fewer resources to marketing and supporting our products than to our competitors’ products and could discontinue selling our products at any time in favor of our competitors’ products or for any other reason.

The lengthy sales cycles of some of our products and the difficulty in predicting the timing of our sales may cause fluctuations in our quarterly operating results.

The uncertainty of our sales cycle makes the timing of sales difficult to predict and may cause fluctuations in our quarterly operating results. Our sales cycles generally vary from four to twelve months for our eQueue products and from one to six months for our Millennium voice switching platform. The purchase of our products may involve a significant commitment of our customers’ time, personnel, and financial and other resources. Also, it is difficult to predict the timing of indirect sales because we have little control over the selling activities of our dealers and value added resellers.

22



We incur substantial sales and marketing expenses and spend significant management time before customers place orders with us, if at all. Revenues from a specific customer may not be recognized in the quarter in which we incur related sales and marketing expense, which may cause us to miss our revenues or earnings expectations.

Unanticipated difficulties in integrating our recent acquisition of Cortelco Shanghai could harm our business.

On June 1, 2004 eOn purchased a controlling interest in Cortelco Shanghai. Cortelco Shanghai provides telecommunications products in China, including fiber optic transmission equipment, data communications systems, and network management software. eOn’s future operating results may be adversely affected if we are not able to realize operating efficiencies and sales opportunities as a result of this acquisition.

We face many risks from expanding into foreign markets.

The Company expects to increase sales to customers outside of the United States and establish additional distribution channels in Asia.  However, foreign markets for our products may develop more slowly than currently anticipated.  eOn may not be able to successfully establish international distribution channels, or may not be able to hire the additional personnel necessary to support such distribution channels.

Our future results could be harmed by economic, political, regulatory and other risks associated with international sales and operations.

Because our growth initiatives include expansion into foreign markets, we are subject to the risks of conducting business outside of the United States, including:

- changes in a specific country’s or region’s political or economic conditions;

- trade protection measures and import or export licensing requirements;

- potentially negative consequences from changes in tax laws;

- difficulty in managing widespread sales and customer service operations; and

- less effective protection of intellectual property.

Our products must respond to rapidly changing market needs and integrate with changing protocols to remain competitive.

The markets for our products are characterized by rapid technological change, frequent new product introductions, uncertain product life cycles and changing customer requirements. If we are not able to rapidly and efficiently develop new products and improve existing products to meet the changing needs of our customers and to adopt changing communications standards, our business, operating results and financial condition would be harmed.

Key features of our products include integration with standard protocols, computer telephony integration and automatic call distribution applications and protocols, operating systems and databases. If our products cannot be integrated with third-party technologies or if they do not respond to changing market needs, we could be required to redesign our products. Redesigning any of our products may require significant resources and could harm our business, operating results and financial condition.

If we are not able to sustain our Millennium voice switching platform revenues, our business, operating results and financial condition could be harmed.

We may not be able to sustain our Millennium revenues because the traditional private branch exchange (PBX) market, which accounts for a substantial portion of our Millennium revenues, is declining. One reason for the decline of the traditional PBX market is the emergence of voice switching platforms based on standard PCs. If we are not able to grow or sustain our Millennium voice switching platform revenues, our business, operating results and financial condition could be harmed.

In addition, a significant portion of Millennium revenues are derived from dealers and value added resellers who have no obligation to sell our products. Therefore, dealers and value added resellers could discontinue selling our products at any time in favor of our competitors’ products or for any other reason. A reduction or loss of orders from our dealers and value added resellers could harm our business, operating results and financial condition.

23



Delayed deliveries of components from our single source suppliers or third-party manufacturers could reduce our revenues or increase our costs.

We depend on sole source suppliers for certain components, digital signal processors and chip sets, and voice processor boards. Interruptions in the availability of components from our key suppliers could result in delays or reductions in product shipments, which could damage our customer relationships and harm our operating results. Finding alternate suppliers or modifying product designs to use alternative components may cause delays and expenses. Further, a significant increase in the price of one or more third-party components or subassemblies could reduce our gross profit.

We depend upon our primary contract manufacturers ACT Electronics, Innovative Circuits, and Clover Electronics. We may not be able to deliver our products on a timely basis if any of these manufacturers fail to manufacture our products and deliver them to us on time. In addition, it could be difficult to engage other manufacturers to build our products. Our business, results of operations and financial condition could be harmed by any delivery delays.

We may be unable to hire and retain engineering and sales and marketing personnel necessary to execute our business strategy.

Competition for highly qualified personnel is intense due to the limited number of people available with the necessary technical skills, and we may not be able to attract, assimilate or retain such personnel. If we cannot attract, hire and retain sufficient qualified personnel, we may not be able to successfully develop, market and sell new products.

Our business could be harmed if we lose principal members of our management team.

We are highly dependent on the continued service of our management team. The loss of any key member of our management team may substantially disrupt our business and could harm our business, results of operations and financial condition. In addition, replacing management personnel could be costly and time consuming.

We are effectively controlled by our principal stockholders and management, which may limit your ability to influence stockholder matters.

As of July 31, 2004, our executive officers, directors and principal stockholders and their affiliates beneficially owned 4,618,477 shares, or 35.3% of the outstanding shares of common stock. Thus, they effectively control us and direct our affairs, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying, deferring or preventing a change in control of our company and some transactions may be more difficult or impossible without the support of these stockholders. The interests of these stockholders may conflict with those of other stockholders. We also conduct transactions with businesses in which our principal stockholders maintain interests. We believe that these transactions have been conducted on an arm’s length basis, but we cannot assure you that these transactions would have the same terms if conducted with unrelated third parties.

We may not be able to protect our intellectual property, and any intellectual property litigation could be expensive and time consuming.

Our business and competitive position could be harmed if we fail to adequately protect our intellectual property. Although we have filed patent applications, we are not certain that our patent applications will result in the issuance of patents, or that any patents issued will provide commercially significant protection to our technology. In addition, as we grow and gain brand recognition, our products are more likely to be subjected to infringement litigation. We could incur substantial costs and may have to divert management and technical resources in order to respond to, defend against, or bring claims related to our intellectual property rights. In addition, we rely on a combination of patent, trademark, copyright and trade secret laws and contractual restrictions to establish and protect our proprietary rights. These statutory and contractual arrangements may not provide sufficient protection to prevent misappropriation of our technology or to deter independent third-party development of similar technologies. Any litigation could result in our expenditure of funds, management time and resources.

24



Our products may have undetected faults leading to liability claims, which could harm our business.

Our products may contain undetected faults or failures. Any failures of our products could result in significant losses to our customers, particularly in mission-critical applications. A failure could also result in product returns and the loss of, or delay in, market acceptance of our products. In addition, any failure of our products could result in claims against us. Our purchase agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. However, the limitation of liability provisions contained in our purchase agreements may not be effective as a result of federal, state or local laws or ordinances or unfavorable judicial decisions in the United States or other countries. We maintain insurance to protect against certain claims associated with the use of our products, but our insurance coverage may not adequately cover all possible claims asserted against us. In addition, even claims that ultimately are unsuccessful could be expensive to defend and consume management time and resources.

Our charter contains certain anti-takeover provisions that may discourage take-over attempts and may reduce our stock price.

Our board of directors has the authority to issue up to 10,000,000 shares of preferred stock and to determine the preferences, rights and privileges of those shares without any further vote or action by the stockholders. The rights of the holders of common stock may be harmed by the rights of the holders of any preferred stock that may be issued in the future. Certain provisions of our certificate of incorporation and bylaws may make it more difficult for a third party to acquire control of us without the consent of our board of directors, even if such changes were favored by a majority of the stockholders. These include provisions that provide for a staggered board of directors, prohibit stockholders from taking action by written consent and restrict the ability of stockholders to call special meetings.

Future sales of shares may decrease our stock price.

Sales of substantial amounts of our common stock in the public market, including shares issued upon the exercise of outstanding options, or the perception that such sales could occur, could reduce the market price of our common stock. These sales also might make it more difficult for us to raise funds through future offerings of common stock.

RECENT ACCOUNTING PRONOUNCEMENTS

In November 2002, the Emerging Issues Task force (“EITF”) reached a consensus regarding EITF Issue 00-21, Accounting for Revenue Arrangements with Multiple Deliverables.  The consensus addresses not only when and how an arrangement involving multiple deliverables should be divided into separate units of accounting but also how the arrangement’s consideration should be allocated among separate units. The addition of this pronouncement did not have a material impact on our results of operations or financial position.

In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure (“SFAS 148”). SFAS 148 amends Statement No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), to provide alternative methods for voluntary transition to SFAS 123’s fair value method of accounting for stock-based employee compensation. SFAS 148 also requires disclosure of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net earnings (loss) and earnings (loss) per share in annual and interim financial statements. The provisions of SFAS 148 are effective in fiscal years beginning after December 15, 2002.  The Company has implemented the required disclosures of this pronouncement and will continue to account for stock options under the intrinsic value method.

In July 2003, the EITF reached consensus regarding EITF Issue 03-5,  Applicability of AICPA Statement of Position 97-2, Software Revenue Recognition, to nonsoftware deliverables.  The consensus addresses whether nonsoftware deliverables  in a multiple-element arrangement that includes software that is more than incidental to the products or services as a whole should be within the scope of SOP 97-2, Software Revenue Recognition.  The pronouncement is effective prospectively for arrangements entered into after the beginning of an entity’s next reporting period beginning after August 13, 2003.  The adoption of EITF Issue 03-5 did not have a material impact on the Company’s results of operations or financial position.

