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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q/A

 


 

(Mark One)

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

For the quarterly period ended October 31, 2004.

 

¨ 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

 


 

LOGO

(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 office)

 

(770) 423-2200

(Telephone number)

 


 

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

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date: 12,833,068 shares of Common Stock, $.001 par value, as of November 30, 2004.

 



Table of Contents

EON COMMUNICATIONS CORPORATION

FORM 10-Q

QUARTER ENDED OCTOBER 31, 2004

 

INDEX

 

     Page

Part I: FINANCIAL INFORMATION

    
                       Item 1. Condensed Financial Statements     
                                    Condensed Balance Sheets as of October 31, 2004 and July 31,2004.    3
                                    Condensed Statements of Operations for the Three Months ended October 31, 2004 and 2003    4
                                    Condensed Statements of Cash Flows for the Three Months ended October 31, 2004 and 2003    5
                                    Notes to Condensed Financial Statements    6
                       Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations    10
                       Item 3. Qualitative and Quantitative Disclosure about Market Risk    16
                       Item 4. Disclosure Controls and Procedures    16

Part II: OTHER INFORMATION

    

                       Item 6. Exhibits and Reports on Form 8-K

   17

Signature

   18

 

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EON COMMUNICATIONS CORPORATION

PART I - FINANCIAL INFORMATION

 

ITEM 1. CONDENSED FINANCIAL STATEMENTS

 

eOn Communications Corporation

Consolidated Condensed Balance Sheets

October 31, 2004 and July 31, 2004

(Dollars in thousands)

 

     October 31,
2004


    July 31,
2004


 
     (unaudited)        
ASSETS                 

Current assets:

                

Cash and cash equivalents

   $ 3,552     $ 4,679  

Marketable securities

     4,200       4,200  

Trade accounts receivable, net of allowance of $713 and $774, respectively

     7,305       6,656  

Trade accounts receivable – related party, net of allowance of $8 and $18 respectively

     566       615  

Notes receivable

     390       528  

Inventories

     2,962       2,733  

Other current assets

     2,527       1,913  
    


 


Total current assets

     21,502       21,324  

Property and equipment, net

     885       971  
    


 


Total

   $ 22,387     $ 22,295  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY                 

Current liabilities:

                

Trade accounts payable

   $ 5,067     $ 5,394  

Payable to affiliate

     2,071       2,086  

Note payable – current

     768       767  

Deferred acquisition payment

     1,038       1,078  

Accrued expenses and other

     2,625       2,284  
    


 


Total current liabilities

     11,569       11,609  

Minority interest

   $ 1,242     $ 1,227  

Stockholders’ equity:

                

Common stock

     13       13  

Additional paid-in capital

     54,388       54,369  

Treasury stock

     (1,502 )     (1,502 )

Accumulated deficit

     (43,323 )     (43,421 )
    


 


Total stockholders’ equity

     9,576       9,459  
    


 


Total

   $ 22,387     $ 22,295  
    


 


 

See notes to condensed financial statements.

 

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eOn Communications Corporation

Consolidated Condensed Statements of Operations (Unaudited)

For the Three Months ended October 31, 2004 and 2003

(Dollars in thousands, except per share data)

 

     Three Months Ended
October 31,


 
     2004

    2003

 

Net revenue

   $ 6,467     $ 5,039  

Cost of revenues

     3,668       2,100  
    


 


Gross profit

     2,799       2,939  

Operating expenses:

                

Selling, general, and administrative

     1,845       1,918  

Research and development

     866       676  
    


 


Total operating expenses

     2,711       2,594  
    


 


Income from operations

     88       345  

Interest income

     (36 )     (16 )

Interest expense

     —         9  

Other expense (income), net

     9       22  
    


 


Income before income tax expense and minority interest

     115       330  

Income tax expense

     4       —    
    


 


Income before minority interest

     111       330  

Minority interest

     13       —    
    


 


Net Income

   $ 98     $ 330  
    


 


Net income per common share

                

Basic and diluted

   $ 0.01     $ 0.03  

 

See notes to condensed financial statements

 

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eOn Communications Corporation

Consolidated Condensed Statements of Cash Flows (Unaudited)

For the Three Months Ended October 31, 2004 and 2003

(Dollars in thousands)

 

     Three Months Ended
October 31,


 
     2004

    2003

 

