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, 2010.

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

incorporation or organization)

 

(I.R.S. Employer

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.    x  Yes    ¨  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    ¨   Smaller 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    x  No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

2,758,730 shares of common stock, $0.005 par value, were outstanding as of May 31, 2010.

 

 

 


Table of Contents

EON COMMUNICATIONS CORPORATION

FORM 10-Q

QUARTER ENDED APRIL 30, 2010

TABLE OF CONTENTS

 

PART I   

FINANCIAL INFORMATION

  

Item 1.

  

Financial Statements

   3
  

Condensed Consolidated Balance Sheets at April 30, 2010 (unaudited) and July 31, 2009

   3
  

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Nine Months Ended April 30, 2010 and 2009 (Unaudited)

   4
  

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended April 30, 2010 and 2009 (Unaudited)

   5
  

Notes to Condensed Consolidated Financial Statements (unaudited)

   6

Item 2.

  

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

   15

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   21

Item 4T.

  

Controls and Procedures

   21
PART II   

OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

   22

Item 1A.

  

Risk Factors

   22

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   22

Item 3.

  

Defaults Upon Senior Securities

   22

Item 4.

  

Reserved

   22

Item 5.

  

Other Information

   22

Item 6.

  

Exhibits

   22

 

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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,
2010
    July 31,
2009
 
     (unaudited)        

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 2,536      $ 3,010   

Trade accounts receivable, net of allowance of $298 and $332, respectively

     1,995        2,943   

Trade accounts receivable—related party

     10        228   

Inventories

     4,848        5,032   

Deferred income taxes

     270        270   

Prepaid and other current assets

     177        242   
                

Total current assets

     9,836        11,725   

Property and equipment, net

     142        209   

Intangibles, net

     771        410   

Investments

     1,142        1,136   

Investment in unconsolidated equity investee

     191        140   
                

Total assets

   $ 12,082      $ 13,620   
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities:

    

Trade accounts payable

   $ 822      $ 1,127   

Trade accounts payable—related party

     5        11   

Notes payable—related party

     564        1,157   

Accrued expenses and other

     1,180        1,628   
                

Total current liabilities

     2,571        3,923   

Note payable—related party, net of current portion

     3,603        3,891   
                

Total liabilities

     6,174        7,814   
                

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, 2,898,310 and 2,873,992 shares issued, respectively)

     15        14   

Additional paid-in capital

     56,060        56,048   

Treasury stock, at cost (139,580 shares)

     (1,503     (1,503

Accumulated deficit

     (48,772     (48,856

Accumulated other comprehensive income

     108        103   
                

Total stockholders’ equity

     5,908        5,806   
                

Total liabilities and stockholders’ equity

   $ 12,082      $ 13,620   
                

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,
 
     2010     2009    2010     2009  

REVENUE

         

Net revenue

   $ 3,576      $ 2,465    $ 11,617      $ 5,556   
                               

COST OF REVENUE

         

Cost of revenue

     2,250        1,356      7,306        2,872   
                               

Gross profit

     1,326        1,109      4,311        2,684   
                               

OPERATING EXPENSE

         

Selling, general and administrative

     1,058        852      3,346        2,307   

Research and development

     141        172      395        754   

Other expenses

     25        26      57        87   
                               

Total operating expense

     1,224        1,050      3,798        3,148   
                               

Income (loss) from operations

     102        59      513        (464

Interest (expense) income, net

     (149     1      (499     14   

Equity in earnings of unconsolidated investee

     2        —        51        —     
                               

(Loss) income before income taxes

     (45     60      65        (450

Income tax expense (benefit)

     2        —        (19     —     
                               

Net (loss) income

   $ (47   $ 60    $ 84      $ (450
                               

COMPREHENSIVE (LOSS) INCOME

         

Net (loss) income

   $ (47   $ 60    $ 84      $ (450

Unrealized gains on available-for-sale securities

     1        —        5        —     

Foreign currency translation adjustment

     —          —        —          (1
                               

Comprehensive (loss) income

   $ (46   $ 60    $ 89      $ (451
                               

Weighted average shares outstanding

         

Basic

     2,756        2,736      2,743        2,735   
                               

Diluted

     2,756        2,736      2,745        2,735   
                               

Basic (loss) income per share

   $ (0.02   $ 0.02    $ 0.03      $ (0.16
                               

Diluted (loss) income per share

   $ (0.02   $ 0.02    $ 0.03      $ (0.16
                               

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,
 
     2010     2009  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income (loss)

   $ 84      $ (450

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

    

Stock-based compensation expense

     —          17   

Depreciation and amortization

     144        129   

Provision for doubtful accounts

     (3     63   

Loss on disposal of property and equipment

     —          29   

Imputed interest expense on note payable

     499        —     

Equity in earnings of unconsolidated investee

     (51     —     

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

    