25



QUARTERLY FINANCIAL DATA (UNAUDITED)

Quarterly financial data for the years ended July 31, 2004 and 2003 is summarized as follows:

2004

 

First
Quarter

 

Second
Quarter

 

Third
Quarter

 

Fourth
Quarter

 

 

 


 


 


 


 

 

 

(In thousands)

 

Net revenues

 

$

5,039

 

$

3,958

 

$

2,770

 

$

6,183

 

Gross profit

 

 

2,939

 

 

2,367

 

 

1,511

 

 

2,626

 

Income (loss) before discontinued operations
   and extraordinary item

 

 

330

 

 

87

 

 

(944

)

 

(400

)

Net income (loss)

 

 

330

 

 

87

 

 

(944

)

 

(400

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before discontinued operations
   and extraordinary item per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

     Basic and diluted

 

$

0.03

 

$

0.01

 

$

(0.07

)

$

(0.03

)

Net income loss per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

     Basic and diluted (1)

 

$

0.03

 

$

0.01

 

$

(0.07

)

$

(0.03

)


2003

 

First
Quarter

 

Second
Quarter

 

Third
Quarter

 

Fourth
Quarter

 

 

 


 


 


 


 

 

 

(In thousands)

 

Net revenues

 

$

3,555

 

$

4,118

 

$

4,749

 

$

5,035

 

Gross profit

 

 

1,785

 

 

2,489

 

 

2,969

 

 

2,736

 

Income (loss) before discontinued operations
   and extraordinary item

 

 

(1,262

)

 

(532

)

 

82

 

 

208

 

Net income (loss)

 

 

(1,262

)

 

(532

)

 

82

 

 

208

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) before discontinued operations
   and extraordinary item per common share (1):

 

 

 

 

 

 

 

 

 

 

 

 

 

     Basic and diluted

 

$

(0.10

)

$

(0.04

)

$

0.01

 

$

0.02

Net income loss per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

     Basic and diluted (1)

 

 

(0.10

)

 

(0.04

)

 

0 01

 

 

0.02


(1)

Due to rounding and changes in outstanding shares, the sum of the four quarters does not equal the earnings per common share amounts calculated for the year.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The majority of our cash equivalents and marketable securities are invested in variable rate instruments with frequent rate resets. Because these securities have short effective maturities, we believe the market risk for such holdings is insignificant. We do not have any derivative instruments, and we do not engage in hedging transactions.

26



ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

                         INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

Page

 


Reports of Independent Registered Public Accounting Firms

28

 

 

 

Consolidated Balance Sheets as of July 31, 2004 and 2003

 

30

 

 

 

Consolidated Statements of Operations for the Years ended July 31, 2004, 2003, and 2002

 

31

 

 

 

Consolidated Statements of Cash Flows for the Years ended July 31, 2004, 2003, and 2002

 

32

 

 

 

Consolidated Statement of Stockholders’ Equity for the Years Ended July 31, 2004, 2003, and 2002

 

34

 

 

 

Notes to Financial Statements

 

35

 

 

 

Schedule II – Valuation and Qualifying Accounts for Each of the Three Years in the Period Ended July 31, 2004

 

56

27



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors
eOn Communications Corporation

We have audited the accompanying consolidated balance sheets of eOn Communications Corporation and subsidiary as of July 31, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the two years in the period ended July 31, 2004.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of eOn Communications Corporation and subsidiary as of July 31, 2004, and the results of their operations and their cash flows for each of the two years in the period ended July 31, 2004 in conformity with accounting principles generally accepted in the United States of America. 

Our audit was conducted for the purpose of forming an opinion on the basic financial statements taken as a whole.  The Schedule II, Valuation and Qualifying Accounts listed in the Index at Item 15(A), is presented for purposes of additional analysis and is not a required part of the basic financial statements.  The schedule as of July 31, 2004 and 2003 and for the years then ended has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.

/s/ Grant Thornton LLP

 

Atlanta, Georgia

August 26, 2004

28



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of eOn Communications Corporation

We have audited the accompanying consolidated statements of operations, cash flows, and stockholders’ equity of eOn Communications Corporation and subsidiaries (the “Company”) for the year ended July 31, 2002. Our audit also included the financial statement schedule listed in the Index at Item 15 for the year ended July 31, 2002. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of the Company for the year ended July 31, 2002 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

As discussed in Note 5 to the consolidated financial statements, on August 1, 2001 the Company changed its method of accounting for goodwill and other intangible assets to conform with FASB Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.

/s/ Deloitte & Touche LLP

 

Atlanta, Georgia

August 29, 2002

29



eOn Communications Corporation
Consolidated Balance Sheet
s
July 31, 2004 and 2003
(Dollars in thousands)

ASSETS

 

 

July 31,

 

 

 


 

 

 

2004

 

2003

 

 

 


 


 

Current assets:

 

 

 

 

 

 

 

     Cash and cash equivalents

 

$

4,679

 

$

3,221

 

     Marketable securities

 

 

4,200

 

 

4,200

 

     Trade accounts receivable, net of allowance for
        doubtful accounts of $774 and $689

 

 

6,656

 

 

2,849

 

     Trade accounts receivable – related party, net of
        allowance for doubtful accounts of $18

 

 

615

 

 

-

 

     Notes receivable

 

 

528

 

 

-

 

     Inventories

 

 

2,733

 

 

2,162

 

     Other current assets

 

 

1,913

 

 

134

 

 

 



 



 

Total current assets

 

 

21,324

 

 

12,566

 

 

 

 

 

 

 

 

 

Property and equipment, net

 

 

971

 

 

1,149

 

Intangible assets, net of accumulated amortization

 

 

0

 

 

2

 

 

 



 



 

Total

 

$

22,295

 

$

13,717

 

 

 



 



 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

     Trade accounts payable

 

$

5,431

 

$

1,240

 

     Payable to affiliate

 

 

2,049

 

 

121

 

     Note payable – current

 

 

767

 

 

613

 

     Deferred acquisition payment

 

 

1,078

 

 

-

 

     Accrued expenses and other

 

 

2,284

 

 

2,279

 

 

 



 



 

Total current liabilities

 

 

11,609

 

 

4,253

 

 

 



 



 

 

 

 

 

 

 

 

 

Minority Interest

 

 

1,227

 

 

-

 

 

 



 



 

 

 

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

 

 

     Common Stock, $.001 par value (50,000,000 shares
        authorized, 12,810,260 and 12,176,312 shares issued
        and outstanding)

 

 

13

 

 

12

 

     Additional paid-in capital

 

 

54,369

 

 

53,447

 

     Treasury stock, at cost (676,900 and 676,900 shares,
        respectively)

 

 

(1,502

)

 

(1,502

)

     Accumulated deficit

 

 

(43,421

)

 

(42,493

)

 

 



 



 

Total stockholders' equity

 

 

9,459

 

 

9,464

 

 

 

 

 

 

 

 

 

 

 



 



 

Total

 

$

22,295

 

$

13,717

 

 

 



 



 

See notes to financial statements.

30



eOn Communications Corporation
Consolidated Statements of Operation
s
For the Years Ended July 31, 2004, 2003, and 2002
(Dollars in thousands, except per share data)

 

 

Year Ended July 31,

 

 

 


 

 

 

2004

 

2003

 

2002

 

 

 


 


 


 

Net revenues

 

$

17,950

 

$

17,457

 

$

15,046

 

Cost of revenues

 

 

8,507

 

 

7,478

 

 

6,706

 

Special charges

 

 

-

 

 

-

 

 

752

 

 

 



 



 



 

          Gross profit

 

 

9,443

 

 

9,979

 

 

7,588

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

     Selling, general and administrative

 

 

7,087

 

 

8,667

 

 

9,538

 

     Research and development

 

 

3,106

 

 

2,859

 

 

2,959

 

     Special charges

 

 

-

 

 

(63

)

 

970

 

 

 



 



 



 

          Total operating expenses

 

 

10,193

 

 

11,463

 

 

13,467

 

 

 

 

 

 

 

 

 

 

 

 

Loss from operations

 

 

(750

)

 

(1,484

)

 

(5,879

)

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

29

 

 

35

 

 

6

 

Interest income

 

 

(79

)

 

(99

)

 

(287

)

Other (income) expense, net

 

 

167

 

 

84

 

 

210

 

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

Loss from continuing operations
   before income taxes and minority interest

 

 

(867

)

 

(1,504

)

 

(5,808

)

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

 

24

 

 

-

 

 

(121

)

 

 



 



 



 

Loss before minority interest

 

 

(891

)

 

(1,504

)

 

(5,687

)

 

 

 

 

 

 

 

 

 

 

 

Minority interest

 

 

(37

)

 

-

 

 

-

 

 

 



 



 



 

Loss before discontinued operations,
   extraordinary loss, and cumulative effect
   of change in accounting principle

 

 

(928

)

 

(1,504

)

 

(5,687

)

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from discontinued operations,
   net of income tax effect

 

 

-

 

 

-

 

 

(2,633

)

 

 

 

 

 

 

 

 

 

 

 

Cumulative effect of change in accounting
   principle, net of income tax effect

 

 

-

 

 

-

 

 

(10,375

)

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

Net loss and comprehensive loss

 

$

(928

)

$

(1,504

)

$

(18,695

)

 

 



 



 



 

 

 

 

 

 

 

 

 

 

 

 

Net loss per common share:

 

 

 

 

 

 

 

 

 

 

   Basic and diluted:

 

 

 

 

 

 

 

 

 

 

     Loss before discontinued
        operations and extraordinary items

 

$

(0.07

)

$

(0.12

)

$

(0.47

)

     Income (loss) from discontinued operations

 

 

-

 

 

-

 

 

(0.22

)

     Cumulative effect of change in accounting
        principle

 

 

-

 

 

-

 

 

(0.86

)

 

 



 



 



 

Net loss per common share

 

$

(0.07

)

$

(0.12

)

$

(1.56

)

 

 



 



 



 

See notes to financial statements.