CASH FLOWS FROM OPERATING ACTIVITIES:

                

Net income

   $ 98     $ 330  

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

                

Depreciation and amortization

     139       164  

Minority interest

     15       —    

Provision for allowance of doubtful accounts

     (61 )     (6 )

Changes in net assets and liabilities:

                

Trade accounts receivable

     (588 )     (795 )

Inventories

     (229 )     73  

Notes receivable

     138       —    

Other current assets

     (614 )     38  

Trade accounts payable

     (327 )     430  

Receivable/payable to affiliate

     34       (49 )

Accrued expenses and other

     341       98  
    


 


Net cash provided by (used in) operating activities

     (1,054 )     283  

CASH FLOWS FROM INVESTING ACTIVITIES:

                

Purchases of property and equipment

     (56 )     (72 )

Disposals of property and equipment

     3       —    

Cash used in business acquisition

     (40 )     —    
    


 


Net cash used in investing activities

     (93 )     (72 )

CASH FLOWS FROM FINANCING ACTIVITIES:

                

Borrowing (Repayment) of note payable

     1       (166 )

Proceeds from ESPP

     19       36  
    


 


Net cash provided by (used in) financing activities

     20       (130 )

Net increase (decrease) in cash and cash equivalents

     (1,127 )     81  

Cash and cash equivalents, beginning of period

     4,679       3,221  
    


 


Cash and cash equivalents, end of period

   $ 3,552     $ 3,302  
    


 


 

See notes to condensed financial statements.

 

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eOn Communications Corporation

Notes to Consolidated Condensed Financial Statements (Unaudited)

For the Three Months Ended October 31, 2004 and 2003

(Dollars in thousands)

 

1. BASIS OF PRESENTATION

 

The accompanying unaudited consolidated condensed financial statements have been prepared by eOn Communications Corporation (“eOn” or the “Company”). It is management’s opinion that these statements include all adjustments, consisting of only normal recurring adjustments necessary to present fairly the financial position, results of operations, and cash flows as of October 31, 2004 and for all periods presented.

 

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.

 

Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. It is suggested that these condensed financial statements be read in conjunction with the financial statements and notes thereto as of July 31, 2004 and 2003 and for each of the three years in the period ended July 31, 2004, which are included in the Annual Report on Form 10-K filed with the Securities and Exchange Commission.

 

Stock Compensation Plans

 

At October 31, 2004, the Company had three stock-based compensation plans for employees and an Employee Stock Purchase Plan (ESPP), which are more fully described in the Company’s Annual Report on Form 10-K for the year ended July 31, 2004. 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 income (loss) and net income (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:

 

     Three Months Ended
October 31


 
     2004

    2003

 
     (Thousands of Dollars,
excluding per share data)
 

Net income (loss) as reported

   $ 98     $ 330  

Add: Stock-based compensation, as reported

     —         —    

Deduct: Total stock-based compensation determined under fair value based method for all awards, net of tax

     (92 )     (127 )
    


 


Pro forma net income (loss)

   $ 6     $ 203  

Net income (loss) per share – basic and diluted:

                

Net income (loss) per share – as reported

   $ 0.01     $ 0.03  

Net income (loss) per share – pro forma

   $ 0.00     $ 0.02  

 

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2. REVENUE RECOGNITION

 

Revenues from our Millennium, eQueue and Cortelco Shanghai 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 believes that its revenue recognition policies are compliant with Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” and Statement of Position No. 97-2, “Software Revenue Recognition.”

 

3. EARNINGS (LOSS) PER SHARE

 

The computations of basic and diluted income (loss) per share were as follows:

 

     Three Months Ended
October 31,


     2004

   2003

     (In thousands, except per share data)

Basic income (loss) per share:

             

Net income (loss)

   $ 98    $ 330

Weighted average shares outstanding

     12,821      12,231
    

  

Basic income (loss) per share

   $ 0.01    $ 0.03
    

  

Diluted income (loss) per share:

             

Net income (loss)

   $ 98    $ 330

Weighted average shares:

             

Outstanding

     12,821      12,231

Dilutive effect of stock options

     97      554
    

  

Weighted average shares – diluted

     12,918      12,785
    

  

Income (loss) from operations per share

   $ 0.01    $ 0.03
    

  

 

Potential common shares related to options outstanding to purchase shares of common stock were excluded from the computation of diluted earnings per shares for both quarters presented above because their inclusion would have had an anti-dilutive effect. There were 944,579 and 682,161 options excluded for the periods ending October 31, 2003 and 2002, respectively.