Trade accounts receivable

     951        55   

Inventories

     184        749   

Prepaid and other assets

     64        179   

Trade accounts payable

     (305     (73

Trade accounts receivable/payable—related party

     212        (45

Accrued expenses and other

     (447     (449
                

Net cash provided by operating activities

     1,332        204   
                

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Net cash used in business acquisition

     —          (400

Purchases of property and equipment

     (14     (13

Purchase of investments

     —          (194

Sale of investments

     —          58   

Capitalized software development costs

     (424     (107

Purchases of marketable securities

     —          (1,000

Disposal of marketable securities

     —          1,300   
                

Net cash used in investing activities

     (438     (356
                

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Proceeds from note payable

     —          58   

Repayment of note payable

     (1,381     (58

Proceeds from employee stock purchase plan and stock option exercises

     11        2   

Proceeds from stock warrant exercise

     2        —     
                

Net cash (used in) provided by financing activities

     (1,368     2   
                

Effect of exchange rate changes on cash

     —          (1
                

Net decrease in cash and cash equivalents

     (474     (151

Cash and cash equivalents, beginning of period

     3,010        1,545   
                

Cash and cash equivalents, end of period

   $ 2,536      $ 1,394   
                

Supplemental cash flow information:

    

Interest paid

   $ 597      $ —     
                

Income taxes paid

   $ —        $ —     
                

Net assets acquired in merger with Cortelco Systems Holding Corp., excluding cash

   $ —        $ 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, 2010 and 2009

 

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, 2010, and for all periods presented.

Description of Business

eOn is a global provider of innovative communications solutions. The Company’s solutions enable its customers to 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). 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.

Interim Condensed 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”), and Cortelco Systems Holding Corp. (“Cortelco”) acquired on April 1, 2009. 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, 2009 and 2008 and for each of the two years in the period ended July 31, 2009, which are included in the Annual Report on Form 10-K 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 Measurements

Accounting standards define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact, and considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of non performance.

Accounting standards have established a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Accounting standards have established three levels of inputs that may be used to measure fair value:

 

  •Level 1: Quoted prices in active markets for identical assets and liabilities.

 

  •Level 2: Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets with insufficient volume or infrequent transactions (less active markets), or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.

 

  •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).

 

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

The note payable to the former Cortelco shareholders (Note 6) is valued using a discounted cash flow analysis of the projected future payments of Cortelco using a discount rate of 15.22%. The note is classified within Level 3 of the fair value hierarchy. The following represents transactions related to the note payable for the nine months ended April 30, 2010 (in thousands):

 

Beginning fair value - July 31, 2009

   $ 4,910   

Imputed interest

     466   

Change in estimates

     33   
        

Interest expense

     499   

Payments

     (1,381
        

Ending fair value - April 30, 2010

   $ 4,028   
        

Income Taxes

For the nine months ended April 30, 2010, the Company recorded a current income tax benefit of approximately $19,000, related to a federal income tax refund receivable.

Due to uncertainties surrounding the timing of realizing the benefits of its net favorable tax attributes in future returns, to the extent that it is more likely than not that deferred tax assets may not be realized, the Company continues to record a valuation allowance against substantially all of its deferred tax assets at April 30, 2010.

Software Development Costs

In accordance with accounting standards, the Company capitalizes 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, 2010 was approximately $667,000 and is included in intangibles, net in the accompanying condensed consolidated balance sheet. The software is under development and is expected to be available for general release to customers in the second fiscal quarter of 2011, at which time the Company will begin amortizing it.

Recently Issued and Adopted Accounting Standards

In June 2009, the Financial Accounting Standards Board (“FASB”) approved the FASB Accounting Standards Codification (the “Codification”) as the single source of authoritative non-governmental generally accepted accounting principles (GAAP). All existing accounting standard documents, such as FASB, American Institute of Certified Public Accountants, Emerging Issues Task Force and other related literature, excluding guidance from the Securities and Exchange Commission (“SEC”), have been superseded by the Codification. All other non-grandfathered, non-SEC accounting literature not included in the Codification has become nonauthoritative. The Codification did not change GAAP, but instead introduced a new structure that combines all authoritative standards into a comprehensive, topically organized online database. The Codification is effective for interim or annual periods ending after September 15, 2009, and impacts the Company’s consolidated financial statements, as all future references to authoritative accounting literature will be referenced in accordance with the Codification. As a result of the Company’s implementation of the Codification during the quarter ended October 31, 2009, previous references to new accounting standards and literature are no longer applicable.