31



eOn Communications Corporation
Consolidated Statements of Cash Flow
s
For the Years Ended July 31, 2004, 2003, and 2002
(Dollars in thousands)

 

 

Year Ended July 31,

 

 

 


 

 

 

2004

 

2003

 

2002

 

 

 


 


 


 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(928

)

$

(1,504

)

$

(18,695

)

Adjustments to reconcile net loss to net cash
   used in operating activities:

 

 

 

 

 

 

 

 

 

 

     Loss from discontinued operations

 

 

-

 

 

-

 

 

2,633

 

     Impairment of goodwill from adoption of FAS 142

 

 

-

 

 

-

 

 

10,375

 

     Depreciation and amortization

 

 

596

 

 

729

 

 

744

 

     Minority Interest

 

 

37

 

 

-

 

 

-

 

     Provision for the allowance for doubtful accounts

 

 

85

 

 

110

 

 

164

 

     Loss on investments

 

 

-

 

 

-

 

 

94

 

     Changes in net assets and liabilities (net of effect
        of discontinued operations):

 

 

 

 

 

 

 

 

 

 

               Trade accounts receivable

 

 

(2,523

)

 

(973

)

 

1,563

 

               Accounts receivable from/payable to affiliates

 

 

(106

)

 

37

 

 

24

 

               Notes receivable

 

 

(174

)

 

-

 

 

-

 

               Inventories

 

 

363

 

 

915

 

 

1,310

 

               Other assets

 

 

(26

)

 

(9

)

 

48

 

               Trade accounts payable

 

 

1,916

 

 

(52

)

 

(51

)

               Accrued special charges

 

 

-

 

 

(195

)

 

(707

)

               Accrued expenses and other

 

 

(569

)

 

(110

)

 

117

 

               Income taxes payable (refund receivable)

 

 

-

 

 

-

 

 

271

 

 

 



 



 



 

          Net cash used in operating activities

 

 

(1,329

)

 

(1,052

)

 

(2,110

)

 

 

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

 

 

 

     Net cash acquired in business acquisition

 

 

3,108

 

 

-

 

 

-

 

     Purchases of property and equipment

 

 

(345

)

 

(221

)

 

(301

)

     Disposal of property and equipment

 

 

146

 

 

-

 

 

-

 

     Sales of marketable securities

 

 

-

 

 

3,909

 

 

7,438

 

     Purchases of marketable securities

 

 

-

 

 

(1,500

)

 

(5,310

)

 

 



 



 



 

          Net cash provided by investing activities

 

 

2,909

 

 

2,188

 

 

1,827

 

 

 

 

 

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

 

 

 

     Repayment of note payable

 

 

(724

)

 

(665

)

 

(53

)

     Repurchases of common stock

 

 

-

 

 

(3

)

 

(203

)

     Proceeds from the exercise of stock options and
        employee stock purchase plan

 

 

602

 

 

71

 

 

84

 

 

 



 



 



 

          Net cash used in financing activities

 

 

(122

)

 

(597

)

 

(172

)

 

 

 

 

 

 

 

 

 

 

 

Cash used by discontinued operations

 

 

-

 

 

-

 

 

(453

)

32



eOn Communications Corporation
Consolidated Statements of Cash Flows (continued)
For the Years Ended July 31, 2004, 2003, and 2002

 

 

Year Ended July 31,

 

 

 


 

 

 

2004

 

2003

 

2002

 

 

 


 


 


 

Net increase (decrease) in cash and cash equivalents

 

 

1,458

 

 

539

 

 

(908

)

Cash and cash equivalents, beginning of year

 

 

3,221

 

 

2,682

 

 

3,590

 

 

 



 



 



 

Cash and cash equivalents, end of year

 

$

4,679

 

$

3,221

 

$

2,682

 

 

 



 



 



 

Supplemental cash flow information:

 

 

 

 

 

 

 

 

 

 

     Interest paid

 

$

29

 

$

35

 

$

6

 

     Income taxes paid

 

 

24

 

 

-

 

 

-

 

Noncash activity:

2002:

 

 

The Company distributed its entire ownership interest in Cortelco Systems Puerto Rico, Inc. to the shareholders of eOn via a stock distribution of 1,204,157 shares of CSPR on July 31, 2002.

 

 

 

The Company contributed a $264,000 note receivable plus accrued interest from our former parent, Cortelco Systems Holding Corporation, to Cortelco Systems Puerto Rico prior to the spin-off.

 

 

 

In connection with the lease termination agreement for the former facility in Memphis, Tennessee, the Company issued a non-interest bearing note payable in the amount of $1,400,000. After imputing a discount for interest over the life of the note, $1,331,000 was reclassified from accrued special charges upon the issuance of the note.

See notes to financial statements.

33



eOn Communications Corporation
Consolidated Statement of Stockholders' Equit
y
For the Years Ended July 31, 2004, 2003, and 2002
(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note
Receivable
From
Affiliate/
Former
Parent

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock

 

Additional
Paid-In
Capital

 

Treasury Stock

 

 

 

 

 

Total
Stockholders’
Equity

 

 

 


 

 


 

Accumulated
Deficit

 

 

 

 

 

Shares

 

Amount

 

 

Shares

 

Amount

 

 

 

 

 

 


 


 


 


 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at July 31, 2001

 

 

12,473,445

 

$

12

 

$

57,919

 

 

(431,500

)

$

(1,296

)

$

(22,294

)

$

(264

)

$

34,077

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of common stock

 

 

-

 

 

-

 

 

-

 

 

(234,500

)

 

(203

)

 

-

 

 

-

 

 

(203

)

Exercise of stock options

 

 

112,620

 

 

-

 

 

56

 

 

-

 

 

-

 

 

-

 

 

-

 

 

56

 

Issuances from employee stock purchase plan

 

 

120,569

 

 

-

 

 

81

 

 

-

 

 

-

 

 

-

 

 

-

 

 

81

 

Distribution of CSPR stock

 

 

-

 

 

-

 

 

(4,680

)

 

-

 

 

-

 

 

-

 

 

264

 

 

(4,416

)

Net loss and comprehensive loss

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

(18,695

)

 

-

 

 

(18,695

)

 

 



 



 



 



 



 



 



 



 

Balance at July 31, 2002

 

 

12,706,634

 

$

12

 

$

53,376

 

 

(666,000

)

$

(1,499

)

$

(40,989

)

$

-

 

$

10,900

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of common stock

 

 

-

 

 

-

 

 

-

 

 

(10,900

)

 

(3

)

 

-

 

 

-

 

 

(3

)

Exercise of stock options

 

 

34,831

 

 

-

 

 

34

 

 

-

 

 

-

 

 

-

 

 

-

 

 

34

 

Issuances from employee stock purchase plan

 

 

111,747

 

 

-

 

 

37

 

 

-

 

 

-

 

 

-

 

 

-

 

 

37

 

Net loss and comprehensive loss

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

(1,504

)

 

-

 

 

(1,504

)

 

 



 



 



 



 



 



 



 



 

Balance at July 31, 2003

 

 

12,853,212

 

$

12

 

$

53,447

 

 

(676,900

)

$

(1,502

)

$

(42,493

)

$

-

 

$

9,464

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options

 

 

355,023

 

 

1

 

 

510

 

 

-

 

 

-

 

 

-

 

 

-

 

 

511

 

Issuances from employee stock purchase plan

 

 

121,758

 

 

-

 

 

91

 

 

-

 

 

-

 

 

-

 

 

-

 

 

91

 

Issuances of common stock for acquisitions

 

 

157,167

 

 

-

 

 

321

 

 

-

 

 

-

 

 

-

 

 

-

 

 

321

 

Net loss and comprehensive loss

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

(928

)

 

-

 

 

(928

)

 

 



 



 



 



 



 



 



 



 

Balance at July 31, 2004

 

 

13,487,160

 

$

13

 

$

54,369

 

 

(676,900

)

$

(1,502

)

$

(43,421

)

$

-

 

$

9,459

 

 

 



 



 



 



 



 



 



 



 

See notes to financial statements.

34



eOn Communications Corporation
Notes to Consolidated Financial Statement
s
Years Ended July 31, 2004, 2003, and 2002

1.  DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION  

Description of Business - eOn Communications Corporation (the “Company” or “eOn”) designs, develops and markets communication products that include next generation communications servers and software which integrate and manage voice, email and Internet communications for customer contact centers and other applications. The Company also offers a traditional voice-switching platform which addresses the voice communication needs of small and medium-sized installations.  The company also owns a controlling interest in Cortelco Shanghai Telecom Equipment Company based in China, which provides fiber optic transmission equipment, data communications systems, and network management software.

Principles of Consolidation – The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, and includes the accounts of the company’s majority owned subsidiary, Cortelco Shanghai.  All significant balances and transactions have been eliminated during the consolidation. 

The Company also had a wholly-owned subsidiary, Cortelco Systems Puerto Rico, Inc. (“CSPR”), based in San Juan Puerto Rico. On August 28, 2001, the Board of Directors approved a plan to spin-off this subsidiary as a separate entity to the stockholders of eOn. This action was completed on July 31, 2002 via a distribution of all the outstanding shares of CSPR to the shareholders of eOn. Therefore, the assets, liabilities, results of operations and cash flows of this entity have been segregated and are reflected in the financial statements of eOn as a discontinued operation for all periods. The Company’s financial statements have been restated to conform to the discontinued operations presentation. See Footnote 4 for additional information.

The Company is affiliated with the following entities through common stockholder ownership:

 

CSPR (former subsidiary)

 

Cortelco Systems Holding Corporation (“CSHC”)

 

Cortelco International, Inc. (“CII”, subsidiary of CSHC)

 

Cortelco Puerto Rico, Inc. (“CPR”, subsidiary of CSHC)

 

Cortelco Canada (“CC”, subsidiary of CSHC)

 

Alcatel Shanghai Bell Co., Ltd. (“Shanghai Bell”)

2.  ACQUISITION OF CORTELCO SHANGHAI TELECOM EQUIPMENT COMPANY

On June 1, 2004, eOn acquired a controlling interest in Cortelco Shanghai Telecom Equipment Company (“Cortelco Shanghai”), a provider of fiber optic transmission equipment, data communications systems, and network management software in China.

Under the terms of the agreement, eOn acquired all of the stock of Cortelco China Corp, a California corporation that owns a 54.14% ownership interest in Cortelco Shanghai, from Cortelco Systems Holding Corporation (“CSHC”).  CSHC received 157,167 shares of eOn common stock valued at $321,250.  It is anticipated that up to an additional 471,501 shares may be issued over the next four fiscal quarters if Cortelco Shanghai attains specified revenue targets as set forth in the purchase agreement which is classified as Accrued earnout liability in the purchase allocation.   

35



This acquisition has been accounted for under the purchase method pursuant to Statement of Financial Accounting Standards No. 141, “Business Combinations.” A summary of the net assets acquired is as follows: 

Acquisition cost:

 

 

 

 

 

 

 

 

 

Shares issued on May 31, 2004

 

$

321,000

 

Additional Consideration

 

 

7,000

 

Total consideration

 

 

328,000

 

As of May 31, 2004:

 

 

 

 

Current assets

 

$

8,100,000

 

Long term assets

 

 

206,000

 

Current Liabilities

 

 

(5,710,000

)

Minority Interest

 

 

(1,190,000

)

Accrued earnout liability

 

 

(1,078,000

)

 

 



 

Net assets acquired

 

$

328,000

 

3.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  

Principles of Consolidation – The accompanying consolidated financial statements include the accounts of eOn Communications Corporation and its majority owned subsidiary — Cortelco Shanghai Telecom Equipment Company. All significant inter-company accounts and transactions have been eliminated in consolidation. 

