Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED APRIL 30, 2009.

OR

 

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

Commission File Number: 000-26399

eOn Communications Corporation

(Exact name of registrant as specified in its charter)

 

Delaware   62-1482176
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification Number)
185 Martinvale Lane  
San Jose, CA   95119
(Address of principal executive offices)   (Zip code)

(408) 694-9500

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filler, a non-accelerated filer, or a small reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨   Accelerated filer                ¨
Non-accelerated filer    ¨   Small reporting company x

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

2,734,412 shares of common stock, $0.005 par value, were outstanding as of May 29, 2009.

 

 

 


Table of Contents

EON COMMUNICATIONS CORPORATION

FORM 10-Q

QUARTER ENDED APRIL 30, 2009

TABLE OF CONTENTS

 

PART I

  

FINANCIAL INFORMATION

  

Item 1.

   Financial Statements    3
   Condensed Consolidated Balance Sheets at April 30, 2009 (unaudited) and July 31, 2008    3
   Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Nine Months Ended April 30, 2009 and 2008 (Unaudited)    4
   Condensed Consolidated Statements of Cash Flows for the Nine Months Ended April 30, 2009 and 2008 (Unaudited)    5
   Notes to Condensed Consolidated Financial Statements (unaudited)    6

Item 2.

   Management’s Discussion and Analysis or Plan of Operation    15

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    19

Item 4.

   Controls and Procedures    19

PART II

   OTHER INFORMATION   

Item 1.

   Legal Proceedings    20

Item 1A.

   Risk Factors    20

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    23

Item 3.

   Defaults Upon Senior Securities    23

Item 4.

   Submission of Matters to a Vote of Security Holders    23

Item 5.

   Other Information    23

Item 6.

   Exhibits    23

 

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PART I—FINANCIAL INFORMATION

Item  1.—Financial Statements.

EON COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share amounts)

 

     April 30,
2009
    July 31,
2008
 
     (Unaudited)        

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 1,394      $ 1,545   

Marketable securities

     700        1,000   

Trade accounts receivable, net of allowance of $341 and $680, respectively

     2,392        932   

Trade accounts receivable—related party

     3        84   

Inventories

     5,164        2,501   

Deferred income taxes

     212        —     

Prepaid and other current assets

     294        177   
                

Total current assets

     10,159        6,239   

Property and equipment, net

     251        176   

Intangibles, net

     295        251   

Investments

     1,207        900   

Deferred income taxes

     58        —     

Non-current assets

     —          88   
                

Total assets

   $ 11,970      $ 7,654   
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities:

    

Trade accounts payable

   $ 725      $ 214   

Trade accounts payable—related party

     —          126   

Notes payable

     138        138   

Accrued expenses and other

     1,029        1,145   
                

Total current liabilities

     1,892        1,623   

Note payable

     4,430        —     
                

Total liabilities

     6,322        1,623   
                

Commitments and contingencies

    

Stockholders’ equity:

    

Preferred stock, $0.001 par value, (10,000,000 shares authorized, no shares issued and outstanding)

     —          —     

Common stock, $0.005 par value (10,000,000 shares authorized, 2,873,992 and 2,869,608 shares issued, respectively)

     14        14   

Additional paid-in capital

     56,000        55,931   

Treasury stock, at cost (139,580 shares)

     (1,503     (1,502

Accumulated deficit

     (48,967     (48,517

Accumulated other comprehensive income

     104        105   
                

Total stockholders’ equity

     5,648        6,031   
                

Total liabilities and stockholders’ equity

   $ 11,970      $ 7,654   
                

See accompanying notes to the condensed consolidated financial statements.

 

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EON COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Amounts in thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended
April 30,
    Nine Months Ended
April 30,
 
     2009    2008     2009     2008  

REVENUE

         

Third party revenue

   $ 2,465    $ 1,387     $ 5,556     $ 5,047  

Related party revenue

     —        127       —         343  
                               

Net revenue

     2,465      1,514       5,556       5,390  
                               

COST OF REVENUE

         

Third party cost of revenue

     1,356      635       2,872       2,103  

Related party cost of revenue

     —        116       —         316  
                               

Cost of revenue

     1,356      751       2,872       2,419  
                               

Gross profit

     1,109      763       2,684       2,971  
                               

OPERATING EXPENSE

         

Selling, general and administrative

     852      1,150       2,307       3,297  

Research and development

     172      703       754       2,140  

Other expense

     26      123       87       160  
                               

Total operating expense

     1,050      1,976       3,148       5,597  
                               

Income (loss) from continuing operations

     59      (1,213 )     (464 )     (2,626 )

Interest income

     1      16       14       96  
                               

Income (loss) from continuing operations before income taxes

     60      (1,197 )     (450 )     (2,530 )

Income tax expense

     —        —         —         —    
                               

Income (loss) from continuing operations after income taxes

     60      (1,197 )     (450 )     (2,530 )

DISCONTINUED OPERATIONS

         

Loss from discontinued operations

     —        (7 )     —         (584 )
                               

Loss from discontinued operations

     —        (7 )     —         (584 )
                               

Net income (loss)

   $ 60    $ (1,204 )   $ (450 )   $ (3,114 )
                               

COMPREHENSIVE INCOME (LOSS)

         

Net income (loss)

   $ 60    $ (1,204 )   $ (450 )   $ (3,114 )

Unrealized losses on available-for-sale securities

        (75 )       (75 )

Foreign currency translation adjustment

     —        37       (1 )     102  
                               

Comprehensive income (loss)

   $ 60    $ (1,242 )   $ (451 )   $ (3,087 )
                               

Weighted average shares outstanding

         

Basic

     2,736      2,734       2,735       2,722  

Diluted

     2,736      2,734       2,735       2,722  

Basic income (loss) per share:

         

From continuing operations

   $ 0.02    $ (0.44 )   $ (0.16 )   $ (0.93 )

From discontinued operations, net of tax

     —        —         —         (0.21 )
                               

Basic income (loss) per share

   $ 0.02    $ (0.44 )   $ (0.16 )   $ (1.14 )
                               

Diluted income (loss) per share:

         

From continuing operations

   $ 0.02    $ (0.44 )   $ (0.16 )   $ (0.93 )

From discontinued operations, net of tax

     —        —         —         (0.21 )
                               

Diluted income (loss) per share

   $ 0.02    $ (0.44 )   $ (0.16 )   $ (1.14 )
                               

See accompanying notes to the condensed consolidated financial statements.