On July 1, 2009, the Company adopted new guidance issued by the FASB related to the accounting for business combinations and related disclosures. This new guidance addresses the recognition and accounting for identifiable assets acquired, liabilities assumed, and noncontrolling interests in business combinations. The guidance also establishes expanded disclosure requirements for business combinations. The guidance was effective for the Company on July 1, 2009, and the Company will apply this new guidance prospectively to all business combinations subsequent to July 1, 2009.

On July 1, 2009, the Company adopted new guidance issued by the FASB related to the accounting for noncontrolling interests in consolidated financial statements. This guidance establishes accounting and reporting standards

 

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for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This guidance requires that noncontrolling interests in subsidiaries be reported in the equity section of the controlling company’s balance sheet. It also changes the manner in which the net income of the subsidiary is reported and disclosed in the controlling company’s income statement. The adoption of this guidance had no impact on the Company’s financial statements.

In April 2009, the FASB issued new accounting guidance related to interim disclosures about the fair values of financial instruments. This guidance requires disclosures about the fair value of financial instruments whenever a public company issues financial information for interim reporting periods. This guidance is effective for interim reporting periods ending after June 15, 2009. The Company adopted this guidance upon its issuance, and it had no material impact on the Company’s financial statements.

In October 2009, the FASB issued authoritative guidance on revenue recognition that becomes effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued authoritative guidance on revenue arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance. Under the new guidance, when vendor-specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. The Company is evaluating the potential impact of this new guidance on its consolidated financial statements.

In January 2010, the FASB issued Accounting Standard Update No. 2010-06, Improving Disclosures about Fair Value Measurements (“ASU No. 2010-06”), which amends the existing fair value measurements and disclosures guidance currently included in Accounting Standards Codification No. 820 to require additional disclosures regarding fair value measurements. Specifically, ASU No. 2010-06 requires entities to disclose the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers, the reasons for any transfer in or out of Level 3, and information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuance and settlements on a gross basis. In addition, ASU No. 2010-06 also clarifies the requirement for entities to disclose information about both the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. ASU No. 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for additional disclosures related to Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010. We do not expect ASU No. 2010-06 to have a material impact on our financial statements or results of operations.

Reclassification

Certain amounts in the April 30, 2009 condensed consolidated financial statements have been reclassified to conform to the April 30, 2010 condensed consolidated financial statement presentation.

 

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, 2010, there were no options to purchase shares of common stock granted by the Company.

Employee Stock Purchase Plan

The Employee Stock Purchase Plan permits employees to purchase up to 200,000 shares of the Company’s common stock. 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, 2010, employees purchased 9,318 shares under the plan.

 

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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 the 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.

No stock-based compensation was recognized for the nine months ended April 30, 2010. As of April 30, 2010, the Company has total unrecognized compensation cost of approximately $1,000 related to unvested stock options under the Plans.

General Stock Option Information

Activity in the Company’s stock option plans since July 31, 2009 is as follows:

 

     Shares
Available
for Grant
   Options
Outstanding
    Weighted
Average
Exercise
Price

Options at July 31, 2009

   202,914    173,363      $ 12.46

Granted

   —      —          —  

Exercised

   —      —          —  

Cancelled

   25,019    (25,019     21.68
                 

Options at April 30, 2010

   227,933    148,344      $ 10.91
                 

Information regarding the stock options outstanding under the Company’s stock option plans at April 30, 2010 is summarized as follows:

 

Range of Exercise Prices

   Outstanding
at April 30
2010
   Weighted
Average
Remaining
Contractual Term
   Weighted
Average
Exercise Price
   Exercisable
at April 30
2010
   Weighted
Average
Exercise Price

$  0.00 – $  5.00

   15,688    3.1 years    $ 3.45    14,125    $ 3.78

$  5.01 – $10.00

   78,003    4.8 years      7.22    78,003      7.22

$10.01 – $15.00

   1,000    3.5 years      11.90    1,000      11.90

$15.01 – $25.00

   53,653    2.6 years      18.43    53,653      18.43
                            
   148,344    3.8 years    $ 10.91    146,781    $ 11.02
                            

The aggregate intrinsic value of both options outstanding and options exercisable as of April 30, 2010 was $6,000. The aggregate intrinsic value of the 496 options which vested during the nine months ended April 30, 2010 was $1,000. During the nine months ended April 30, 2010, no options to purchase common stock were exercised.

 

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 Products

   Individual sale      

 

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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 recorded 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.

Cortelco sells corded and cordless analog and digital telephones capable of operating in the multiple PBX, Key System and Centrex environments primarily through stocking distributors.

The Company records shipping and handling fees billed to customers as revenue, and shipping and handling costs incurred with the delivery of products as cost of sales.

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.