 

4. RELATED PARTIES

 

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

 

    Cortelco Systems Holding Corporation (“CSHC”);

 

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

 

    Cortelco Canada (“CC”, subsidiary of CSHC) and

 

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

 

 

The following represents related party transactions:

 

     Three Months Ended
October 31,


     2004

   2003

     (Thousands of Dollars)

Purchases from CSHC and subsidiaries

   $ 205    $ 176

Purchases from Shanghai Bell

     7      —  

Sales to Shanghai Bell

     378      —  

 

The following represents related party balances:

 

     October 31,
2004


   July 31,
2004


     (Thousands of Dollars)

Receivable from Shanghai Bell

   $ 566    $ 615

Payable to CII

     90      101

Payable to Shanghai Bell

     1,981      1,985

 

Shanghai Bell

 

The chairman of the Board of Directors of Shanghai Bell is also the chairman of the Board of Directors of Shanghai Fortune. Shanghai Fortune is the minority shareholder of the Company’s Cortelco Shanghai subsidiary. Shanghai Bell is Cortelco Shanghai’s largest customer and a significant supplier. Cortelco Shanghai buys various telecom equipment from different Shanghai Bell divisions for resale to third parties and Cortelco Shanghai sells, and installs various telecom equipment for Shanghai Bell divisions. Accounts receivable and accounts payable are usually settled in three to six months, sometimes by offset rather than payment in local currency. Payment terms on some installation projects are extended beyond one year from completion, reflecting a negotiated repayment schedule.

 

Cortelco International, Inc. and Cortelco Systems Holding Corporation

 

Cortelco International, Inc. (“CII”) is a subsidiary of Cortelco Systems Holding Corporation (“CSHC”) and a supplier of Millenium equipment, eQueue peripheral hardware and operations services. Accounts payable are paid on thirty to sixty day terms. The Company has had no significant transactions with CSHC.

 

5. INVENTORIES

 

Inventories consist of the following:

 

    

Oct 31,

2004


  

July 31,

2004


       
     (In thousands)

Raw materials and purchased components

   $ 578    $ 723

Finished goods

     2,384      2,010
    

  

Total inventories

   $ 2,962    $ 2,733
    

  

 

 

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6. OTHER CURRENT ASSETS

 

Other current assets consists of the following:

 

    

October 31,

2004


  

July 31,

2004


       
     (In thousands)

Customer deposits

   $ 808    $ 794

Advances to suppliers

     1,550      893

Prepaid expenses

     158      132

Other

     11      94
    

  

Total

     2,527      1,913

 

7. PRODUCT WARRANTIES

 

The Company provides standard product warranties from the date of purchase. The costs of satisfying warranty claims have historically been comprised of materials and direct labor costs. The Company estimates the cost of satisfying warranty claims based on analysis of past claims experience. Quarterly evaluations of these estimates are performed, and any changes in estimate, which could potentially be significant, are included in earnings in the period in which the evaluations are completed.

 

Information regarding the changes in the Company’s aggregate product warranty accrual for the three-month reporting period was as follows:

 

     Three Months Ended October 31,

 
     2004

    2003

 
     (in thousands)  

Beginning balance

   $ 361     $ 283  

Warranty cost incurred

     (64 )     (62 )

Accruals for warranties for sales during the period

     98       76  
    


 


     $ 395     $ 297  
    


 


 

8. CHANGES IN STOCKHOLDERS’ EQUITY

 

The following represents the changes in stockholders’ equity for the three months ended October 31, 2003:

 

     (In thousands, except share data)

     Common Stock

   Additional
Paid-in
Capital


   Treasury Stock

          Total
Stockholders’
Equity


     Shares

   Amount

      Shares

    Amount

    Accumulated
Deficit


   

Balance at July 31, 2004

   13,487,160    $ 13    $ 54,369    (676,900 )   $ (1,502 )   $ (43,421 )   $ 9,459

Net income and comprehensive income

   —        —        —      —         —         98       98

Issuance of common stock under employee stock plan

   19,892      —        19    —         —         —         19
    
  

  

  

 


 


 

Balance at October 31, 2004

   13,507,052    $ 13    $ 54,388    (676,900 )   $ (1,502 )   $ (43,323 )   $ 9,576
    
  

  

  

 


 


 

 

9. COMMITMENTS AND CONTINGENCIES

 

At October 31, 2004, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $1,955,000.