 

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EON COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

 

     Nine Months Ended
April 30,
 
     2009     2008  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net loss

   $ (450   $ (3,114

Change in operating assets and liabilities of discontinued operations

     —          238   

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

    

Stock-based compensation expense

     17        146   

Depreciation and amortization

     129        175   

Provision for allowance for doubtful accounts

     63        53   

Loss on disposal of property and equipment

     29        106   

Changes in net assets and liabilities, net of effects of business acquisition

    

Trade accounts receivable

     55        577   

Inventories

     749        (447

Prepaid and other assets

     72        (195

Trade accounts payable

     (73     (15

Trade accounts receivable/payable—related party

     (45     (10

Accrued expenses and other

     (449     51   
                

Net cash provided by (used in) operating activities

     97        (2,435

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Cash used in business acquisition, net

     (400     —     

Purchases of property and equipment

     (13     (137

Purchase of investments

     (194     (900

Sale of investments

     58        63   

Purchases of marketable securities

     (1,000     —     

Disposal of marketable securities

     1,300        2,400   
                

Net cash (used in) provided by investing activities

     (249     1,426   

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Proceeds from note payable

     58        —     

Repayment of note payable

     (58     —     

Proceeds from employee stock purchase plan and stock option exercises

     2        11   
                

Net cash provided by financing activities

     2        11   
                

Effect of exchange rate changes on cash

     (1     102   
                

Net decrease in cash and cash equivalents

     (151     (896

Cash and cash equivalents, beginning of period

     1,545        2,256   
                

Cash and cash equivalents, end of period

   $ 1,394      $ 1,360   
                

Supplemental cash flow information:

    

Net assets acquired in merger with Cortelco Systems Holding Corp., excluding cash (See note 4)

   $ 4,954     

See accompanying notes to the condensed consolidated financial statements.

 

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EON COMMUNICATIONS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

For the Three and Nine Months Ended April 30, 2009 and 2008

 

1. Basis of Presentation

The accompanying unaudited condensed consolidated 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 April 30, 2009 and for all periods presented.

Description of Business

eOn is a global provider of innovative communications solutions. Backed with over 20 years of telecommunications engineering expertise, the Company’s solutions enable its 8,000 customers to easily leverage advanced technologies in order to communicate more effectively. eOn’s offerings are built on reliable open architectures that enable easy adoption of emerging technologies, such as Voice over Internet Protocol (VoIP) and concepts such as Service Oriented Architecture (SOA). Whether businesses are looking to leverage the advantages of enterprise IP telephony or advanced contact center technologies, eOn delivers proven, IP-ready products that improve business performance. The Company’s Cortelco product line provides customer premise equipment (CPE) commercial grade telephone products primarily for use in businesses, government agencies, colleges and universities, telephone companies, and utilities.

The Company split its common shares in a 5 to 1 reverse split effective at market close on April 18, 2008. Stock and stock option data have been adjusted for presentation to reflect the reverse split.

On April 1, 2009, the Company acquired Cortelco Systems Holding Corp. (“Cortelco”) for up to $11,000,000 in cash. Cortelco merged with a newly formed wholly-owned subsidiary of eOn and is now a wholly-owned subsidiary of eOn. In exchange for all of the outstanding shares of Cortelco stock, Cortelco shareholders received an initial aggregate payment of $500,000. The Company executed a note payable to Cortelco’s former shareholders for $10,500,000. The note is non-interest bearing and is contingent primarily upon the level of Cortelco earnings after closing and all Cortelco shareholders are eligible to receive quarterly payments thereunder in cash until the full consideration has been paid. The fair value of the note payable obligation assumed on the April 1, 2009 acquisition date was estimated to be $4,930,000 using a discounted cash flow method, and together with approximately $124,000 in acquisition costs, resulted in a total purchase price of $5,054,000. David Lee, Chairman and CEO of eOn, was the Chairman and the controlling shareholder of Cortelco.

For additional information, refer to the amended and restated Merger Agreement among the Company, Cortelco, and a wholly-owned subsidiary of the Company, setting forth the terms and conditions of the acquisition, filed as an exhibit to the Company’s 8-K dated as of December 18, 2008.

Interim Consolidated Financial Statements

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, and include the accounts of eOn Communications Corporation, eOn Communications (Beijing) Corporation Limited (“eOn China”), eOn IP Voice, Inc. (“EIPV”) and Cortelco. All significant inter-company balances and transactions have been eliminated in 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 consolidated financial statements be read in conjunction with the financial statements and notes thereto as of July 31, 2008 and 2007 and for each of the two years in the period ended July 31, 2008, which are included in the Annual Report on Form 10-KSB filed with the Securities and Exchange Commission.

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.

Fair Value Accounting

        In September 2006, the FASB issued FASB Statement No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The provisions of SFAS No. 157 were adopted by the Company on August 1, 2008. In February 2008, the FASB staff issued FSP No. 157-2 “Effective Date of FASB Statement

 

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No. 157” (“FSP FAS 157-2”). FSP FAS 157-2 delayed the effective date of FAS 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The provisions of FSP FAS 157-2 are effective for the Company’s fiscal year beginning August 1, 2009, and are not expected to have a significant impact on the Company.

SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under SFAS No. 157 are described below:

 

Level 1    Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2    Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability;
Level 3    Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity).

The Company’s cash equivalent instruments are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices. The cash instruments that are valued based on quoted market prices in active markets are primarily money market securities and U.S. Treasury securities.

The Company’s marketable securities are valued using quoted market prices in active markets and as such are classified within Level 1 of the fair value hierarchy. The fair value of the marketable securities is calculated as the quoted market price of the marketable security multiplied by the quantity of securities held by the Company.

In February 2007, the FASB issued SFAS No. 159, Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). SFAS No. 159 permits companies to elect to measure eligible financial instruments, commitments and certain arrangements at fair value at specified election dates, with changes in fair value recognized in earnings at each subsequent reporting period. SFAS No. 159 was effective for eOn on August 1, 2008 and did not have a material impact on the Company’s consolidated financial statements.