Cash and Cash Equivalents - - All highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents.  At July 31, 2004 there was $2,924,392 held in foreign bank accounts.

Marketable Securities - Marketable securities are classified as available for sale and are reported at fair value. Unrealized holding gains and losses, if any, net of the related income tax effect, are excluded from income and are reported in other comprehensive income. Realized gains and losses are included in income on the specific identification method.  

Inventories - Inventories are valued at the lower of cost or market. Cost is determined by the first-in, first-out (“FIFO”) method.

Property and Equipment - Property and equipment are stated at cost. Depreciation is provided using the straight-line method for financial reporting purposes and accelerated methods for income tax reporting purposes over the estimated useful lives of the assets, generally three to five years.  Maintenance and repair costs are charged to expense as incurred.

Goodwill - Goodwill represented the cost in excess of the fair value of net assets acquired. Prior to July 31, 2001, these costs were being amortized on a straight line basis over twenty years. On August 1, 2001, the Company adopted FAS 142, “Goodwill and Other Intangible Assets” and ceased amortizing goodwill as of that date. It was also determined that goodwill was impaired as of that date, and the Company recorded an impairment charge of $10,375,000. See Footnote 5 for more information.

Intangible Assets - Intangible assets primarily represent costs incurred to acquire and/or establish patents, trademarks, and software technology. These costs are being amortized on a straight-line basis over the estimated useful lives of the assets, generally five years. The amortization period begins with the initial introduction of the underlying product to the market in order to properly match revenue and expense. The Company reviews the carrying value of intangible assets for impairment by comparing the net book value of such assets to the future undiscounted cash flows attributable to such assets whenever events or changes in circumstances occur which might indicate that the carrying amount might not be recoverable. If impairment is indicated, the carrying amount of the asset is written down to fair value.

36



Stock Compensation Plans - The Company has three stock-based compensation plans for employees and an Employee Stock Purchase Plan (ESPP), which are more fully described in Footnote 15. The Company accounts for those plans under the intrinsic value method, which follows the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the stock compensation plans had an exercise price equal to or greater than the market value of the underlying common stock on the grant date. Further, the ESPP is a noncompensatory plan under APB Opinion No. 25, and, as such, no compensation cost was recognized with respect to the ESPP.

The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation:

 

 

Fiscal Year Ended July 31,

 

 

 

 

 

 

 

2004

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

 

Net loss as reported

 

$

(928

)

$

(1,504

)

$

(18,695

)

Add: Stock-based compensation, as reported

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deduct: Total stock-based compensation

 

 

 

 

 

 

 

 

 

 

determined under fair value based method for all

 

 

(612

)

 

(995

)

 

(1,249

)

awards, net of tax

 

 

 

 

 

 

 

 

 

 

 

 



 



 



 

Pro forma net loss

 

$

(1,540

)

$

(2,499

)

$

(19,944

)

 

 

 

 

 

 

 

 

 

 

 

Net loss per share – basic and diluted:

 

 

 

 

 

 

 

 

 

 

     Net loss per share – as reported

 

$

(0.07

)

$

(0.12

)

$

(1.56

)

     Net loss per share – pro forma

 

$

(0.12

)

$

(0.21

)

$

(1.66

)

Product Warranties - The Company provides the customer with a warranty from the date of purchase. Estimated warranty obligations are recorded based on actual claims experience.

Income Taxes - Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided for deferred tax assets when it is more likely than not that the asset will not be realized.

Revenue Recognition – Revenues from our Millennium and eQueue products are recognized only when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price to the customer is fixed or determinable, and collectibility is reasonably assured. Generally, revenue is recognized (1) upon shipment for equipment and software, (2) as work is performed for professional services, and (3) in equal periodic amounts over the term of the contract for software and hardware maintenance.  The Company’s revenue recognition policies are in accordance with Staff Accounting Bulletin No. 104, “Revenue Recognition,” and Statement of Position No. 97-2, “Software Revenue Recognition”

Medical Care and Disability Benefit Plans - The Company is fully insured with respect to the medical and disability benefits offered to substantially all employees. The Company does not provide benefits to retired employees.

Earnings Per Share - The Company follows Statement of Financial Accounting Standard (“SFAS”) No. 128, “Earnings Per Share”,” which requires disclosure of basic and diluted earnings per share (“EPS”). Basic EPS is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the year.  Diluted EPS is similar to basic EPS except that the weighted average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares, such as options, had been issued.

37



Fair Value of Financial Instruments - The carrying amounts of financial instruments such as cash, accounts receivable, accounts payable, and notes payable approximate their fair value due to the short term nature of the instruments. 

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 disclosures 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.

Comprehensive Income - In June 1997, the Financial Accounting Standards Board (“FASB”) issued SFAS 130, “Reporting Comprehensive Income,” which establishes standards for reporting and display of comprehensive income and its components and requires a separate statement to report the components of comprehensive income for each period reported. For the years ended July 31, 2004, 2003, and 2002, net loss equaled comprehensive loss.

Research and Development Costs – The Company allocates expenses to Research and Development costs based on headcount that is partially dedicated to Research and Development activities.

Advertising Expense – The Company expenses advertising expenses as incurred. Advertising expenses for 2004, 2003, and 2002 were not significant.

Recently Issued Accounting Standards - In November 2002, the Emerging Issues Task force (“EITF”) reached a consensus regarding EITF Issue 00-21, Accounting for Revenue Arrangements with Multiple Deliverables.  The consensus addresses not only when and how an arrangement involving multiple deliverables should be divided into separate units of accounting but also how the arrangement's consideration should be allocated among separate units.  The adoption of EITF Issue 00-21 did not have a material impact on the Company’s results of operations or financial position.

In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, Accounting for Stock -Based Compensation – Transition and Disclosure (“SFAS 148”). SFAS 148 amends Statement No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), to provide alternative methods for voluntary transition to SFAS 123’s fair value method of accounting for stock-based employee compensation. SFAS 148 also requires disclosure of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net earnings (loss) and earnings (loss) per share in annual and interim financial statements. The provisions of SFAS 148 are effective in fiscal years beginning after December 15, 2002.  The Company has implemented the required disclosures of this pronouncement and will continue to account for stock options under the intrinsic value method.

In July 2003, the EITF reached consensus regarding EITF Issue 03-5,  Applicability of AICPA Statement of Position 97-2, Software Revenue Recognition, to nonsoftware deliverables.  The consensus addresses whether nonsoftware deliverables  in a multiple-element arrangement that includes software that is more than incidental to the products or services as a whole should be within the scope of SOP 97-2, Software Revenue Recognition.  The pronouncement is effective prospectively for arrangements entered into after the beginning of an entity’s next reporting period beginning after August 13, 2003.  The adoption of EITF Issue 03-5 did not have a material impact on the Company's results of operations or financial position. 

Reclassifications - Certain amounts in the 2003 and 2002 financial statements have been reclassified to conform with the 2004 presentation. 

38



4.  DISCONTINUED OPERATIONS  

On August 28, 2001, the Board of Directors of the Company approved a plan to spin-off Cortelco Systems Puerto Rico,  eOn’s wholly-owned Caribbean/Latin America service and distribution subsidiary, as an independent entity headquartered in San Juan, Puerto Rico. The spin-off transaction was completed on July 31, 2002 with the issuance of CSPR shares on a 1-for-10 basis to eOn stockholders.

The Company’s financial statements have been restated to reflect the Caribbean / Latin America subsidiary as a discontinued operation for all periods presented.  Summarized results of the discontinued business are shown separately as discontinued operations in the accompanying consolidated financial statements.

Operating results of the discontinued operations are as follows:

 

 

Year ended July 31,

 

 

 


 

 

 

2002

 

 

 


 

 

 

(In thousands)

 

 

 

 

 

Net sales

 

 

$

10,384

 

 

 

 

 



 

 

Loss before income taxes
   and extraordinary loss

 

 

 

(2,633

)

 

Income tax expense

 

 

 

-

 

 

 

 

 



 

 

 

 

 

 

 

 

 

Net loss from discontinued
   operations

 

 

$

(2,633

)

 

 

 

 



 

 

Net loss per share:

 

 

 

 

 

 

     Basic and Diluted

 

 

$

(0.22

)

 

5.  ACCOUNTING FOR GOODWILL 

In June 2001, the FASB issued SFAS No.142,  “Goodwill and Other Intangible Assets”  which changes the method by which companies may recognize intangible assets in purchase business combinations and generally requires identifiable intangible assets to be recognized separately from goodwill.  In addition, it eliminates the amortization of all existing and newly acquired goodwill on a prospective basis and requires companies to assess goodwill for impairment, at least annually, based on the fair value of the reporting unit associated with the goodwill.  The Company elected to early adopt SFAS No.142 on August 1, 2001, and ceased amortizing goodwill as of this date.

Goodwill of $11,724,000 had been recorded in conjunction with the acquisition of BCS Technologies in April 1999. This balance was subsequently reduced by $1,349,000 due to amortization expense in fiscal years 2001, 2000, and 1999.  On August 1, 2001 the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” which changed the method of evaluating goodwill from a recoverability test based upon undiscounted cash flows to a fair value approach. Accordingly, the Company's previously recognized goodwill was tested for impairment as of August 1, 2001. The Company calculated the fair value of the reporting unit using a combination of the Company’s quoted market prices and a discounted cash flow analysis. As a result of this analysis, the Company concluded that goodwill was impaired and recorded an impairment charge in the amount of $10,375,000, which is reflected as a cumulative effect of change in accounting principle in the accompanying consolidated statement of operations for the year ended July 31, 2002. The income tax effect of this change in accounting principle was $0.

39



6.  SPECIAL CHARGES   

To reduce costs and improve productivity, the Company adopted a restructuring plan during the second quarter of fiscal year 2001, which included headcount reductions and office space consolidation. During the fourth quarter of 2001, the Company made the decision to consolidate the majority of functions to its Atlanta headquarters. In fiscal 2002, the Company recorded additional special charges to reflect the impact of a lease termination agreement for its former facility in Memphis, Tennessee and to properly value excess inventories on hand at July 31, 2002. In fiscal 2003, the company settled all remaining property tax liabilities associated with the former facility in Memphis, Tennessee and recorded an expense reversal to reflect this favorable settlement and close out the restructuring accrual.