 

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.

 

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10. EQUITY INCENTIVE PLANS

 

The status of the Company’s stock option plans since July 31, 2004 is as follows:

 

     Number of
Shares


    Weighted
Average
Exercise
Price


Options outstanding, July 31, 2004

   1,631,470     $ 4.21

Granted

   65,000       1.14

Exercised

   —         —  

Cancelled

   (64,814 )     1.07
    

 

Options outstanding, October 31, 2004

   1,631,656     $ 4.21
    

 

Options exercisable, October 31, 2004

   1,074,948     $ 5.16
    

 

Exercise price range

   $0.24 -$24.25

Options available for grant, October 31, 2004

   511,864

 

11. 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 three 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.

 

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

     47,000  

Total consideration

     368,000  

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

     (1,038,000 )
    


Net assets acquired

   $ 368,000  

 

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12. 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 for the quarter ended October 31, 2004.

 

     eOn US

   Cortelco
Shanghai


   Elimination

    Consolidated

     (In thousands)

Revenues from customers

   $ 4,571    $ 1,896    $ —       $ 6,467

Business segment income

   $ 82    $ 16    $ —       $ 98

Business Segment Assets at October 31, 2004

   $ 13,721    $ 10,094    $ (1,428 )   $ 22,387

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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 below. 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 condensed financial statements and the notes included thereto.

 

Overview

 

We design, develop and market next-generation communications servers 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.

 

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 Note 3, “Summary of Significant Accounting Policies,” in Part II, Item 8, “Consolidated Financial Statements and Supplementary Data,” of our Annual Report on Form 10-K for the year ended July 31, 2004.

 

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  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.

 

  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 and relationship of 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. During the quarter the companied had $4 thousand in foreign income tax expense.

 

Accounting principles generally accepted in the United States 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.

 

Three Months Ended October 31, 2004 and 2003

 

Net Revenues. Total revenues increased 28.3.7% to $6.5 million in the quarter ended October 31, 2004 from $5.0 million in the quarter ended October 31, 2003. The increase from Q1 2004 to Q1 2005 resulted primarily from increased sales of our Millenium product line of $0.3 million and the addition of Cortelco Shanghai who had revenues of $1.9 million in the quarter ended October 31, 2004, which was offset by a decline in revenues from our eQueue product line of $0.3 million.

 

Cost of Revenues and Gross Profit. Cost of revenues consist primarily of purchases from our contract manufacturers and other suppliers and costs incurred for final assembly of our systems. Gross profit decreased 4.8% to $2.8 million in the quarter ended October 31, 2004 from $2.9 million in the quarter ended October 31, 2003, primarily due to the higher level of Millenium revenues and the addition of revenues from Cortelco Shanghai. Gross margin decreased to 45.1% in the quarter ended October 31, 2004 from 58.3% in the quarter ended October 31, 2003, due to a larger percentage of current quarter revenues being derived from the sale of our Millenium products and the addition of lower margin revenues from Cortelco Shanghai.

 

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Selling, General and Administrative. Selling, general and administrative expenses consist primarily of salaries and benefit costs, advertising and trade show related costs, and facilities and other overhead expenses incurred to support our business. Selling, general and administrative expenses decreased 3.8% to $1.8 million in the quarter ended October 31, 2004, from $1.9 million in the quarter ended October 31, 2003. The decrease was primarily due to reductions in personnel and associated overhead costs during the year from the Company’s cost-cutting initiatives in the amount of $0.4 million, offset by the addition of $0.3 million in SG&A expenses from Cortelco Shanghai

 

Research and Development. Research and development expenses consist primarily of personnel and related facility costs for our engineering staff. Research and development expenses increased 28.1% to 0.9 million in the quarter ended October 31, 2004, from 0.7 million in the quarter ended October 31, 2003. This increase was primarily due to increased headcount among our engineering staff and expenses related to product certification in China.

 

Interest and other income and expense. Interest income was $36 thousand in the current quarter, as compared to $16 thousand in the quarter ended October 31, 2003. Interest expense was $0 in the current quarter and $9 thousand in the prior year quarter. Other income and expense was $9 thousand in the current quarter and $22 thousand in the prior year period.