Software Development Costs

We account for costs related to software developed for external use in accordance with SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.” As required by SFAS No. 86, we capitalize costs in developing software products upon determination that technological feasibility has been established for the product, if that product is to be sold, leased or otherwise marketed. Costs incurred prior to the establishment of technological feasibility are charged to research and development expense. When the product or enhancement is available for general release to customers, capitalization is ceased, and previously capitalized costs are amortized based on current and anticipated future revenues for the product, but with an annual amortization amount at least equal to the straight-line amortization over an estimated economic life of five years. The Company’s unamortized software cost at April 30, 2009 was approximately $107,000.

Recent Accounting Standards

In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations, (“SFAS No. 141R”). SFAS No. 141R will change the accounting for business combinations. Under SFAS No. 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS No. 141R will also change the accounting treatment and disclosure for certain specific items in a business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Accordingly, any business combinations the Company engages in will be recorded and disclosed following existing GAAP until July 31, 2009. The Company expects SFAS No. 141R will have an impact on accounting for business combinations once adopted and the effect is dependent upon acquisitions at that time.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interest in Consolidated Financial Statements—An Amendment of ARB No. 51, or SFAS No. 160. SFAS No. 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008. The Company is currently evaluating what impact, if any, the adoption of SFAS No. 160 will have on its consolidated financial statements.

 

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In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133 (“SFAS No. 161”) effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. SFAS No. 161 requires an entity to provide enhanced disclosures about derivative instruments and hedging activities. The Company does not expect SFAS No. 161 to have a material impact on its consolidated financial statements.

In April 2008, the FASB issued FASB Staff Position No. 142-3, Determination of the Useful Life of Intangible Assets (“FSP No. 142-3”). FSP No. 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142. The intent of this FSP is to improve the consistency between the useful life of an intangible asset determined under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141R. FSP No. 142-3 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company is evaluating the potential impact of this FASB Staff Position on its consolidated financial statements.

In June 2008, the FASB issued EITF No. 07-5, Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. EITF No. 07-5 provides guidance for determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock. The adoption of EITF No. 07-5 is not expected to have a material effect on the Company’s consolidated financial statements.

 

2. Stock Based Compensation

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. The board of directors has declared that no future grants will be made under the plan adopted in 1997. 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. 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. During the nine months ended April 30, 2009, options to purchase 2,500 shares of common stock were granted by the Company.

Employee Stock Purchase Plan

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 2005 to increase the number of shares available under the plan to 1,000,000. The shares available under the plan were converted to 200,000 shares on April 18, 2008 when the Company’s common shares were split in a 5 to 1 reverse split. 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. During the nine months ended April 30, 2009, employees purchased 4,384 shares under the plan.

Determining Fair Value

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model. Expected volatilities are based on historical daily closing prices adjusted for expected future volatility. The Company believes that implied volatility is more reflective of market conditions and a better indicator of expected volatility than historical volatility. The Company uses historical information to calculate expected life of option grants. The Company believes that historical information is currently reflective of the economic life of outstanding option grants. The dividend yield is determined by dividing the expected per share dividend during the coming year by the average fair market value of the stock during the quarter. The Company has not historically declared any cash dividends on its common stock, and currently intends to retain any retained earnings to finance the operation and expansion of the business and therefore does not expect to pay cash dividends on the common stock in the foreseeable future. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. The estimated fair value of the employee stock options are amortized to expense using the straight-line method over the vesting period.

 

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The assumptions used to value option grants for the nine months ended April 30, 2009 are as follows:

 

Expected volatility

   107 %

Expected term (in years)

   6.25  

Dividend yield

   —    

Risk-free interest rate

   2.91 %

Total stock-based compensation recognized for the nine months ended April 30, 2009 is as follows (in thousands):

 

Income Statement Classifications

   Option
Grants
   ESPP    Total

Selling, general and administrative

   $ 16    $ 1    $ 17

Research and development

     —        —        —  
                    

Total

   $ 16    $ 1    $ 17
                    

As of April 30, 2009, the Company has total unrecognized compensation cost of $6,000 related to unvested stock options under the Plans. The Company expects these costs to be recognized on a declining basis ending during fiscal year 2013.

General Stock Option Information

Activity in the Company’s stock option plans since July 31, 2008 is as follows:

 

      Shares
Available
for Grant
    Options
Outstanding
    Weighted
Average
Exercise Price

Options at July 31, 2008

   181,871     210,096     $ 17.30

Granted

   (2,500 )   2,500       0.54

Exercised

   —       —         —  

Cancelled

   23,543     (39,233 )     37.60
                  

Options at April 30, 2009

   202,914     173,363     $ 12.46
                  

Information regarding the stock options outstanding under the Company’s stock option plans at April 30, 2009 is summarized as follows:

 

Range of Exercise Prices

   Outstanding
at April 30,
2009
   Weighted
Average
Remaining
Contractual Life
   Weighted
Average
Exercise Price
   Exercisable
at April 30,
2009
   Weighted
Average
Exercise Price

$  0.00 – $  25.00

   167,843    4.9 years    $ 10.74    164,258    $ 10.92

$25.01 – $  50.00

   —      —        —      —        —  

$50.01 – $  75.00

   4,920    0.8 years      57.98    4,920      57.98

$75.01 – $125.00

   600    0.8 years      121.25    600      121.25
                            
   173,363    4.8 years    $ 12.46    169,778    $ 12.68
                            

The aggregate intrinsic value of both options outstanding and options exercisable as of April 30, 2009 was $0. The aggregate intrinsic value of the 3,150 options which vested during the nine months ended April 30, 2009 was $0. During the nine months ended April 30, 2009, no options to purchase common stock were exercised.

 

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3. Revenue Recognition

The Company’s revenues from its four product lines are the result of separate, individual deliverables:

 

     Type of Revenues Earned

Product Line

   Equipment/Software    Professional Services    Maintenance Contracts

Millennium PBX System

   Individual sale      

eQueue Contact Center System

   Individual sale    Individual sale    Individual sale

VOIP Telephones

   Individual sale      

Cortelco

   Individual sale      

Because the eQueue system is very flexible in its applications, some customers contract for professional services to tailor their system to specific requirements. Professional services are invoiced separately upon completion.

eQueue customers can also elect to enter into maintenance contracts to receive software updates and free technical support. Revenue is booked quarterly for each maintenance period as provided.