Major components of the restructuring plan included corporate management changes; the relocation and concentration of management and strategic functions at the Company’s headquarters in Atlanta, Georgia; site closures; outsourcing initiatives for the assembly, repair, and manufacturing of our products; and workforce reductions of approximately 40%. The majority of the restructuring plan was completed by July 31, 2002. 

As a result of the adoption of the restructuring plan, the Company recognized special charges  in operating expenses.  The special charge in operating expenses included ($63,000) and $970,000 in fiscal 2003 and 2002, respectively, for the expected costs associated with excess space at the Company’s locations in Memphis, Tennessee; Englewood, Colorado; and Guelph, Ontario.  The excess space resulted from the Company’s relocation of personnel and certain functions to the Atlanta headquarters and the corresponding reductions in the company’s workforce.

The Company also recognized special charges of $752,000 in cost of revenues during 2002. The noncash charge was recorded to properly value excess inventories in light of then-current economic conditions.

The following tables summarize the activity relating to the special charges during fiscal years 2003 and 2002 and the associated liabilities at July 31, 2003 and 2002:

 

 

July 31, 2001
Liability
Balance

 

Charges

 

Expenditures

 

Other
Adjustments

 

July 31, 2002
Liability
Balance

 

 

 


 


 


 


 


 

Inventory charges

 

 

$

-

 

 

 

$

752

 

 

$

-

 

 

 

$

(752

) (1)

 

 

$

-

 

 

Termination benefits

 

 

 

625

 

 

 

 

58

 

 

 

(622

)

 

 

 

-

 

 

 

 

61

 

 

Excess facilities cost

 

 

 

1,605

 

 

 

 

912

 

 

 

(1,013

)

 

 

 

(1,331

) (2)

 

 

 

173

 

 

Relocation costs

 

 

 

42

 

 

 

 

-

 

 

 

(42

)

 

 

 

-

 

 

 

 

-

 

 

 

 

 



 

 

 



 

 



 

 

 



 

 

 



 

 

     Total

 

 

$

2,272

 

 

 

$

1,722

 

 

$

(1,677

)

 

 

$

(2,083

)

 

 

$

234

 

 

 

 

 



 

 

 



 

 



 

 

 



 

 

 



 

 


 

 

July 31, 2002
Liability
Balance

 

Charges

 

Expenditures

 

Other
Adjustments

 

July 31, 2003
Liability
Balance

 

 

 


 


 


 


 


 

Termination benefits

 

 

 

61

 

 

 

 

-

 

 

 

(61

)

 

 

 

-

 

 

 

 

-

 

 

Excess facilities cost

 

 

 

173

 

 

 

 

(63

)

 

 

(110

)

 

 

 

-

 

 

 

 

-

 

 

 

 

 



 

 

 



 

 



 

 

 



 

 

 



 

 

     Total

 

 

$

234

 

 

 

$

(63

)

 

$

(171

)

 

 

$

-

 

 

 

$

-

 

 

 

 

 



 

 

 



 

 



 

 

 



 

 

 



 

 

(1)  Represents write-down of inventory to net realizable value

(2)  Reflects issuance of note payable in connection with the lease termination agreement for the Company’s former facility in Memphis, Tennessee. The note payable does not bear interest and is payable in 24 equal monthly installments beginning July 1, 2002 and ending June 1, 2004.

40



7.  MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK 

Financial instruments which potentially subject the Company to a concentration of credit risk consist principally of cash, marketable securities, trade accounts receivable, and notes receivable. The Company maintains its cash balances with large regional financial institutions and has not experienced losses. The marketable securities are invested in accounts at large national brokerages which maintain insurance coverage. The Company's products are sold principally to dealers, value added resellers, national accounts, the U.S. government and foreign telecommunications companies. The Company's credit risk is limited principally to trade accounts receivable. The Company performs ongoing credit evaluations of its customers and generally does not require collateral.  No additional risk beyond amounts provided for collection losses is believed inherent in the Company's trade accounts receivable.

The company had sales to a single customer during 2004 that equaled 11% of total sales.  The related accounts receivable due from this customer at July 31, 2004 was $428,810.

8.  MARKETABLE SECURITIES

Marketable securities consists of the following:

 

 

July 31, 2004

 

July 31, 2003

 

 

 


 


 

 

 

Cost

 

Market value

 

Cost

 

Market Value

 

 

 


 


 


 


 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Municipal bonds

 

$

4,200

 

 

$

4,200

 

 

$

4,200

 

 

$

4,200

 

 

 

 



 

 



 

 



 

 



 

 

     Total

 

$

4,200

 

 

$

4,200

 

 

$

4,200

 

 

$

4,200

 

 

 

 



 

 



 

 



 

 



 

 

The municipal bond investments are comprised solely of taxable auction-rate securities with stated maturities ranging from 17-26 years. Due to the fact that these investments have frequent interest rate resets, the Company did not have any gross unrealized gains or losses at July 31, 2004 or 2003. The Company has classified the municipal bonds as available for sale investments.

The Company has pledged a $175,000 municipal security to secure a standby letter of credit associated with the sublease termination agreement for the Memphis facility. 

9.  INVENTORIES    

The Company accounts for inventories at the lower of cost or market. Cost has been determined by the first-in, first-out (“FIFO”) method.  The Company adopted FIFO costing for these inventories as of August 1, 2001 in order to provide a better matching of revenues and costs and to conform to a single method of accounting for all of the Company’s inventories. The effect of the accounting change on income for fiscal year 2002 was as follows:

 

 

2002

 

 

 


 

 

 

(In thousands, except per share data)

 

 

 

 

 

 

 

 

Decrease in loss before discontinued
   operations and extraordinary items

 

 

$

8

 

 

 

 

 

 

 

 

 

Increase in basic and diluted loss per common share

 

 

$

0.00

 

 

 

 

 



 

 

The balance of accumulated deficit as of July 31, 2000 was adjusted for the effect of applying retroactively the new method of accounting.

Inventories consist of the following:

 

 

2004

 

2003

 

 

 


 


 

 

 

(In thousands)

 

Raw materials and purchased components

 

$

723

 

$

392

 

Finished goods

 

 

2,010

 

 

1,770

 

 

 



 



 

     Total inventories

 

$

2,733

 

$

2,162

 

 

 



 



 

41



10. OTHER CURRENT ASSETS

Other current assets consists of the following:

 

 

2004

 

2003

 

 

 


 


 

 

 

(In thousands)

 

Customer deposits

 

$

794

 

$

-

 

Advances to suppliers

 

 

893

 

 

-

 

Prepaid expenses

 

 

132

 

 

96

 

Other

 

 

94

 

 

38

 

 

 



 



 

     Total

 

 

1,913

 

 

134

 

11. PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

 

 

2004

 

2003

 

 

 


 


 

 

 

(In thousands)

 

Leasehold improvements

 

$

311

 

$

300

 

Equipment

 

 

2,565

 

 

3,593

 

Furniture and fixtures

 

 

501

 

 

751

 

 

 



 



 

     Total

 

 

3,377

 

 

4,644

 

Less accumulated depreciation

 

 

(2,406

)

 

(3,495

)

 

 



 



 

     Property and equipment, net

 

$

971

 

$

1,149

 

 

 



 



 

Depreciation expense was $596,000, $703,000, and $711,000 for 2004, 2003, and 2002, respectively.

12. ACCRUED EXPENSES AND OTHER

Accrued expenses and other consists of the following:

 

 

2004

 

2003

 

 

 


 


 

 

 

(In thousands)

 

Employee compensation

 

$

197

 

$

362

 

Commissions

 

 

37

 

 

65

 

Vacation

 

 

35

 

 

271

 

Deferred income

 

 

651

 

 

657

 

Employee withholdings

 

 

533

 

 

69

 

Warranty reserve

 

 

361

 

 

283

 

Other

 

 

470

 

 

572

 

 

 



 



 

     Total

 

$

2,284

 

$

2,279

 

 

 



 



 

FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), requires that upon issuance of a guarantee, the guarantor must disclose and recognize a liability for the fair value of the obligation it assumes under that guarantee. 

42



The requirements of FIN 45 are applicable to the Company’s product warranty liability. As of July 31, 2004 and July 31, 2003, the Company’s product warranty liability recorded in other accrued liabilities was $361,000 and $283,000, respectively. The following table summarizes the activity related to the product warranty liability during fiscal 2004 and 2003 (in thousands):

 

 

July 31, 2004

 

July 31, 2003

 

 

 


 


 

Balance at beginning of period

 

 

$

283

 

 

 

$

199

 

 

Accruals for warranty liability

 

 

 

325

 

 

 

 

312

 

 

Warranty expense

 

 

 

(247

)

 

 

 

(228

)

 

 

 

 



 

 

 



 

 

Balance at end of period

 

 

$

361

 

 

 

$

283

 

 

 

 

 



 

 

 



 

 

13. LEASE COMMITMENTS 

The Company leases its primary warehouse and office facilities, as well as certain office equipment under operating leases.

The following is a schedule of future minimum lease payments required under operating leases that have remaining initial or noncancellable lease terms in excess of one year as of July 31, 2004:

Year Ending July 31, 2004

 

(In thousands)

 

 

 


 

2005

 

 

$

287

 

 

2006

 

 

 

288

 

 

2007

 

 

 

182

 

 

2008

 

 

 

-

 

 

Thereafter

 

 

 

-

 

 

 

 

 



 

 

     Total

 

 

$

757

 

 

 

 

 



 

 

Rent expense for the years ended July 31, 2004, 2003, and 2002 totaled $357,000, $319,000, and $327,000, respectively.