 

4. 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, Chairman of eOn, is a significant shareholder of CSPR. On June 9, 2010, the Company executed a definitive agreement to purchase 501,382 shares of common stock of Cortelco Systems Puerto Rico, Inc. from David Lee in a privately negotiated transaction (Note 12). The following represents related party transactions for the nine months ended April 30, 2010 and 2009 (in thousands):

 

     2010     2009  

Receivable from CSPR

    

Balance at beginning of period

   $ 1      $ —     

Receivable acquired in merger

   $ —        $ 6   

Purchases

     11        4   

Payments

     (10     (9
                

Balance at end of period

   $ 2      $ 1   
                

The Company acquired 300,100 shares (or 18.89%) of CSPR stock as the result of the acquisition of Cortelco on April 1, 2009. These shares were valued at approximately $111,000 at April 1, 2009 based on the quoted market price of CSPR’s shares at that date. Because David Lee is a significant shareholder of CSPR, eOn is accounting for this investment using the equity method of accounting, and eOn’s proportionate share of CSPR’s earnings or losses are included in income (loss) in the consolidated financial statements. The Company’s proportionate share of CSPR’s net income was approximately $51,000 for the nine months ended April 30, 2010. The carrying value of the CSPR stock was $191,000 as of April 30, 2010 and $140,000 as of July 31, 2009. Summarized financial information of CSPR as of April 30, 2010 and for the nine months ended April 30, 2010, is as follows (unaudited, in thousands):

 

     April 30, 2010  

Assets:

  

Current assets

   $ 2,848   

Property and equipment

     127   

Other assets

     (5
        

Total assets

   $ 2,970   
        

Liabilities and stockholders’ equity:

  

Current liabilities

   $ 1,317   
        

Total liabilities

     1,317   

Stockholders’ equity

     1,653   
        

Total liabilities and stockholders’ equity

   $ 2,970   
        

 

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     Nine Months Ended
April 30, 2010
 

Revenues

   $ 5,990   

Cost of revenues

     (4,620
        

Gross profit

     1,370   

Expenses

     (1,101
        

Net income

   $ 269   
        

Spark Technologies, Inc.

eOn and Spark Technologies, Inc. (“Spark”), a company that is majority owned by David Lee, share office space in San Jose, California. Spark bills eOn approximately $4,000 per month for rent and facility costs. The following represents related party transactions for the nine months ended April 30, 2010 and 2009 (in thousands):

 

     2010     2009  

Payable to Spark

    

Balance at beginning of period

   $ —        $ —     

Operating costs billed to eOn

     43        52   

Payments to Spark

     (43     (49

Balance offset against receivable from Spark

     —          (3
                

Balance at end of period

   $ —        $ —     
                

Symbio Group

On August 1, 2007 and August 27, 2007, the Company made strategic investments in Symbio Investment Corp. (“Symbio”) of $500,000 and $400,000 for 250,000 and 200,000 shares, respectively, or a total of approximately 3% of Symbio. Symbio is a China-based provider of software development, testing, and globalization outsourcing services to multinational companies. The investment is expected to establish eOn as a 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.

At the time of the second investment in Symbio, 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 was granted a total of 45,000 shares of Symbio stock in April 2008 and April 2009 as compensation for Mr. Lee’s services. These shares have been valued at $90,000, and have been recorded as an increase in investments and a capital contribution by David Lee.

 

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Symbio currenty shares office space and personnel with eOn in Shanghai, China and is billed for expenses attributable to its business. Symbio has contracted to assist eOn in the United States with software development. The following represent related party transactions for the nine months ended April 30, 2010 and 2009 (in thousands):

 

     2010     2009  

Receivable from Symbio

    

Balance at beginning of period

   $ 9      $ 84   

Operating costs billed

     84        155   

Payments

     (85     (237
                

Balance at end of period

   $ 8      $ 2   
                
     2010     2009  

Payable to Symbio

    

Balance at beginning of period

   $ 11      $ —     

Billings and accruals for engineering services

     22        —     

Payments

     (27     —     
                

Balance at end of period

   $ 6      $ —     
                

Symbio-ES Park 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 Hangzhou Nature Opto Company, an entity related to Hangzhou and executed a promissory note due January 19, 2009. The Company is negotiating the transfer of its ownership interest in the joint venture to Hangzhou Nature Opto Company in exchange for payment of the promissory note (Note 6).