The VOIP telephones can be deployed with either the Millennium or eQueue systems to provide lower call costs as well as flexible telecom management across multiple locations. These phones may be sold with a new system, but are often sold subsequent to the system sale.

Revenues from our 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 SEC Staff Accounting Bulletin No. 101, “Revenue Recognition,” and Statement of Position No. 97-2, “Software Revenue Recognition.”

 

4. Acquisition of Cortelco Systems Holding Corporation

On April 1, 2009, the Company acquired Cortelco for up to $11,000,000 in cash. Cortelco merged with a newly formed wholly-owned subsidiary of eOn and is now a wholly-owned subsidiary of eOn. In exchange for all of the outstanding shares of Cortelco stock, Cortelco shareholders received an initial aggregate payment of $500,000. The Company executed a note payable to Cortelco’s former shareholders for $10,500,000. The note is non-interest bearing and is contingent primarily upon the level of Cortelco earnings after closing and all Cortelco shareholders are eligible to receive quarterly payments thereunder in cash until the full consideration has been paid. The fair value of the note payable obligation assumed on the April 1, 2009 acquisition date was estimated using a discounted cash flow method (Level 3 input of the FASB 157 hierarchy), and together with approximately $124,000 in acquisition costs, resulted in a total purchase price of $5,054,000. David Lee, Chairman and CEO of eOn, was the Chairman and the controlling shareholder of Cortelco.

The following represents the preliminary purchase price allocation at the date of the Cortelco acquisition (in thousands):

 

Cash

   $ 100   

Accounts receivable

     1,578   

Inventories

     3,412   

Deferred income taxes, current

     212   

Other current assets

     333   

Property and equipment

     157   

Deferred income taxes, long-term

     58   

Other assets

     121   

Current liabilities

     (917
        

Net assets acquired

   $ 5,054   
        

Although the purchase price allocation is not considered final as of the date of this report, management believes the final allocation will not be materially different than presented herein.

The following unaudited pro forma financial information gives effect to the acquisition as if it had been consummated at the beginning of the periods presented. This information is not necessarily indicative of the operational

 

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results that would have occurred if the acquisition had been consummated on the dates indicated nor is it necessarily indicative of the future consolidated results of operations or financial condition.

 

     Three Months Ended
April 30,
    Nine Months Ended
April 30,
 
     2009     2008     2009     2008  

Revenue

   $ 4,080      $ 5,081      $ 13,953      $ 16,556   

Loss from continuing operations

     (3     (1,009     (40     (2,361

Loss from discontinued operations

     —          (7     —          (584

Net loss

   $ (3   $ (1,016   $ (40   $ (2,945

Basic and diluted pro forma loss per share:

        

From continuing operations

     *      $ (0.37   $ (0.01   $ (0.86

From discontinued operations, net of tax

     *        *        *        (0.21
                                

Basic and diluted pro forma loss per share

     *      $ (0.37   $ (0.01   $ (1.07
                                

 

* Less than $0.01

 

5. eOn IP Voice, Inc. (“EIPV) and Discontinued Operations

On February 23, 2007, the Company’s subsidiary, EIPV purchased certain accounts receivable, inventory and fixed assets and assumed certain liabilities of One IP Voice, Inc. for $150,000 in order to enter the hosted VoIP Services market. These assets, net of liabilities were purchased under an order of the United States Bankruptcy Court Chapter 11 Order Authorizing Sale of Assets at Auction Out of the Ordinary Course of Business. The results of EIPV were included in the Company’s consolidated financial statements beginning February 23, 2007, the date the assets were purchased. The Company accounted for this purchase as an acquisition in accordance with SFAS No. 141, “Business Combinations”.

During the quarter ended April 30, 2008, the Company sold the assets of EIPV for approximately $90,000. EIPV activity for the three and nine months ended April 30, 2008 is as follows:

 

     Three Months Ended
April 30, 2008
    Nine Months Ended
April 30, 2008
 

Revenue

   $ —        $ 43   

Cost of revenue

     —          120   

Impaired user licenses

     —          28   

Inventory obsolescence

     —          39   
                

Gross profit (loss)

     —          (144

General and administrative expense

     20        341   

Impaired property and equipment

     —          57   

Allowance for bad debts

     —          55   
                

Loss from discontinued operations

     (20     (597

Income on disposal

     13        13   
                

Loss from discontinued operations

   $ (7   $ (584
                

 

6. Related Parties

Cortelco Systems Puerto Rico

Cortelco Systems Puerto Rico (“CSPR”) was a wholly-owned subsidiary of the Company until August 28, 2001, when it was spun off to the shareholders of eOn. David Lee is a significant shareholder of CSPR. Since the spin-off, the Company has not had significant transactions with CSPR. The following represent related party transactions for the nine months ended April 30, 2009 and 2008 (in thousands):

 

     2009     2008  

Receivable from CSPR

    

Balance at beginning of period

   $ —        $ 9   

Cortelco balance at April 1

     6        —     

Purchases

     4        4   

Payments

     (9     (13
                

Balance at end of period

   $ 1      $ —     
                

 

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The Company acquired 300,100 shares (or 18.89%) of CSPR stock in the merger with Cortelco on April 1, 2009. These shares were valued at approximately $111,000 at April 1, 2009. eOn is accounting for this investment using the equity method of accounting, and eOn’s proportionate share of CSPR’s earnings or losses, which was not significant for the three months ended April 30, 2009, will be included in income in the consolidated financial statements.

Spark Technologies, Inc.