 

LIQUIDITY AND CAPITAL RESOURCES

 

As of October 31, 2004, we had cash and cash equivalents of $3.6 million, $4.2 million in short term investments, and a working capital balance of $9.9 million. Our short term investments are primarily invested in taxable auction rate securities with frequent rate resets.

 

Our operating activities resulted in net cash outflows of $1.1 million in three months ended October 31, 2004 and a net cash inflow of $0.3 million in the three months ended October 31, 2003. The net operating cash outflow for the current period is primarily the result of increased accounts receivable and other assets and a decrease in accounts payable. The net operating cash inflow for the prior period was primarily the result of our net income (adjusted for non-cash items) and increases in accounts payable and accrued expenses, offset by an increase in accounts receivable.

 

Our investing activities resulted in a cash outflow of $0.1 million for the three months ended October 31, 2004, and $0.1 million for the three months ended October 31, 2003. Cash used in investing activities in the current period is a result of capital expenditures and an increase in cash used in the acquisition of Cortelco Shanghai. Cash used in investing activities in the prior period consisted entirely of $0.1 million in capital expenditures.

 

Our financing activities resulted in no cash changes during the current period and cash outflows of $0.1 million for the three months ended October 31, 2003. Cash used in financing activities in the prior period consisted primarily of payments against our outstanding note payable.

 

Liquidity

 

Since inception, the Company has financed its operations through debt financing and proceeds generated from public offerings of its common stock. The proceeds from these transactions have been used primarily to fund research and development costs, and selling, general and administrative expenses. Additionally, since inception, the Company has invested $4.5 million in capital expenditures.

 

The Company has incurred substantial net operating losses since inception and negative cash flows from operating activities through July 31, 2004 resulting in an accumulated deficit of $43.4 million. During the second fiscal quarter of 2001, the Company adopted a restructuring plan, which included headcount reductions and office space consolidation to reduce costs and improve productivity. During fiscal year 2004, cash and cash equivalents and short term investments increased from $7.4 million to $8.7 million, primarily reflecting $3.1 million of cash acquired from Cortelco Shanghai, partially offset by an operating loss of $0.9 million.

 

The Company had income from continuing operations of $88,000 for the three months ended October 31, 2004 versus income from continuing operations of $345,000 for the same period in the prior year. As of October 31, 2004, the Company had $5.4 million in cash and cash equivalents and short term investments in the United States available to fund operations, and Cortelco Shanghai had $2.4 million in cash and cash equivalents to fund its operations.

 

The Company is dependent on available cash, short-term investments and operating cash flow to finance operations and meet its other capital needs. If such sources are not sufficient, alternative funding sources may not be available. The Company believes that cash on hand and short-term marketable securities plus the additional liquidity that it expects to generate from operations will be sufficient to cover its working capital and fund expected capital expenditures over at least the next twelve months.

 

Capital Resources

 

We have principally relied on the proceeds from equity and cash provided from operations as our primary sources of capital. While we do not currently anticipate the need to raise additional capital to meet our operating and capital expenditure requirements in the foreseeable future, our funding status is dependent on a number of factors influencing projections of operating cash flows, including those related to profit margins, controlling selling, general and administrative costs and research and development costs. Further, we believe that the cash and short-term investment securities on hand plus the additional liquidity that we expect to generate from operations will be sufficient to meet the cash requirements of the business including capital expenditures, cash interest payments and working capital needs for at least the next twelve months. Should actual results differ significantly from our current assumptions, our liquidity position could be adversely affected and we could be in a position that would require us to raise additional capital, which may not be available to us or may not be available on acceptable terms.

 

COMMITMENTS AND CONTINGENCIES

 

At October 31, 2004, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $1,955,000.

 

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.

 

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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.

 

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.

 

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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.

 

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.

 

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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.

 

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 October 31, 2004, our executive officers, directors and principal stockholders and their affiliates beneficially owned 3,676,296 shares, or 28.2% 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

 

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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.

 

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.

 

ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE 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. In addition, the vast majority of our sales are made in U.S. dollars and, consequently, we believe that our foreign currency exchange rate risk is immaterial. We do not have any derivative instruments and do not engage in hedging transactions.