The following represents related party transactions for the nine months ended April 30, 2010 (in thousands):

 

Receivable from Hangzhou

  

Balance at beginning of period

   $ 154   

Billings for product and services

     —     

Payments

     (154
        

Balance at end of period

   $ —     
        

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. The following represents related party transactions for the nine months ended April 30, 2010 (in thousands):

 

Receivable from TaiCang

  

Balance at beginning of period

   $ 64   

Billings for product and services

     27   

Payments

     (91
        

Balance at end of period

   $   —     
        

 

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5. Inventories

Inventories consist of the following (in thousands):

 

     April 30,
2010
    July 31,
2009
 

Raw materials and purchased components

   $ 1,302      $ 1,626   

Finished goods

     5,262        5,098   
                

Total

     6,564        6,724   

Inventory obsolescence reserve

     (1,716     (1,692
                

Inventory

   $ 4,848      $ 5,032   
                

 

6. Notes Payable, Related Party

On June 20, 2008, eOn China issued a note to Hangzhou Nature Opto Company 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 Company is negotiating the transfer of its ownership interest in the joint venture to Hangzhou Nature Opto Company in exchange for payment of the promissory note (Note 4).

On April 1, 2009, the Company executed a note payable to Cortelco’s former shareholders for $10,500,000 (the “Cortelco Note”). The Cortelco Note is non-interest bearing and is to be repaid based 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 Cortelco Note payable obligation was approximately $4,028,000 at April 30, 2010 using a discounted cash flow analysis of the projected future payments and a discount rate of 15.22%. The Cortelco Note balance includes $149,000 and $499,000 of interest expense during the three and nine months ended April 30, 2010 imputed at the 15.22% discount rate using the effective interest method.

Actual payments under the Cortelco Note, which are to be based on future earnings of Cortelco, may differ significantly from the projected payments estimated at the Cortelco Note’s inception. These differences may result in significant fluctuations in periodic interest expense in order to properly reflect interest expense over the actual life of the Cortelco Note.

 

7. 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 experience and provides for these future claims in the period that revenue is recognized. The cost of satisfying warranty claims, which approximates 0.6%-2.3% of product revenues, 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 following table summarizes the activity related to the product warranty liability during the nine months ended April 30, 2010 and 2009 (in thousands):

 

     2010     2009  

Beginning balance

   $ 196      $ 82   

Warranty cost incurred

     (81     (15

Warranty accrual acquired in merger

     —          120   

Accrued warranty cost

     73        32   
                

Ending balance

   $ 188      $ 219   
                

 

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8. Changes in Stockholders’ Equity

The following represents the changes in stockholders’ equity for the nine months ended April 30, 2010 (in thousands, excluding share data):

 

                                      Accumulated     
               Additional                      Other    Total
     Common Stock    Paid-In    Treasury Stock     Accumulated     Comprehensive    Stockholders’
     Shares    Amount    Capital    Shares     Amount     Deficit     Income    Equity

Balance at July 31, 2009

   2,873,992    $ 14    $ 56,048    (139,580   $ (1,503   $ (48,856   $ 103    $ 5,806

Issuance of common stock under employee stock purchase plan

   9,318      —        11    —          —          —          —        11

Issuance of common stock for exercise of stock warrant

   15,000      1      1    —          —          —          —        2

Stock based compensation expense, stock options and ESPP

           —                 —  

Comprehensive income :

                    

Unrealized gains on available-for-sale securities

                    5      5

Net income

   —        —        —      —          —          84        —        84

Comprehensive income

   —        —        —      —          —            —        89
                                                      

Balance at April 30, 2010

   2,898,310    $ 15    $ 56,060    (139,580   $ (1,503   $ (48,772   $ 108    $ 5,908
                                                      

 

9. Stock Warrant

In July 2007, the Company issued a warrant to purchase 75,000 shares of common stock in conjunction with the purchase of Aelix Systems, Inc. The warrant was converted to 15,000 shares in a reverse stock split in April 2008. In January 2009, the warrant was exercised to purchase 15,000 shares of common stock at $.05 per share. The intrinsic value of the warrants exercised was approximately $57,000.

 

10. Concentrations, Commitments and Contingencies

 

(a) Customer Concentrations

At April 30, 2010, four customers accounted for approximately 58% of total accounts receivable and individually 20%, 14%, 12% and 12% of the total accounts receivable. For the nine months ended April 30, 2010, four customers accounted for approximately 53% of total revenue and individually 26%, 11%, 10% and 7% of total revenue.

 

(b) Commitments

At April 30, 2010, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $1,973,000.

Cortelco has a line of credit based on an asset formula involving accounts receivable and inventories up to a maximum of $2,500,000, none of which was drawn on as of April 30, 2010. 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.