Aelix Systems, Inc. (“Aelix”), the Company’s former Banglore, India based subsidiary, and eOn China performed engineering development projects for Spark Technologies, Inc. (“Spark”), a California company that is majority owned by David Lee. On November 1, 2006, the Company entered into a professional services agreement with Spark. Under the terms of the agreement, Spark was charged based upon actual personnel, actual operating costs and allocated general overhead based upon pro rata head count, plus a margin of 10% for these services. Prior to this agreement, under the terms of an engineering development agreement, Aelix billed Spark for personnel and operating costs directly attributable to engineering work on Spark projects and allocated general overhead based upon pro rata head count. On April 1, 2008, an outsourcing services transfer agreement was entered into and eOn transferred all of its rights and obligations under the professional services agreement with Spark to Symbio Investment Corporation. eOn holds an equity interest in Symbio.

eOn and Spark share office space in San Jose, California. Spark bills eOn approximately $7,000 per month for rent and facility costs. The following represent related party transactions for the nine months ended April 30, 2009 and 2008 (in thousands):

 

     2009     2008  

Receivable from Spark

    

Balance at beginning of period

   $ —        $ 108   

Related party billings for engineering development and costs

     —          352   

Costs offset against operating expenses

     3        6   

Cash payments received from Spark

     —          (317

Payables offset against accounts receivable

     (3     (109
                

Balance at end of period

   $ —        $ 40   
                

 

     2009     2008  

Payable to Spark

    

Balance at beginning of period

   $ —        $ 37   

Operating costs billed to eOn

     52        72   

Payments to Spark

     (49     —     

Balance offset against receivable from Spark

     (3     (109
                

Balance at end of period

   $ —        $ —     
                

During July 2007, Spark gave notice of its intent to terminate the engineering development work performed by Aelix in India. As a result of this termination, the Company reduced the balance due from Spark by $26,000. This credit represented unamortized leasehold costs as of January 2008 and a facility deposit, offset by lost Aelix profits and rent through January 2008.

Symbio Group

On August 1, 2007 and August 27, 2007, the Company made strategic investments in Symbio Group (“Symbio”) of $500,000 and $400,000 for 250,000 and 200,000, respectively shares or a total of approximately 3% of Symbio Investment Corporation. Symbio is a leading China-based provider of software development, testing, and globalization outsourcing services to multinational companies. The investment is expected to establish eOn as a preferred provider of telephony and contact center solutions for Symbio’s outsourcing engagements requiring customer interaction management. eOn also gains the ability to provide Symbio outsourcing services to its customer base. Symbio is a privately held entity and the Company accounts for its 3% investment by the cost method.

 

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At the time of the second investment in Symbio ($400,000), the Company received a put option from David Lee, effective beginning January 1, 2008 and expiring on January 1, 2011. The put option allows the Company to sell to David Lee a maximum aggregate of 200,000 shares of its investment in Symbio for a per share price of $2.00.

In consideration of the put option, in the event that the 200,000 shares are sold without exercise of the put option before January 1, 2011, the Company has agreed to pay David Lee 50% of the proceeds in excess of $1,000,000.

In conjunction with the purchase of these shares, David Lee was appointed to the board of directors of Symbio and has been elected Chairman. eOn has been granted an additional 25,000 shares of Symbio as compensation for Mr. Lee’s services. These shares have been valued at $50,000, and have been recorded as an increase in investments and a capital contribution by David Lee.

Until November 1, 2008, Symbio shared office space and personnel with eOn in Shanghai, China and was billed for expenses attributable to its business. The following represent related party transactions for the nine months ended April 30, 2009 and 2008 (in thousands):

 

     2009     2008

Receivable from Symbio

    

Balance at beginning of period

   $ 84      $ —  

Operating costs billed

     155        —  

Payments

     (237     —  
              

Balance at end of period

   $ 2      $ —  
              

Joint Venture

On October 24, 2008, eOn China invested RMB 400,000 (approximately $58,000) into a joint venture in TaiCang, China. eOn China had borrowed RMB 300,000 from an unrelated third party in TaiCang and RMB 100,000 from an employee in October to make this investment. These borrowings were unsecured and interest free. In November 2008, David Lee purchased this investment from eOn China for $58,000 and took personal ownership of the investment. The proceeds from David Lee were used to repay these borrowings in November 2008.

 

7. Inventories

Inventories consist of the following (in thousands):

 

     April 30,
2009
    July 31,
2008
 

Raw materials and purchased components

   $ 1,706      $ 961   

Finished goods

     5,231        2,759   
                

Total

     6,937        3,720   

Inventory obsolescence reserve

     (1,773     (1,219
                

Inventory

   $ 5,164      $ 2,501   
                

 

8. Notes Payable

On June 20, 2008, eOn China issued a note to Hangzhou Nature Opto Company, an unrelated third party, in exchange for RMB 945,000, or approximately $138,000. The note payable is non-interest bearing and was due on January 19, 2009. The board of directors has approved the sale of eOn’s interest in Symbio-ESPark Business Outsourcing Joint Venture to Symbio in return for Symbio’s assumption of the note payable to Hangzhou Nature Opto Company. See Note 12.

 

9. Product Warranties

The Company generally provides customers a one year product warranty from the date of purchase for the Millennium and eQueue product lines. Warranty for the Cortelco product line ranges from one to five years based upon the product purchased. The Company estimates the costs of satisfying warranty claims based on analysis of past claims

 

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experience and provide for these future claims in the period that revenue is recognized. The cost of satisfying warranty claims, which approximates 2%-3% of product revenues for the eQueue and Millennium product line, has historically been comprised of materials and direct labor costs. The cost of satisfying warranty claims for the Cortelco product line, which approximates 0.5% of product revenues that are applicable to warranty, has historically been comprised of materials and direct labor costs. The Company performs quarterly evaluations of these estimates, and any changes in estimates, which could potentially be significant, are included in earnings in the period in which the evaluations are completed. The requirements of FIN 45 are applicable to the Company’s product warranty liability. The following table summarizes the activity related to the product warranty liability during the nine months ended April 30, 2009 and 2008 (in thousands):

 

     2009     2008  

Beginning balance

   $ 82      $ 133   

Warranty cost incurred

     (15     (47

Warranty accrual acquired in merger

     120        —     

Accrued warranty cost

     32        58   
                

Ending balance

   $ 219      $ 144   
                

 

10. Changes in Stockholders’ Equity

The following represent the changes in stockholders’ equity for the nine months ended April 30, 2009 (in thousands, excluding share data):

 

     Common Stock    Additional
Paid-In
Capital
   Treasury Stock     Accumulated
Deficit
    Accumulated
Other
Comprehensive

Income
    Total
Stockholders’

Equity
 
     Shares    Amount       Shares     Amount        

Balance at July 31, 2008

   2,869,608    $ 14    $ 55,931    (135,380   $ (1,502   $ (48,517   $ 105      $ 6,031   