14. INCOME TAXES   

The income tax provision is summarized as follows:

 

 

2004

 

2003

 

2002

 

 

 


 


 


 

 

 

(In thousands)

 

Continuing operations

 

$

24

 

$

-

 

$

(121

)

Discontinued operations

 

 

-

 

 

-

 

 

-

 

Extraordinary item

 

 

-

 

 

-

 

 

-

 

 

 



 



 



 

     Total income tax benefit

 

 

24

 

 

-

 

 

(121

)

 

 



 



 



 

The components of income tax expense (benefit) for 2004, 2003, and 2002 attributable to continuing operations are as follows:

 

 

2004

 

2003

 

2002

 

 

 


 


 


 

 

 

(In thousands)

 

Current:

 

 

 

 

 

 

 

 

 

 

     Federal

 

$

-

 

$

-

 

$

(121

)

     State

 

 

-

 

 

-

 

 

-

 

     Foreign Income Tax Expense

 

 

24

 

 

-

 

 

-

 

 

 



 



 



 

          Total current

 

 

24

 

 

-

 

 

(121

)

 

 

 

 

 

 

 

 

 

 

 

Deferred:

 

 

 

 

 

 

 

 

 

 

     Federal

 

 

-

 

 

-

 

 

-

 

     State

 

 

-

 

 

-

 

 

-

 

 

 



 



 



 

          Total deferred

 

 

-

 

 

-

 

 

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 



 



 

Total income tax expense (benefit)

 

$

24

 

$

-

 

$

(121

)

 

 



 



 



 

43



A reconciliation between the income tax expense (benefit) from continuing operations recognized in the Company’s consolidated statement of operations and the income tax benefit computed by applying the domestic federal statutory income tax rate to income from continuing operations before income taxes is as follows:

 

 

2004

 

2003

 

2002

 

 

 


 


 


 

 

 

(In thousands)

 

Income tax at Federal statutory rate (35%)

 

$

(340

)

$

(526

)

$

(5,664

)

State income taxes, net of federal benefit

 

 

(35

)

 

(66

)

 

(308

)

Change in valuation allowance

 

 

245

 

 

120

 

 

2,227

 

Amortization of goodwill

 

 

-

 

 

-

 

 

3,631

 

Adjustment to effective state tax rate

 

 

120

 

 

-

 

 

-

 

Over provision of deferred taxes in prior year

 

 

-

 

 

461

 

 

-

 

Foreign income tax expense

 

 

24

 

 

-

 

 

-

 

Other, net

 

 

11

 

 

10

 

 

(7

)

 

 



 



 



 

     Total income tax expense (benefit)

 

$

24

 

$

-

 

$

(121

)

 

 



 



 



 

The deferred tax effects of the Company’s principal temporary differences at July 31, 2004 and 2003 are as follows:

2004

 

Assets

 

Liabilities

 

Total

 

 

 


 


 


 

 

 

(In thousands)

Allowance for doubtful receivables

 

$

207

 

 

$

-

 

 

$

207

 

Inventories

 

 

653

 

 

 

-

 

 

 

653

 

Basis difference in property and equipment

 

 

33

 

 

 

-

 

 

 

33

 

Accrued warranty costs

 

 

156

 

 

 

-

 

 

 

156

 

Accrued expenses and other

 

 

-

 

 

 

(58

)

 

 

(58

)

Deferred revenue

 

 

232

 

 

 

-

 

 

 

232

 

Loss reserve

 

 

326

 

 

 

-

 

 

 

326

 

Net operating loss carryforwards

 

 

7,086

 

 

 

-

 

 

 

7,086

 

Capital loss carryforward

 

 

36

 

 

 

-

 

 

 

36

 

Valuation allowance

 

 

(8,729

)

 

 

58

 

 

 

(8,671

)

 

 



 

 



 

 



 

     Total deferred asset (liability)

 

$

-

 

 

$

-

 

 

$

-

 

 

 



 



 



 


 


2003

 

Assets

 

Liabilities

 

Total

 


 


 


 


 

 

 

(In thousands)

 

Allowance for doubtful receivables

 

$

256

 

 

$

-

 

 

$

256

 

Inventories

 

 

551

 

 

 

-

 

 

 

551

 

Basis difference in property and equipment

 

 

59

 

 

 

-

 

 

 

59

 

Accrued warranty costs

 

 

116

 

 

 

-

 

 

 

116

 

Accrued expenses and other

 

 

101

 

 

 

-

 

 

 

101

 

Deferred revenue

 

 

180

 

 

 

-

 

 

 

180

 

Loss reserve

 

 

332

 

 

 

-

 

 

 

332

 

Net operating loss carryforwards

 

 

6,632

 

 

 

-

 

 

 

6,632

 

Capital loss carryforward

 

 

199

 

 

 

-

 

 

 

199

 

Valuation allowance

 

 

(8,426

)

 

 

-

 

 

 

(8,426

)

 

 



 

 



 

 



 

     Total deferred asset (liability)

 

$

-

 

 

$

-

 

 

$

-

 

 

 



 

 



 

 



 

44



Due to uncertainties surrounding the timing of realizing the benefits of its net favorable tax attributes in future tax returns; the Company has placed a valuation allowance against its deferred tax assets at July 31, 2004 and 2003.

At July 31, 2004, net operating loss carryforwards of approximately $18.8 million are available to reduce future taxable income. The net operating loss carryforwards expire as follows:

 

 

NOL

 

 

 


 

 

 

(In thousands)

 

2012

 

 

$

63

 

 

2013

 

 

 

233

 

 

2020

 

 

 

9

 

 

2021

 

 

 

6,167

 

 

2022

 

 

 

8,730

 

 

2023

 

 

 

2,283

 

 

2024

 

 

 

1,346

 

 

 

 

 



 

 

     Total

 

 

$

18,830

 

 

 

 

 



 

 

No provision has been made for income taxes which may become payable upon distribution of the foreign subsidiary’s earnings since management considers essentially all of these earnings permanently invested. As of July 31, 2004 the unrecorded tax liability related to the undistributed earnings of the Company’s foreign subsidiary was insignificant.

15.  EQUITY INCENTIVE PLANS

The Company’s Equity Incentive Plans, adopted in fiscal years 1997, 1999 and 2001, authorize the granting of incentive stock options, supplemental stock options, stock bonuses, and restricted stock purchase agreements to officers, directors, and employees of the Company and to non-employee consultants. Incentive stock options are granted only to employees and are issued at prices not less than 100% of the fair market value of the stock at the date of grant. The options generally vest over a four-year period and the term of any option cannot be greater than ten years from the date of grant. Stock bonuses and restricted stock purchase agreements are issued at prices not less than 85% of the fair market value of the stock at the date of grant.

No grants were made under the 1997 Equity Incentive Plan during 2004, 2003, or 2002. The board of directors has declared that no future grants will be made under this plan.

The board of directors has authorized up to an aggregate of 2,000,000 shares of the Company’s common stock for issuance under the 1999 Equity Incentive Plan. 264,000, 215,000, and 200,000 options were issued under this plan during fiscal years 2004, 2003, and 2002, respectively, with exercise prices ranging from $0.45 to $3.27 per share.

During fiscal year 2001, the board of directors authorized 500,000 shares of the Company’s common stock for issuance under the 2001 Equity Incentive Plan. Grants to officers or directors are prohibited under the terms of this plan. 64,000, 81,250, and 130,500 options, respectively, were issued under this plan during fiscal years 2004, 2003, and 2002, respectively, with exercise prices ranging from $0.24 - $3.99.

Additionally, during 1999, the board of directors adopted an Employee Stock Purchase Plan which permits employees to purchase up to 250,000 shares of the Company’s common stock. The plan was amended in 2001 to increase the number of shares available under the plan to 500,000. The purchase price under this plan is 85% of the fair market value of the common stock at the beginning of an offering period or on a purchase date, whichever is less.  Offering periods generally last one year with purchase dates six and twelve months from the beginning of an offering period. The plan qualifies as a noncompensatory plan under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” 121,758, 111,747, and 120,569 shares were purchased by employees under this plan during fiscal years 2004, 2003, and 2002, respectively.

45



The status of the Company’s equity incentive plans is summarized below:

 

 

2004

 

2003

 

2002

 

 

 


 


 


 

 

 

Number of
Shares

 

Weighted
Average
Exercise
Price

 

Number of
Shares

 

Weighted
Average
Exercise
Price

 

Number of
Shares

 

Weighted
Average
Exercise
Price

 

 

 


 


 


 


 


 


 

Outstanding, beginning of year

 

 

1,824,053

 

 

$

3.66

 

 

 

1,842,566

 

 

$

3.90

 

 

 

2,002,837

 

 

$

4.71

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Granted

 

 

328,000

 

 

 

3.15

 

 

 

296,250

 

 

 

1.48

 

 

 

330,500

 

 

 

0.51

 

 

     Exercised

 

 

(355,023

)

 

 

1.44

 

 

 

(34,831

)

 

 

0.98

 

 

 

(113,192

)

 

 

0.03

 

 

     Cancelled

 

 

(165,560

)

 

 

1.95

 

 

 

(279,932

)

 

 

3.28

 

 

 

(377,579

)

 

 

6.39

 

 

 

 



 

 



 

 



 

 



 

 



 

 



 

 

Outstanding, end of year

 

 

1,631,470

 

 

$

4.21

 

 

 

1,824,053

 

 

$

3.66

 

 

 

1,842,566

 

 

$

3.90

 

 

 

 



 

 



 

 



 

 



 

 



 

 

 


 

 

Exercisable, end of year

 

 

1,082,180

 

 

$

5.10

 

 

 

1,184,425

 

 

$

4.75

 

 

 

1,009,162

 

 

$

5.34

 

 

 

 



 

 



 

 



 

 



 

 



 

 



 

 

Exercise price range

 

 

$0.24-$24.25

 

 

$0.24-$24.25

 

 

$0.24 - $24.25

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Options available for
   grant, end of year

 

 

559,600

 

 

725,311

 

 

743,054

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average grant date
   fair value of options
   granted during the year

 

 

 $ 2.65

 

 

 $ 1.20

 

 

 $ 0.57

 

The following table summarizes information about the options outstanding as of July 31, 2004:

 

 

Options Outstanding

 

Options Exercisable

 

 

 


 


 

Range of
Exercise
Prices

 

Outstanding
at
July 31,
2004

 

Weighted
Average
Remaining
Contractual
Life

 

Weighted
Average
Exercise
Price

 

Exercisable
at
July 31,
2004

 

Weighted
Average
Exercise
Price

 


 


 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$0.00 -$5.00

 

 

1,218,691

 

 

7.0 years

 

 

$

2.43

 

 

 

669,401

 

 

$

2.41

 

 

$5.01 - $10.00

 

 

317,979

 

 

3.4 years

 

 

$

8.74

 

 

 

317,979

 

 

$

8.74

 

 

$10.01 - $15.00

 

 

86,300

 

 

5.0 years

 

 

$

10.73

 

 

 

86,300

 

 

$

10.73

 