 

11. Segments

The Company’s reportable segments are Communications Systems and Services and Telephony Products, each of which offers different products and services. The Communications Systems and Services segment develops and markets products that help businesses communicate more effectively and efficiently with their customers. The Telephony Products segment provides telephone products, service and support to businesses and organizations. Performance of each segment is assessed independently. Prior to the acquisition of Cortelco on April 1, 2009, the Company reported all of its operations as one segment. Segment reporting for activity as of and for the three and nine months ended April 30, 2010 follows:

 

     Communications                         
     Systems and Services     Telephony Products     Total  
     3 Months     9 Months     3 Months    9 Months     3 Months     9 Months  

Revenue

   $ 942      $ 2,853      $ 2,634    $ 8,764      $ 3,576      $ 11,617   

(Loss) income before income taxes

     (277     (826     232      891        (45     65   

Income tax expense (benefit)

     —          —          2      (19     2        (19

Net (loss) income

     (277     (826     230      910        (47     84   

Total assets

     N/A        6,067        N/A      6,015        N/A        12,082   

Capital expenditures

     3        13        —        1        3        14   

Capitalized software development

     136        424        —        —          136        424   

Allowance for doubtful accounts

     N/A        282        N/A      16        N/A        298   

Depreciation and amortization

     30        92        17      52        47        144   

 

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Substantially all of the Company’s revenues are earned in the United States and the People’s Republic of China (“PRC”). Revenue earned in the PRC for the nine months ended April 30, 2010 was approximately $163,000 or 1% of total revenue for the period. During the nine months ended April 30, 2009, revenue in the PRC was approximately $571,000 or 10% of total revenue for the period. Substantially all of the Company’s assets are located in the United States. Assets located in the PRC represented approximately 3% of the Company’s total assets at April 30, 2010.

 

12. Subsequent Event

On June 9, 2010, the Company executed a definitive agreement to purchase 501,382 shares of common stock of Cortelco Systems Puerto Rico, Inc. from a director of eOn in a privately negotiated transaction. The stock, valued at $391,077 was purchased with the issuance of 90,959 shares of eOn stock valued at the average closing price of the shares during the thirty trading days ending June 8, 2010 and cash consideration of $185,511 payable in three annual installments beginning June 9, 2011.

The director has the right to share in sale proceeds received by the Company if the Company sells the shares on or before June 9, 2013 for a price that is more than the Company paid for the shares. The Company has the right to require the director to repurchase the shares at the price paid by the Company on or after June 9, 2013, but before June 9, 2014. The purchase, combined with shares already owned by the Company, establishes eOn Communications Corporation as the majority shareholder of Cortelco Systems Puerto Rico. The Company believes the acquisition will enable it to expand geographical and introduce new product lines. The assets acquired include cash and property and equipment and liabilities assumed consist of accounts payable and accrued liabilities. The Company has not completed the allocation of purchase price due to the timing of executing the definitive agreement. The following unaudited pro forma information was prepared assuming that the acquisition of Cortelco Systems Puerto Rico, Inc. had taken place at the beginning of fiscal 2010. In preparing the pro forma financial information, various assumptions were made; therefore, the Company does not imply that the future results will be indicative of the following pro forma information:

 

     Three months ended
April 30, 2010
    Nine months ended
April 30, 2010

Net sales

   5,719      17,607

Net (loss) income

   (44   123

Net (loss) income per share – basic

   (0.02   0.03

Net (loss) income per share – diluted

   (0.02   0.03

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

 

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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 in the Company’s most recently filed 10-K. 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. Cortelco is committed to fulfilling the communication needs of business and organizations worldwide. Cortelco’s mission is to provide our valued customers with telephone products together with service and support. Cortelco has formed partnerships with distributors and provides the support needed to supply customers with sales, marketing, customer service, technical support and training. 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 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 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 “Cortelco Note”). The Cortelco Note is non-interest bearing and is to be repaid based 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 Cortelco Note payable obligation assumed on the April 1, 2009 acquisition date was estimated 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. As of April 30, 2010, the Company has made payments of approximately $1,681,000 to former Cortelco shareholders for the acquisition, including the initial aggregate payment of $500,000. David Lee, Chairman of eOn, was the Chairman and the controlling shareholder of Cortelco at the date of acquisition.

Critical Accounting Policies and Estimates

There were no material changes during the nine months ended April 30, 2010 to the critical accounting policies reported in our Annual Report on Form 10-K for the fiscal year ended July 31, 2009.

Results of Operations

For the Three Months Ended April 30, 2010 compared to the Three Months Ended April 30, 2009

Net Revenue

Net revenue increased by approximately 45% to $3,576,000 for the three months ended April 30, 2010 compared to $2,465,000 for the same period of the previous year. The increase was attributable to the inclusion of Cortelco net revenue of $2,634,000 for the full three months in the current quarter compared to net revenue of $1,151,000 for one month in the previous year and an increase in Millennium revenue. The increase is partially offset by declines in eQueue and international product revenue and maintenance revenue.