Issuance of common stock under employee stock purchase plan

   4,384      —        2    —          —          —          —          2   

Stock based compensation expense, stock options and ESPP

           17              17   

Capital contribution by David Lee

           50              50   

Treasury stock acquired in merger

            (4,200     (1         (1

Comprehensive income (loss):

                   

Foreign currency translation adjustments

                    (1     (1

Net loss

   —        —        —      —          —          (450     —          (450
                         

Comprehensive loss

   —        —        —      —          —            —          (451
                                                         

Balance at April 30, 2009

   2,873,992    $ 14    $ 56,000    (139,580   $ (1,503   $ (48,967   $ 104      $ 5,648   
                                                         

 

11. Concentrations, Commitments and Contingencies

 

(a) Customer Concentrations

At April 30, 2009, three customers accounted for approximately 43% of total accounts receivable and individually 20%, 12% and 11% of the total accounts receivable.

 

(b) Commitments

At April 30, 2009, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $1,699,000.

Cortelco has a line of credit based on an asset formula involving accounts receivable and inventory up to a maximum of $2,500,000, none of which was drawn on as of April 30, 2009. The line of credit is secured by substantially all of Cortelco’s assets. The loan’s interest rate is floating based on LIBOR and expires June 29, 2010.

 

(c) Litigation

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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12. Symbio-ESPark Business Processing Outsourcing Joint Venture

On August 12, 2008, Hangzhou East Software Park (“Hangzhou”), Symbio and eOn formed Symbio-ESPark Business Processing Outsourcing Joint Venture (the “Joint Venture”) located in Hangzhou, China.

On September 9, 2008, eOn invested RMB 900,000 (approximately $136,000) into the Joint Venture for a 9% ownership interest in the Joint Venture. On June 20, 2008, the Company received approximately $138,000 from an entity related to Hangzhou and executed a promissory note due January 19, 2009. The eOn board of directors has approved the sale of eOn’s interest in the Joint Venture to Symbio in return for Symbio’s assumption of the promissory note. The transaction was not complete as of this report date. See Note 8.

Item 2.—Management’s Discussion and Analysis or Plan of Operation.

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

eOn Communications Corporation (“eOn” or the “Company”) is a global provider of innovative communications solutions. Backed with over 20 years of telecommunications engineering expertise, the Company’s solutions enable its 8,000 customers to easily leverage advanced technologies in order to communicate more effectively. eOn’s offerings are built on reliable open architectures that enable easy adoption of emerging technologies, such as Voice over Internet Protocol (VoIP) and concepts such as Service Oriented Architecture (SOA). Whether businesses are looking to leverage the advantages of enterprise IP telephony or advanced contact center technologies, eOn delivers proven, IP-ready products that improve business performance. The Company’s Cortelco product line provides customer premise equipment (CPE) commercial grade telephone products primarily for use in businesses, government agencies, colleges and universities, telephone companies, and utilities.

On February 23, 2007, the Company’s subsidiary, eOn IP Voice, Inc. (“EIPV”) purchased certain accounts receivable, inventory and fixed assets and assumed certain liabilities of One IP Voice, Inc. for $150,000 in order to enter the hosted VoIP Services market. These assets, net of liabilities were purchased under an order of the United States Bankruptcy Court Chapter 11 Order Authorizing Sale of Assets at Auction Out of the Ordinary Course of Business. The results of EIPV are included in the Company’s consolidated financial statements beginning February 23, 2007, the date the assets were purchased.

During October 2007, the Company committed to a plan to discontinue offering EIPV Business Connect hosted products and services. Accordingly, balances and activity have been reported as discontinued operations. During the quarter ended April 30, 2008, the Company sold the assets of EIPV for approximately $90,000.

On March 8, 2008, the Company and Cortelco entered into an outsourcing agreement whereby Cortelco provides management for all U.S operations of eOn. Included in the management services are sales, marketing, product management, engineering, technical support, quality assurance, accounting, and information.

On December 12, 2008, the Company executed a restructured Agreement and Plan of Merger to acquire Cortelco Systems Holding Corporation (“Cortelco”) for up to $11,000,000 in cash, contingent primarily on the future earnings of Cortelco. On April 1, 2009, the Company completed the acquisition of Cortelco. Cortelco merged with a newly formed wholly-owned subsidiary of eOn and is now a wholly-owned subsidiary of eOn. In exchange for all of the outstanding shares of Cortelco stock, Cortelco shareholders received an initial aggregate payment of $500,000. The Company executed a note payable to Cortelco’s former shareholders for $10,500,000. The note is non-interest bearing and is contingent primarily upon the level of Cortelco earnings after closing and all Cortelco shareholders are eligible to receive quarterly payments in cash until the full $11,000,000 consideration has been paid.

 

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Critical Accounting Policies and Estimates

There were no material changes during the nine months ended April 30, 2009 to the critical accounting policies reported in our Annual Report on Form 10-KSB for the fiscal year ended July 31, 2008.

Results of Operations

For the Three Months Ended April 30, 2009 compared to the Three Months Ended April 30, 2008

Net Revenue

Net revenue was up by approximately 63% at $2,465,000 for the three months ended April 30, 2009 compared to $1,514,000 for the same period of the previous year. The increase was attributable to the inclusion of Cortelco net revenue of $1,151,000 for the current quarter and higher international and service revenue partially offset by a decline of eQueue and Millennium product revenue. eQueue and Millennium product revenues declined during the quarter due to decreased customer demand.

Cost of Revenue and Gross Profit

Cost of revenue is primarily comprised of purchases from our contract manufacturers and other suppliers and costs incurred for final assembly of our systems. Gross profit increased approximately 45% to $1,109,000 for the three months ended April 30, 2009 from $763,000 for the same period of the previous year, reflecting Cortelco gross profit of $344,000 and increases in eQueue gross profit partially offset by declines in Millennium gross profit. Maintenance contract revenues declined compared to the same period of the previous year. Gross margin % decreased to approximately 45% for the three months ended April 30, 2009 compared with gross margin of approximately 50% for the same period of the previous year, primarily the result of product mix.