 

$15.01 - $25.00

 

 

8,500

 

 

3.7 years

 

 

$

24.25

 

 

 

8,500

 

 

$

24.25

 

 

 

 



 



 

 



 

 



 

 



 

 

 

 

 

1,631,470

 

 

6.2 years

 

 

$

4.21

 

 

 

1,082,180

 

 

$

5.10

 

 

 

 



 



 

 



 

 



 

 



 

 

The Company accounts for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, under which no compensation cost for stock options is recognized for options granted at or above the fair market value of the underlying common stock. The company recognized $53,000 in compensation expense during FY 2002 for stock grants to employees. No compensation expense related to stock options was recorded during 2004 or 2003 as the option exercise prices were equal to or greater than the fair market value of the underlying common stock on the date of the grant. In addition, no compensation expense was recognized on any purchases of common stock under the Employee Stock Purchase Plan during the year. Had compensation expense been determined based upon fair values of the options at the grant date in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation”, the Company’s net income (loss) and earnings per share would have been as follows:

 

 

2004

 

2003

 

2002

 

 

 


 


 


 

 

 

(In thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss:

 

 

 

 

 

 

 

 

 

 

 

 

     As reported

 

$

(928

)

$

(1,504

)

 

$

(18,695

)

 

     Pro forma

 

 

(1,540

)

 

(2,499

)

 

 

(19,944

)

 

Loss per share:

 

 

 

 

 

 

 

 

 

 

 

 

          As reported – basic and diluted

 

$

(0.07

)

$

(0.12

)

 

$

(1.56

)

 

          Pro forma – basic and diluted

 

$

 (0.12

)

$

(0.21)

 

 

$

(1.66)

 

 

46



The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:

 

 

2004

 

2003

 

2002

 

 

 


 


 


 

Risk-free interest rate

 

 

4.25

%

 

4.25

%

 

4.25

%

Dividend yield

 

 

-

 

 

-

 

 

-

 

Expected volatility

 

 

100

%

 

75

%

 

75

%

Expected option life in years

 

 

7

 

 

10

 

 

10

 

16.   RELATED PARTIES

The following represent related party transactions:

 

 

Year Ended July 31,

 

 

 

 

 

 

 

2004

 

2003

 

2002

 

 

 


 


 


 

 

 

(In thousands)

 

Purchases from CSHC and subsidiaries

 

 

609

 

 

615

 

 

784

 

Sales to CSHC and subsidiaries

 

 

-

 

 

-

 

 

1

 

Sales to CSPR

 

 

-

 

 

28

 

 

-

 

Purchases from Shanghai Bell

 

 

25

 

 

-

 

 

-

 

Sales to Shanghai Bell

 

 

134

 

 

-

 

 

-

 

The following represent related party balances:

 

 

July 31,

 

 

 

 

 

 

 

2004

 

2003

 

 

 


 


 

 

 

(In thousands)

 

Payable to CII

 

 

64

 

 

121

 

Payable to Shanghai Bell

 

 

1,985

 

 

-

 

In addition, at July 31, 1998 the Company had a $3,184,000 note receivable from CSHC that was reflected as a reduction of stockholder’s equity in the accompanying financial statements. The note was to mature on  December 31, 2002. During 1999, the Company received 250,000 shares of its common stock from CSHC in exchange for a $2,500,000 reduction of the outstanding note balance. Additionally, the Company loaned the former parent $2,600,000. The loan was due and payable on demand and provided for interest at a rate equal to prime plus 1.5%. During 2000, the Company received $420,000 in principal payments against the note receivable and distributed the $2,600,000 note to CSHC in payment of a dividend payable. During 2002, the note receivable and accrued interest was contributed to CSPR prior to the spin-off.

The acquisition disclosed in footnote 2 was made from an entity related to eOn through common ownership.

17.  EMPLOYEE SAVINGS PLAN 

Substantially all employees of the company can participate in the eOn Communications Corporation Profit Sharing Savings Plan, which is qualified under Section 401 of the Internal Revenue Code. Under the provisions of the plan, all participants may contribute up to 60% of their compensation, subject to limitations established by the Internal Revenue Service. The Company may contribute a matching contribution of not less than 50% of the employee contributions up to 6% of the employee’s compensation. The Company may also provide special discretionary contributions equal to a percentage of an employee’s annual compensation and/or an amount determined by management. During 2004, 2003, and 2002, contributions made by the Company totaled $77,000, $79,000, and $96,000, respectively.

18.  COMMITMENTS AND CONTINGENCIES

At July 31, 2004, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $1,518,000.

47



During fiscal 2002, the Company entered into a lease termination agreement for its former facility in Memphis, Tennessee. A $1,400,000 declining balance letter of credit was issued to secure payments under the termination agreement. The balance of the letter of credit as of July 31, 2004 was $175,000.  

The Company is involved in various matters of litigation, claims, and assessments arising in the ordinary course of business.  In the opinion of management, the eventual disposition of these matters will not have a material adverse effect on the financial statements.

19. SEGMENT INFORMATION

The company is comprised of two principal business segments:  eOn US and Cortelco Shanghai.  The eOn US business segment designs, develops and markets communication products for customer contact centers and other applications and offers a traditional voice-switching platform. Cortelco Shanghai provides fiber optic transmission equipment, data communications systems, and network management software.  There is no overlap in operational management reporting or of decision making authority between the two segments as defined.  Following is a tabulation of business segment information on eOn US for fiscal year ended July 31, 2004 and for Cortelco Shanghai for the two months ended July 31, 2004.

 

 

eOn US

 

Cortelco
Shanghai

 

Consolidated

 

 

 


 


 


 

 

 

(In thousands)

 

Revenues from customers

 

$

15,576

 

 

$

2,282

 

 

 

$

17,858

 

 

Revenues from other segments

 

 

92

 

 

 

-

 

 

 

 

92

 

 

 

 



 

 



 

 

 



 

 

Total revenues

 

$

15,668

 

 

$

2,282

 

 

 

$

17,950

 

 

Total expenses

 

 

16,640

 

 

 

2,238

 

 

 

 

18,878

 

 

 

 



 

 



 

 

 



 

 

Business segment income(loss)

 

$

(972

)

 

$

44

 

 

 

$

(928

)

 

 

 



 

 



 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

$

585

 

 

$

11

 

 

 

$

596

 

 

Interest income

 

 

62

 

 

 

17

 

 

 

 

79

 

 

Interest expense

 

 

29

 

 

 

-

 

 

 

 

29

 

 

Income tax expense

 

 

-

 

 

 

24

 

 

 

 

24

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital Expenditures

 

$

334

 

 

$

11

 

 

 

$

345

 

 

Business Segment Assets at July 31, 2004

 

$

11,716

 

 

$

10,218

 

 

 

$

21,934

 

 

20. EARNINGS PER SHARE

The computation of basic and diluted earnings per share for each year were as follows:

 

 

2004

 

2003

 

2002

 

 

 


 


 


 

 

 

(In thousands, except per share data)

 

Basic and diluted loss per share:

 

 

 

 

 

 

 

 

 

 

 

 

     Loss before discontinued operations and
        extraordinary items

 

 

$

(928

)

 

 

$

(1,504

)

 

 

$

(5,687

)

 

     Weighted average shares outstanding

 

 

 

12,522

 

 

 

 

12,091

 

 

 

 

12,013

 

 

 

 

 



 

 

 



 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

          Basic and diluted loss per share before
             discontinued operations and extraordinary items

 

 

$

(0.07

)

 

 

$

(0.12

)

 

 

 

(0.47

)

 

 

 

 



 

 

 



 

 

 



 

 

50



Potential common shares related to options outstanding at July 31, 2004 to purchase 1,631,470 shares of common stock were excluded from the computation of diluted loss per share for the year ended July 31, 2004 because their inclusion would have had an antidilutive effect.

Potential common shares related to options outstanding at July 31, 2003 to purchase 1,824,053 shares of common stock were excluded from the computation of diluted loss per share for the year ended July 31, 2003 because their inclusion would have had an antidilutive effect.

Potential common shares related to options outstanding at July 31, 2002 to purchase 1,842,566 shares of common stock were excluded from the computation of diluted loss per share for the year ended July 31, 2002 because their inclusion would have had an antidilutive effect.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

On June 5, 2003, upon the recommendation of the Audit Committee of the Board of Directors of eOn Communications Corporation (the “Company”), the Board of Directors decided to no longer engage Deloitte & Touche LLP (“Deloitte”) as the Company’s independent auditor, and engaged Grant Thornton, LLP (“Grant Thornton”) to serve as the Company’s independent auditor for the fiscal year ending July 31, 2003.  

Deloitte’s reports on the Company’s consolidated financial statements for each of the fiscal years ended July 31, 2002 and 2001, did not contain an adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting principles. Deloitte’s report on the Company’s consolidated financial statements for 2002 was issued on an unqualified basis in conjunction with the publication of the Company’s 2002 Annual Report and the filing of the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2002.  

During the Company’s fiscal years ended July 31, 2002 and 2001, and the subsequent interim period through June 5, 2003, there were no disagreements with Deloitte on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which, if not resolved to Deloitte’s satisfaction, would have caused them to make reference to the subject matter in connection with their reports on the Company’s consolidated financial statements for such fiscal years.  

None of the reportable events described under Item 304(a)(1)(v) of Regulation S-K occurred within the Company’s fiscal years ended July 31, 2002 and 2001, or the subsequent interim period through June 5, 2003. 

During the Company’s fiscal years ended July 31, 2002 and 2001, and the subsequent interim period through June 5, 2003, the Company did not consult Grant Thornton regarding (i) either the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the Company’s consolidated financial statements, or (ii) any matter that was either the subject of a disagreement (as defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions) or a reportable event (as described in Item 304(a)(1)(v) of Regulation S-K). 