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 20% to $1,326,000 for the three months ended April 30, 2010 from $1,109,000 for the same period of the previous year, reflecting an increase of $445,000 in Cortelco gross profit due to the inclusion of Cortelco activity for the full three months and an increase of $74,000 in Millennium gross profit. The increases were partially offset by declines in eQueue and maintenance gross profit when compared to the same period of the previous year. Gross margin % decreased to approximately 37% for the three months ended April 30, 2010 compared with gross margin of approximately 45% for the same period of the previous year, primarily the result of product mix. The margin percentage on Cortelco revenue is significantly less than the historical margins for both the Millennium and eQueue products.

 

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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 increased approximately 24% to $1,058,000 for the three months ended April 30, 2010, from $852,000 for the same period of the previous year. The increase primarily reflects increases in Cortelco expenses of approximately $327,000 due to the inclusion of a full quarter’s expenses and increases in contract services of $42,000, partially offset by lower compensation related expenses of approximately $120,000, and lower professional expenses of approximately $21,000. Expenses in both the current and prior periods include approximately $21,000 in amortization related to technology that the Company plans to amortize through 2011. The Company expects to continue to sell products utilizing this technology through 2011 and beyond.

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 18% to $141,000 for the three months ended April 30, 2010 from $172,000 for the same period of the previous year. The decrease reflects a decrease of approximately $14,000 in rent, depreciation and facility costs. In addition, in the three months ended April 30, 2010, the Company capitalized approximately $136,000 of software development, most of which was internal labor related to a new IP PBX. Amortization of the capitalized costs is projected to begin in the second fiscal quarter of 2011 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 $25,000 for the three months ended April 30, 2010 compared to $26,000 for the same period of the previous year.

Interest Income (Expense), net

Interest expense was $149,000 for the three months ended April 30, 2010 compared to interest income of $1,000 for the same period of the previous year. Interest expense in the current period includes $149,000 of imputed interest on the Cortelco Note, of which approximately $1,000 in interest expense is a result of changes in the estimated timing of future principal payments.

For the Nine Months Ended April 30, 2010 compared to the Nine Months Ended April 30, 2009

Net Revenue

Net revenue increased by approximately 109% to $11,617,000 for the nine months ended April 30, 2010 compared to $5,556,000 for the same period of the previous year. The increase was primarily attributable to an increase of $7,613,000 in Cortelco net revenue due to inclusion of nine months of revenue in the current fiscal year compared to one month in the previous year. The increase in the current period is partially offset by declines in eQueue, Millennium and international product revenue and maintenance revenue in the current period.

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 61% to $4,311,000 for the nine months ended April 30, 2010 from $2,684,000 for the same period of the previous year, reflecting an increase in Cortelco gross profit of $2,323,000 partially offset by declines in eQueue and Millennium gross profit in the current period. Maintenance contract revenues declined compared to the same period of the previous year. Gross margin % decreased to approximately 37% for the nine months ended April 30, 2010 compared with gross margin of approximately 48% for the same period of the previous year, primarily the result of product mix. The margin percentage on Cortelco revenue is significantly less than the historical margins for both the Millennium and eQueue products.

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 increased approximately 45% to $3,346,000 for the nine months ended April 30, 2010, from $2,307,000 for the same period of the previous year. The increase primarily reflects an increase in Cortelco expenses of approximately $1,595,000 due to inclusion of nine months of expenses in the current fiscal period verses one month in the prior period. The increase in the

 

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current period also reflects higher subcontract expenses of approximately $144,000, partially offset by lower compensation related expenses of approximately $406,000, lower depreciation and facility costs of approximately $110,000, and lower bad debt expense of approximately $67,000. Expenses in both the current and prior periods include approximately $63,000 in amortization related to technology that the Company plans to amortize through 2011. The Company expects to continue to sell products utilizing this technology through 2011 and beyond.

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 48% to $395,000 for the nine months ended April 30, 2010 from $754,000 for the same period of the previous year. The decrease reflects a decrease of approximately $54,000 in rent, depreciation and facility costs. In the nine months ended April 30, 2010, the Company capitalized approximately $424,000 of software development, most of which was internal labor related to a new IP PBX. Amortization of the capitalized costs is projected to begin in the second fiscal quarter of 2011 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 $57,000 for the nine months ended April 30, 2010 compared to $87,000 for the same period of the previous year. The decrease in other expense is primarily attributable to costs related to loss on disposal of leasehold improvements in China in the previous year.

Interest Income (Expense), net

Interest expense was $499,000 for the nine months ended April 30, 2010 compared to interest income of $14,000 for the same period of the previous year. Interest expense in the current period includes $499,000 of imputed interest on the Cortelco Note, of which approximately $33,000 in interest expense is a result of changes in the estimated timing of future principal payments.