Selling, General and Administrative

Selling, general and administrative expense consists primarily of salaries and benefit costs, marketing costs, and facilities and other overhead expenses incurred to support our business. Selling, general and administrative expenses decreased approximately 26% to $852,000 for the three months ended April 30, 2009, from $1,150,000 for the same period of the previous year. The decrease reflects lower compensation and related expenses, lower rent expense and lower depreciation, partially offset by the inclusion of Cortelco expenses for April and higher domestic contract services expense.

Research and Development

Research and development expense consists primarily of personnel and related facility costs for our engineering staff. Research and development expenses decreased approximately 76% to $172,000 for the three months ended April 30 from $703,000 for the same period of the previous year. The Company closed its engineering facility in India effective April 1, 2008 and the decrease reflects lower compensation and related expenses, lower rent expense, and lower depreciation. In the three months ended April 30, 2009, the Company capitalized approximately $107,000 of software development costs related to a new IP PBX. Amortization of the capitalized costs is projected to begin in the first fiscal quarter of 2010 when the product is available for general release to customers.

Other Expense

Other expense is primarily comprised of bank service charges, franchise taxes, currency differences, and gains or losses from disposal of fixed assets. Other expenses were $26,000 for the three months ended April 30, 2009 compared to $123,000 for the same period of the previous year. The decrease in other expense is primarily attributable to costs related to the closure of the India engineering facility and the loss on disposal of assets in India in the previous year.

Interest Income

Interest income was $1,000 for the three months ended April 30, 2009 compared to $16,000 for the same period of the previous year. The decrease reflects a lower weighted average balance of funds invested and lower interest rate earned compared to the same period of the previous year.

For the Nine Months Ended April 30, 2009 compared to the Nine Months Ended April 30, 2008

Net Revenue

Net revenue increased approximately 3% to $5,556,000 for the nine months ended April 30, 2009 compared to $5,390,000 for the same period of the previous year. The increase was attributable to inclusion of Cortelco net revenue of $1,151,000 and higher service revenue, partially offset by declines in eQueue and Millennium product revenues over the same period of the previous year. Sales of Millennium systems were adversely impacted by slowdowns in key US government and education market segments during the nine months ended April 30, 2009. The decrease in eQueue revenues reflect lower domestic and international software sales during the nine months ended April 30, 2009 compared to the same period of the previous year.

 

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Cost of Revenue and Gross Profit

Cost of revenue is primarily comprised of purchases from our contract manufacturers and other suppliers and costs incurred for final assembly of our systems. Gross profit decreased approximately 10% to $2,684,000 for the nine months ended April 30, 2009 from $2,971,000 for the same period of the previous year, reflecting declines in both eQueue and Millennium margins partially offset by the inclusion of Cortelco gross profit in the current fiscal year. Gross profit for eQueue and Millennium sales decreased for the nine months ended April 30, 2009, reflecting lower system sales over the same period of the previous year. Maintenance contract revenues with higher margins declined compared to the same period of the previous year. Gross margin % decreased to approximately 48% for the nine months ended April 30, 2009 compared with gross margin of approximately 55% for the same period of the previous year, primarily the result of product mix.

Selling, General and Administrative

Selling, general and administrative expense consists primarily of salaries and benefit costs, marketing costs, and facilities and other overhead expenses incurred to support our business. Selling, general and administrative expenses decreased approximately 30% to $2,307,000 for the nine months ended April 30, 2009, from $3,297,000 for the same period of the previous year. The decrease reflects lower compensation and related expenses, lower rent expense and lower depreciation, partially offset by the inclusion of Cortelco’s April expenses in the current year and higher domestic contract services expense.

Research and Development

Research and development expense consists primarily of personnel and related facility costs for our engineering staff. Research and development expenses decreased approximately 65% to $754,000 for the nine months ended April 30, 2009 from $2,140,000 for the same period of the previous year. The Company closed its engineering facility in India effective April 1, 2008 and the decrease reflects lower compensation and related expenses, lower rent expense, and lower depreciation. In the nine months ended April 30, 2009, the Company capitalized approximately $107,000 of software development costs related to a new IP PBX. Amortization of the capitalized costs is projected to begin in the first fiscal quarter of 2010 when the product is available for general release to customers.

Other Expense

Other expense is primarily comprised of bank service charges, franchise taxes, currency differences, and gains or losses from disposal of fixed assets. Other expenses were $87,000 for the nine months ended April 30, 2009 compared to $160,000 for the same period of the previous year. The decrease in other expense is primarily attributable to expenses related to the closure of the India engineering facility and the loss on disposal of fixed assets in India in the prior fiscal year.

Interest Income

Interest income was $14,000 for the nine months ended April 30, 2009 compared to $96,000 for the same period of the previous year. The decrease reflects a lower weighted average balance of funds invested and lower interest rate earned compared to the same period of the previous year.

Liquidity and Capital Resources

As of April 30, 2009, we had cash and cash equivalents of $1,394,000 and $700,000 in short-term marketable securities, and working capital of $8,267,000. Our short-term marketable securities are invested in liquid treasury securities.

Our operating activities resulted in a net cash inflow of $97,000 for the nine months ended April 30, 2009 compared to a net cash outflow of $2,435,000 for the same period of the previous year. The net operating cash inflow for the current period primarily reflects net loss (adjusted for non-cash items), lower inventories, prepaid assets, and trade accounts receivable, excluding the assets acquired in the merger with Cortelco. The inflow is partially offset by lower accrued expenses excluding the accrued expenses assumed in the merger with Cortelco. The net operating cash outflow for the prior year period primarily reflects net loss (adjusted for non-cash items) and higher inventories and other current assets partially offset by higher accounts receivable.

Our investing activities resulted in a net cash outflow of $249,000 for the nine months ended April 30, 2009 compared to a net cash inflow of $1,426,000 for the same period of the previous year. Cash used in investing activities for the nine months ended April 30, 2009 was a result of net cash used in the acquisition of Cortelco of $400,000, an investment of approximately $136,000 in a joint venture in Hangzhou, China and purchases of property and equipment. Cash provided by investing activities for the same period of the previous year was a result of disposal of marketable securities and proceeds from the disposal of discontinued operations partially offset by the $900,000 investment in Symbio Group and purchases of property and equipment.