ITEM 9a.  CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures. Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

49



Changes in internal control over financial reporting.  Cortelco Shanghai has historically maintained its books and records in accordance with the Generally Accepted Accounting Principles adopted in the People’s Republic of China (“PRC GAAP”).  Since the acquisition during the fourth quarter of this year, eOn must include Cortelco Shanghai’s financial information in its consolidated financial statements for its fourth quarter and fiscal year 2004 in accordance with the Generally Accepted Accounting Principles adopted in the United States of America (“US GAAP”).  A number of adjustments were made to adjust Cortelco Shanghai’s year end financial information from PRC GAAP to US GAAP. 

eOn’s auditors have rendered an unqualified opinion with respect to eOn’s consolidated financial statements, which include the financial information for Cortelco Shanghai.  However, during the course of the audit of Cortelco Shanghai, the auditors identified certain material internal control deficiencies in Cortelco Shanghai’s financial reporting which could adversely affect the reliability of financial reporting for future periods if not corrected.  Specifically, the auditors noted that the Cortelco Shanghai accounts were not analyzed or reconciled on a monthly, quarterly, or annual basis, as part of the closing process, and there was no provision for any review of any such reconciliations.  The auditors noted that there was no standardized methodology to reconcile the differences between U.S. GAAP and PRC GAAP, and the auditors made numerous adjustments relating to the revenue recognition differences between U.S. GAAP and PRC GAAP.  The auditors concluded that while it was evident that eOn has qualified accounting and finance personnel, Cortelco Shanghai does not have the skilled personnel to accumulate and report financial information in accordance with U.S. GAAP.  In addition, management of Cortelco Shanghai had not established proper physical inventory counting procedures for the relevant staff to follow.

eOn has taken the following actions to address the internal control issues identified by the auditors:

1.

Cortelco Shanghai has hired a person trained in preparing financial information, with an MBA from a United States university , who is a native of the People’s Republic of China and has experience and knowledge with both PRC GAAP and US GAAP;

 

 

2.

eOn has begun the process of taking an inventory of Cortelco Shanghai’s internal controls and making adjustments as necessary to conform with eOn’s systems of internal controls over financial reporting;

 

 

3.

Commencing September 2004, Cortelco Shanghai is reconciling every account monthly, and delivers reconcilement information to eOn monthly for review by eOn’s Controller and the Chief Financial Officer; and

 

 

4.

By the end of October 2004 Cortelco Shanghai will have delivered detailed account information to verify that appropriate adjustments are being made between U.S. GAAP and PRC GAAP. Cortelco Shanghai will deliver such information to eOn monthly.

eOn believes that these actions will satisfactorily address the control deficiencies identified by its auditors and will help ensure that internal controls are sufficient at Cortelco Shanghai to provide reasonable assurance regarding the reliability of the financial information provided to eOn.  eOn will continue to monitor Cortelco Shanghai’s financial reporting systems and controls closely to ensure that any deficiencies are promptly identified and corrected.

Other than as described above, there was no change in our internal control over financial reporting during our fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

50



ITEM 9b.  OTHER INFORMATION

There were no events that occurred in the fourth quarter that were not previously disclosed in a form 8-K.

51



PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

Information set forth under the captions “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive Proxy Statement for the 2004 Annual Meeting of Shareholders to be held on November 30, 2004 (the “Proxy Statement”), which will be filed with the Securities and Exchange Commission not later than 120 days after July 31, 2004, are incorporated herein by reference in response to this item..

Information with respect to executive officers is set forth under the caption “Executive Officers” in Part I of this report.

The Company has adopted a Code of Ethics that applies to all employees, which is attached as Exhibit 14.1 to this report. We intend to satisfy the disclosure requirement under Item 10 of Form 10-K regarding an amendment to, or waiver from, a provision of this code of ethics by posting such information on our investor relations website – investor.eoncc.com.

ITEM 11.  EXECUTIVE COMPENSATION.

Information set forth under the caption “Executive Compensation” in the Proxy Statement is incorporated herein by reference in response to this item.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

Information set forth under the caption “Stock Ownership” in the Proxy Statement is incorporated herein by reference in response to this item.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS.

Information set forth under the caption “Certain Transactions” in the Proxy Statement is incorporated herein by reference.

ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information set forth under the caption “Fees Paid to the Independent Auditors” in the Proxy Statement is incorporated herein by reference.

53



PART IV

ITEM 15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

(A)          (1) Financial Statements

The following information appears in Item 8 of Part II of this Report:

 

- Report of Independent Registered Public Accounting Firm

 

- Consolidated Balance Sheets as of July 31, 2004 and 2003

 

- Consolidated Statements of Operations for the Years Ended July 31, 2004, 2003, and 2002

 

- Consolidated Statements of Cash Flows for the Years Ended July 31, 2004, 2003, and 2002

 

- Consolidated Statements of Stockholders’ Equity for the Years Ended July 31, 2004, 2003, and 2002

 

- Notes to Consolidated Financial Statements

                (2) Financial Statement Schedules

The following financial statement schedule is included in this report:

     Schedule II – Valuation and Qualifying Accounts

All other schedules are omitted because they are not required, not applicable, or the required information is otherwise shown in the consolidated financial statements or the notes thereto.

(B)  Reports on Form 8-K

During the fourth quarter ended July 31, 2004, the Company reported the following events of Form 8-K:

Date Filed or Furnished

 

Item No(s).

 

Description


 


 


June 1, 2004

 

7 and 12

 

Press release reporting financial results for the quarter ended April 30, 2004

 

 

 

 

 

June 1, 2004

 

2 and 7

 

Announcement of acquisition in Cortelco Shanghai Telecomequipment company

(C)  Exhibits

The exhibits listed in the Exhibit Index following the signature page of this report are filed as part of this report or are incorporated by reference herein.

54



SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

EON COMMUNICATIONS CORPORATION

Date:October 27, 2004

By /s/ Stephen R. Bowling

 


 

 

Stephen R. Bowling, Vice President,
Chief Financial Officer, Secretary
(Principal Financial Officer)

     Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Name

 

Title

 

Date


 


 


/s/ David S. Lee

 

President, Chief Executive
Officer  and Chairman(Principal
Executive Officer)

 

October 27, 2004


 

 

 

 

David S. Lee

 

 

 

 

 

 

 

 

/s/ Stephen R. Bowling

 

Vice President, Chief Financial
Officer, Director (Principal
Financial Officer)

 

October 27, 2004


 

 

 

 

Stephen R. Bowling

 

 

 

 

 

 

 

 

/s/ Mitch C. Gilstrap

 

Vice President, Chief Operating

 

October 27, 2004


 

 

Officer

 

 

Mitch C. Gilstrap

 

 

 

 

 

 

 

 

 

/s/ Robert P. Dilworth

 

Director

 

October 27, 2004


 

 

 

 

 

Robert P. Dilworth

 

 

 

 

 

 

 

 

 

/s/ W. Frank King

 

Director

 

October 27, 2004


 

 

 

 

 

W. Frank King

 

 

 

 

 

 

 

 

 

/s/ Frederick W. Gibbs

 

Director

 

October 27, 2004


 

 

 

 

 

Frederick W. Gibbs

 

 

 

 

55



eOn Communications Corporation and Subsidiaries
Schedule II – Valuation and Qualifying Account
s

Column A

 

Column B

 

Column C

 

Column D

 

Column E

 


 


 


 


 


 

 

 

 

 

 

Additions

 

 

 

 

 

 

 

 

 

 

 

 


 

 

 

 

 

 

 

 

 

Balance at Beginning
of Period

 

Charged to
Costs and
Expenses

 

Charged
to Other
Accounts

 

Deductions

 

Balance
at End
of Period

 

 

 


 


 


 


 


 

 

 

 

 

 

 

 

 

 

 

 

 

2002:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for doubtful
   accounts and sales
   allowance

 

 

1,265,135

 

 

 

164,000

 

 

 

-

 

 

562,924

 

 

 

866,211

 

 

Warranty reserve

 

 

220,552

 

 

 

213,044

 

 

 

-

 

 

234,854

 

 

 

198,742

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2003:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for doubtful
   accounts and sales
   allowance

 

 

866,211

 

 

 

110,000

 

 

 

-

 

 

287,182

 

 

 

689,029

 

 

Warranty reserve

 

 

198,742

 

 

 

312,375

 

 

 

-

 

 

227,667

 

 

 

283,450

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2004:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for doubtful
   accounts and sales
   allowance

 

 

689,029

 

 

 

333,000

 

 

 

-

 

 

247,794

 

 

 

774,235

 

 

Warranty reserve

 

 

283,450

 

 

 

324,812

 

 

 

-

 

 

246,975

 

 

 

361,287

 

 

56



EXHIBIT INDEX

Documents listed below are being filed as exhibits herewith. Exhibits identified by asterisks (*) are being incorporated herein by reference and, pursuant to Rule 12b-32 of the General Rules and Regulations promulgated by the Commission under the Securities Exchange Act of 1934, reference is made to such documents as previously filed exhibits with the Commission.

Exhibit
Number

 

Description of Document


 


2.1(&)

 

Plan of Acquisition for Cortelco Shanghai Telecom Equipment Company

 

 

 

3.1*

 

Amended and Restated Certificate of Incorporation of eOn as filed with the Secretary of State of Delaware on November 16, 1999.

 

 

 

3.2*

 

Amended and Restated Bylaws of eOn

 

 

 

4.1*

 

Reference is made to Exhibits 3.1 and 3.2

 

 

 

10.1*

 

Form of Indemnity Agreement between eOn and its officers and directors.

 

 

 

10.2(@)

 

Sublease Termination and Release Agreement between eOn and TC Forest Hill Development, LP dated May 31, 2002.

 

 

 

14.1

 

Code of Ethics

 

 

 

18(@)

 

Preferability letter regarding LIFO to FIFO change in inventory accounting

 

 

 

21.1

 

Subsidiaries of eOn Communications Corporation.

 

 

 

23.1

 

Consent of Grant Thornton LLP.

 

 

 

23.2

 

Consent of Deloitte & Touche LLP.

 

 

 

31.1

 

Officers’ Certification of Periodic Report pursuant to Section 302 of Sarbanes-Oxley Act of 2002

 

 

 

32.1

 

Officers’ Certification of Periodic Report pursuant to Section 906 of Sarbanes- Oxley Act of 2002




(&)

Incorporated by reference to identically numbered exhibits to the Registrant’s previously filed Form 8-K

 

 

(*)

Incorporated by reference to the Company’s Registration Statement on Form S-1 (No. 333-77021) or amendments thereto,
filed with the Securities and Exchange Commission on April 26, 1999.

 

 

(@)

Incorporated by reference to identically numbered exhibits to the Registrant’s previously filed Form 10-K’s or Form 10-Q’s

 

 

(#)

Executive compensation plan or arrangement filed as an exhibit pursuant to Item 14(c) of Form 10-K

57