Liquidity and Capital Resources

As of April 30, 2010, the Company had cash and cash equivalents of $2,536,000 and working capital of $7,265,000.

Our operating activities resulted in a net cash inflow of $1,332,000 for the nine months ended April 30, 2010 compared to a net cash inflow of $204,000 for the same period of the previous year. The net operating cash inflow for the current period primarily reflects net income (adjusted for non-cash items) and lower accounts receivable partially offset by lower accrued expenses and trade accounts payable. The net operating cash inflow for the prior year 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 for the prior year was partially offset by lower accrued expenses excluding the accrued expenses assumed in the merger with Cortelco.

Our investing activities resulted in a net cash outflow of $438,000 for the nine months ended April 30, 2010 compared to a net cash outflow of $356,000 for the same period of the previous year. Cash used in investing activities for the nine months ended April 30, 2010 was a result of net cash used for capitalized software costs of approximately $424,000 and purchases of property and equipment. Cash used in investing activities for the same period of the previous year was a result of net cash used in the acquisition of Cortelco of $400,000, net disposals of marketable securities, an investment of approximately $136,000 in a joint venture in Hangzhou, China, net cash used for capitalized software costs of approximately $107,000, and purchases of property and equipment.

Our financing activities resulted in a cash outflow of $1,368,000 for the nine months ended April 30, 2010 compared to a cash inflow of $2,000 for the same period of the previous year. Cash used in financing activities in the current period reflects payments on the Cortelco Note partially offset by purchases under the Employee Stock Purchase Plan and exercise of a stock warrant. Cash provided by financial activities 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.

The Company has incurred substantial net operating losses since inception and has had negative cash flows from operating activities through July 31, 2009; resulting in an accumulated deficit of $48,856,000 at that date. During the nine months ended April 30, 2010 cash and cash equivalents decreased to $2,536,000 from $3,010,000, primarily as a result of payments made against the Cortelco Note.

 

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The Company had income from operations of $513,000 for the nine months ended April 30, 2010 versus a loss from operations of $464,000 for the same period in the prior year. As of April 30, 2010, the Company had $2,536,000 in cash and cash equivalents available to fund operations, of which $197,000 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 inventories up to a maximum of $2,500,000, none of which was drawn on as of April 30, 2010. 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 cash, cash equivalents, 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.

Net Income (Loss)

Net income was $84,000 for the nine months ended April 30, 2010 compared to a net loss of $450,000 for same period in the previous year due to the acquisition of Cortelco and reduction in expenses explained above.

Reported net income has been materially impacted by the imputed interest expense due to the amortization of the difference between the face value of the contingent obligation to the former Cortelco shareholders and the discounted present value of the note payable recorded on the balance sheet. The table below presents a non-GAAP financial disclosure to provide a quantitative analysis of the impact of the imputed interest expense on reported net loss and loss per share. Management does not include this expense in its analysis of financial results or how resources are allocated. Because of this, we deemed it meaningful to provide this non-GAAP disclosure of the impact of this significant item on our financial results.

Non-GAAP Financial Disclosure

(In thousands, except per share amounts)

 

     Nine Months Ended
April 30, 2010

Net income reported

   $ 84

Imputed interest expense on note payable

     499
      

Net income less imputed interest

   $ 583
      

Net income per common share as reported

   $ 0.03

Interest imputed

     0.18
      

Net income per common share less imputed interest

   $ 0.21
      

Weighted average shares outstanding - basic

     2,743
      

Concentrations, Commitments and Contingencies

 

(a) Customer Concentrations

At April 30, 2010, four customers accounted for approximately 58% of total accounts receivable and individually 20%, 14%, 12% and 12% of the total accounts receivable. For the nine months ended April 30, 2010, four customers accounted for approximately 53% of total revenue and individually 26%, 11%, 10% and 7% of total revenue.

 

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(b) Commitments

At April 30, 2010, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $1,973,000.

Cortelco has a line of credit based on an asset formula involving accounts receivable and inventories up to a maximum of $2,500,000, none of which was drawn on as of April 30, 2010. 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 4T.—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 ended April 30, 2010.

 

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PART II—OTHER INFORMATION

Item 1.—Legal Proceedings.

None.

Item 1A.—Risk Factors.

There have been no material changes in the Company’s risk factors from those reported on the Company’s most recently filed 10-K.

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

None.

Item 3.—Defaults Upon Senior Securities.

None.

Item 4.—Reserved.

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 10, 2010  

  /s/ Lee M. Bowling

    Lee M. Bowling
    Chief Financial Officer
    (Duly Authorized Officer, Principal Financial and Accounting Officer)

 

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