 

ITEM 4. DISCLOSURE 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”)) were ineffective 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 for the following reason:

 

Significant internal control deficiencies with respect to financial reporting of Cortelco Shanghai financial information existed as of the end of the quarter as follows:

 

    Cortelco Shanghai senior financial staff had little knowledge of Generally Accepted Accounting Principles in the United States (“U.S. GAAP”);

 

    No Revenue Recognition policy in conformance with U.S. GAAP;

 

    Internal controls structure relies on single person;

 

    Inadequate detail in procedures for physical inventory counts; and

 

    Financial statements prepared by the Company Chief Financial Officer without review.

 

In response to the internal control deficiencies identified by Grant Thornton, eOn hired a Chinese born US MBA to be full-time Financial Reporting Manager at Cortelco Shanghai. She and the eOn Controller implemented the following monthly controls during the quarter ending October 31, 2004:

 

    Review revenue/margin cut off log;

 

    List all invoices with cost and margin, review ship records and contract terms;

 

    Review/list all shipments date, contract, customer, RMB cost;

 

    Review/list all install team activity date, contract, customer, employee RMB cost;

 

    Review/list all acceptances received date, contract, customer, RMB cost;

 

    Review/list all new contracts ship date/performance period, contract, customer, revenue, cost;

 

    Review/list all receipts of product/inventory date, purchase order, vendor, RMB cost, invoice;

 

    Review/list all new purchase orders (initially included all open PO’s for product and non-product) date, purchase order, vendor, RMB cost;

 

    Reconcile and review all balance sheet accounts;

 

    Review accounts receivable aging, reserve analysis;

 

    Review detailed slow moving inventory analysis;

 

    Review/list all inventory held at customers site;

 

    Prepare comparative analysis of general and administrative expense detail and

 

    Prepare comparative analysis of manufacturing overhead detail.

 

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And quarterly:

 

    Review analysis of aged advances to suppliers and subcontractors;

 

    Review Shanghai Bell transactions and account reconciliations and

 

    Review major customer transactions and account reconciliations.

 

In addition, in order to compensate for the remaining internal control deficiencies at Cortelco Shanghai, eOn’s certifying officers did the following to ensure that eOn’s financial statements fairly present in all material respects the financial condition, results of operations and cash flows as of and for the three month period ending October 31, 2004:

 

    Reviewed all revenue transactions for proper recognition timing, including appropriate matching of expense and revenue where installation was part of contract;

 

    Reviewed expense detail to identify accrual requirements and analyze unusual items;

 

    Compared accruals to prior periods;

 

    Reviewed account reconciliations;

 

    Reviewed detailed inventory analysis for obsolescence;

 

    Reviewed receivables aging and reserve;

 

    Reviewed customer returns data for warranty obligations;

 

    Reviewed terms and payment history of notes receivable and notes payable;

 

    Reviewed accounts payable aging;

 

    Reviewed and adjusted accounts receivable from employees and

 

    Prepared all adjusting journal entries and prepared final adjusted financial statements.

 

Changes in internal control over financial reporting. There were changes in internal control over financial reporting that occurred during the three month period ending October 31, 2004 to remediate the ineffective disclosure controls and procedures described above that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting as follows:

 

  1. All balance sheet accounts are reconciled on a monthly basis;

 

  2. Management has implemented numerous control reports that are approved by the Controller and Chief Financial Officer on a monthly basis, and

 

  3. Management has begun the process of documenting all policies and procedures for the Cortelco Shanghai operations.

 

While this is an ongoing process we believe that the above mentioned measures will improve the reliability of Cortelco Shanghai’s internal control structure.

 

PART II - OTHER INFORMATION

 

Item 6. Exhibits and Reports on Form 8-K.

 

  (A) Exhibits.

 

Exhibit No.

 

Description


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

 

  (B) Reports On Form 8-K.

 

During the first quarter ended October 31, 2003, the Company reported the following event on Form 8-K:

 

Date Filed or Furnished


  

Item No(s).


  

Description


September 17, 2004    2 and 9    Press release reporting financial results for the quarter ended July 31, 2004

 

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SIGNATURE

 

Pursuant to the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto authorized.

 

EON COMMUNICATIONS CORPORATION

 

Date: July 19, 2005  

/s/ Stephen R. Bowling


    Stephen R. Bowling
   

Vice President, Chief Financial Officer

(Duly Authorized Officer, Principal Financial and

Accounting Officer)

 

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