 

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Our financing activities resulted in a cash inflow of $2,000 for the nine months ended April 30, 2009 compared to a cash inflow of $11,000 for the same period of the previous year. Cash provided by financing activities in the current period and in the prior period were due to purchases under the Employee Stock Purchase Plan.

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 approximately $5,295,000 in capital expenditures.

The Company has incurred substantial net operating losses since inception and has had negative cash flows from operating activities through July 31, 2008; resulting in an accumulated deficit of $48,517,000 at that date. During the nine months ended April 30, 2009, cash and cash equivalents and short-term marketable securities decreased to $2,094,000 from $2,545,000, primarily as a result of funding the Cortelco merger and operating losses during the period.

The Company had a loss from continuing operations of $450,000 for the nine months ended April 30, 2009 versus a loss from continuing operations of $2,530,000 for the same period in the prior year. As of April 30, 2009, the Company had $2,094,000 in cash and cash equivalents and short-term marketable securities available to fund operations, of which $79,000 was held in international bank accounts.

The Company is largely dependent on available cash, short-term marketable securities and operating cash flow to finance operations and meet its other capital needs. Cortelco has a line of credit based on an asset formula involving accounts receivable and inventory up to a maximum of $2,500,000, none of which was drawn on as of April 30, 2009. The line of credit is secured by substantially all of Cortelco’s assets. The loan’s interest rate is floating based on LIBOR and expires June 29, 2010. If such sources are not sufficient, alternative funding sources may not be available. The Company believes that cash on hand, short-term marketable securities, and the Cortelco line of credit 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 believe that the cash, short-term marketable securities on hand, and Cortelco’s line of credit 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 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.

Due to the current state of the credit markets, we are not able to predict with any certainty whether we could obtain additional debt or equity financing to provide additional sources of liquidity, should the need arise, at favorable rates.

Concentrations, Commitments and Contingencies

 

(a) Customer Concentrations

At April 30, 2009, three customers accounted for approximately 43% of total accounts receivable and individually 20%, 12% and 11% of the total accounts receivable.

 

(b) Commitments

At April 30, 2009, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $1,699,000.

Cortelco has a line of credit based on an asset formula involving accounts receivable and inventory up to a maximum of $2,500,000, none of which was drawn on as of April 30, 2009. The line of credit is secured by substantially all of Cortelco’s assets. The loan’s interest rate is floating based on LIBOR and expires June 29, 2010.

 

(c) Litigation

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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Item 3.—Quantitative and Qualitative Disclosures About Market Risk.

The Company is subject to market rate risk from exposure to changes in interest rates based on its financing, investing and cash management activities, but the Company does not believe such exposure is material.

Item 4.—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 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.

Changes in internal control over financial reporting.

There were no changes in internal control over financial reporting that occurred during the three-month period ending April 30, 2009.

 

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PART II—OTHER INFORMATION

Item 1.—Legal Proceedings.

None.

Item 1A.—Risk Factors.

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.

Downturns in the U.S. and global economy adversely affect operating results.

Weakness in the U.S. and global economy has had a negative effect on our operating results. In an economic slowdown, we may also experience the negative effects of increased competitive pricing pressure and customer turnover. Worsening economic conditions or a prolonged or recurring recession could adversely affect our operating results. Further, we cannot assure you that an improvement in economic conditions will result in an immediate, if at all positive, improvement in our operating results or cash flows.

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;

 

   

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 continue to develop products that improve communications, increase employee productivity and lower costs. While the industry remains fragmented, it is rapidly moving toward consolidation. A number of our current competitors have been recently acquired by companies seeking to increase market share and their ability to compete. Additionally, robust open-source products have recently emerged in the market further lowering barriers to market entry and increasing competition.

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 and Aspect Software;

 

   

Data communication equipment suppliers, such as Cisco Systems and Huawei;

 

   

VoIP telephone manufacturers, such as Polycom, Linksys, Grand Stream and Aastra

 

   

Hosted solution providers including Packet 8, Five9, Echopass and Oracle.

 

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

 

   

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

 

   

Customer relationship management (CRM) suppliers such as Oracle, and SalesForce.com.

 

   

Telephony product suppliers such as Sprint North Supply (Premier), Telematrix, Sci-Tec, TT Systems, ATT/Vtech, Astra, and Panasonic.

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 maintain our indirect and distribution sales channels our ability to generate revenue would be harmed.

A significant portion of our revenues are derived from distributors, dealers and value added resellers who have no obligation to sell our products. Therefore, distributors, dealers and value added resellers could discontinue selling our products at any time in favor of our competitors’ products or for any other reason. Sales to three distribution customers comprised approximately 59% of Cortelco’s sales for the year ended December 31, 2008. A reduction or loss of orders from our distributors, dealers and value added resellers could harm our business, operating results and financial condition.

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. Our telephone distributor sales are primarily shipped from stock. Also, it is difficult to predict the timing of indirect sales because we have little control over the selling activities of our dealers, distributors 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, on our eQueue and Millennium products. 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. Although largely dependent on end user demand and distributor inventory levels, telephone distribution sales generally have a shorter sales cycle.

There are risks associated with eOn’s strategy of expanding into international markets, particularly in China.

Because some of eOn’s growth initiatives include expansion into foreign markets, it is 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.

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

eOn may not be able to continue to invest in China or other international markets due to the above factors. Foreign markets for our products may continue to develop more slowly than anticipated, particularly with the current economic downturn worldwide.

 

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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.

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 Ayrshire Electronics (formerly 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. Legacy telephones are manufactured in house from domestic and imported components. Other telephony products are sourced globally for sale through distribution channels. 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 April 30, 2009, our executive officers, directors and principal stockholders and their affiliates beneficially owned 722,331 shares, or 29.6% 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

 

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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 2.—Unregistered Sales of Securities and Use of Proceeds.

None.

Item 3.—Defaults Upon Senior Securities.

None.

Item 4.—Submission of Matters to a Vote of Security Holders.

None.

Item 5.—Other Information.

None.

Item 6.—Exhibits.

(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

 

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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

Dated: June 12, 2009

/s/ Stephen R. Bowling

Stephen R. Bowling

Vice President, Chief Financial Officer

(Duly Authorized Officer, Principal Financial and

Accounting Officer)

 

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