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| EONC > SEC Filings for EONC > Form 10QSB on 17-Mar-2008 | All Recent SEC Filings |
17-Mar-2008
Quarterly Report
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 Communications delivers proven, IP-ready products that improve business performance.
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. The Company has identified several potential buyers for the assets, but as of the filing date no offers for the assets have been accepted.
On December 11, 2007, the Company executed a definitive Agreement and Plan of Merger to acquire Cortelco Systems Holding Corporation ("Cortelco") for up to $11,000,000 in stock and cash. The Board of Directors of both eOn and Cortelco have approved the proposed merger. The proposed merger provides that Cortelco would merge into a newly formed wholly-owned subsidiary of eOn.
Cortelco, formerly part of the ITT telephone systems business, is a privately held company that designs and sells telephones in U.S. and Latin America markets. For the year ended December 31, 2006, Cortelco earned $1,750,000 in income before taxes on revenues (excluding those earned from eOn) of $17,625,000. The Company expects that for federal income tax purposes eOn will be able to offset future earnings of Cortelco against its prior year operating losses (approximately $20,000,000). The Company also expects cost savings from the combination.
In exchange for all the outstanding shares of Cortleco stock, Cortelco shareholders, upon the closing of the sale, (except for James W. Hopper) will receive their pro rata share of 50% of the purchase price in eOn common stock. James W. Hopper, Cortelco's CEO, will receive 75% of his pro rata consideration in cash upon the closing of the sale. Contingent upon the level of Cortelco earnings over the next 12 quarters after closing, all stockholders except for Mr. Hopper will receive their pro rata share of the remaining 50% of the purchase price in cash. Mr. Hopper will receive 25% of his pro rata consideration in eOn shares valued as of the closing at the end of the third anniversary after the closing. The stock payable to Mr. Hopper and the cash payable to the other stockholders is subject to a right of offset by eOn in the event of a breach of the merger agreement. David Lee, Chairman and CEO of eOn, is the Chairman and the controlling shareholder of Cortelco.
Completion of the merger is subject to filing a definitive registration and proxy statement with the SEC, obtaining the approval of the eOn and Cortelco stockholders, and other customary conditions of closing. The proposed merger may be terminated if the conditions to closing are not fulfilled, upon mutual agreement of the parties, or upon the occurrence of certain other events.
Auditors for Cortelco are completing audits for calendar years 2005 and 2006. Upon completion, the Company expects to promptly file the registration and proxy statement with the SEC. However, there is no certainty when, or if, the merger will be completed.
Critical Accounting Policies and Estimates
There were no material changes during the six months ended January 31, 2008 to the critical accounting policies reported in our Annual Report on Form 10-KSB for the fiscal year ended July 31, 2007.
Results of Operations
For the Three Months Ended January 31, 2008 compared to the Three Months Ended January 31, 2007
Net Revenue
Net revenue was approximately the same at $1,480,000 for the three months January 31, 2008 compared to $1,487,000 for the same period of the previous year. A decrease in Millennium revenue and related party professional services revenue was partially offset by an increase in eQueue revenue over the same period of the previous year. The decrease in Millennium revenue reflects lower U.S. government and dealer market segment revenues during the three months ended January 31, 2008. The increase in eQueue reflects higher international product revenue, partially offset by lower domestic software sales during the three months ended January 31, 2008 compared to the same period of the previous year.
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 1% to $824,000 for the three months ended January 31, 2008 from $817,000 for the same period of the previous year, reflecting higher eQueue margins offset by lower Millennium margins. Gross profit for eQueue increased over the same period last year reflecting higher product margins and increased international sales. Millennium gross profit decreased for the three months ended January 31, 2008, reflecting lower system sales over the same period of the previous year. Gross margin % increased to approximately 56% for the three months ended January 31, 2008 compared with gross margin of approximately 55% for the same period of the previous year, primarily the result of product mix. The margin on related party 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, advertising and trade show related costs, and facilities and other overhead expenses incurred to support our business. Selling, general and administrative expenses decreased approximately 1% to $1,107,000 for the three months ended January 31, 2008, from $1,120,000 for the same period of the previous year. The decrease reflects lower depreciation, rent expense, and international travel partially offset by higher compensation 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 11% to $680,000 for the three months ended January 31, 2008 from $768,000 for the same period of the previous year. The decrease reflects a decline in travel and related expenses and development costs.
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 $11,000 for the three months ended January 31, 2008 compared to $24,000 for the same period of the previous year.
Interest Income
Interest income was $34,000 for the three months ended January 31, 2008 compared to $80,000 for the same period of the previous year. The decrease reflects a lower weighted average balance of marketable securities invested compared to the same period of the previous year.
For the Six Months Ended January 31, 2008 compared to the Six Months Ended January 31, 2007
Net Revenue
Net revenue decreased approximately 8% to $3,876,000 for the six months January 31, 2008 compared to $4,195,000 for the same period of the previous year. The decrease reflects a decrease in Millennium revenue and a decrease in eQueue revenue over the same period of the previous year, partially offset by related party professional services revenues, which began during the same period of the previous year. Sales of Millennium systems were adversely impacted by seasonal slowdowns traditionally experienced in key US government and education market segments during the six months ended January 31, 2008. The decrease in eQueue reflects lower domestic software sales during the six months ended January 31, 2008 compared to the same period of the previous year.
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 14% to $2,208,000 for the six months ended January 31, 2008 from $2,582,000 for the same period of the previous year, reflecting lower eQueue margins and lower Millennium margins. Gross profit for eQueue decreased over the same period last year reflecting lower product margins and lower professional service revenue, which historically have significantly contributed to our margins. Millennium gross profit decreased for the six months ended January 31, 2008, reflecting lower system sales over the same period of the previous year. Gross margin % decreased to approximately 57% for the six months ended January 31, 2008 compared with gross margin of approximately 62% for the same period of the previous year, primarily the result of product mix. Additionally, the margin on related party 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, advertising and trade show related costs, and facilities and other overhead expenses incurred to support our business. Selling, general and administrative expenses decreased approximately 1% to $2,147,000 for the six months ended January 31, 2008, from $2,177,000 for the same period of the previous year. The decrease reflects lower depreciation and rent expense, partially offset by higher compensation expense resulting from headcount additions in China and rising compensation costs in China.
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 5% to $1,437,000 for the six months ended January 31, 2008 from $1,510,000 for the same period of the previous year. The decrease reflects a decline in travel and related expenses and development costs.
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 $37,000 for the six months ended January 31, 2008 compared to $30,000 for the same period of the previous year.
Interest Income
Interest income was $80,000 for the six months ended January 31, 2008 compared to $160,000 for the same period of the previous year. The decrease reflects a lower weighted average balance of marketable securities invested compared to the same period of the previous year.
Liquidity and Capital Resources
As of January 31, 2008, we had cash and cash equivalents of $926,000 and $1,900,000 in short-term marketable securities, and working capital of $5,606,000. Our short-term marketable securities are primarily invested in taxable auction rate securities ("ARS") with frequent rate resets. Recently there have been failed auctions in the auction rate securities market. The Company liquidated $150,000 in a successful auction on March 6, but an auction for $600,000 on March 10, 2008 failed. As of March 14, we hold $1,750,000 in these AAA rated municipal bond and FFELP student loan securities which are guaranteed by the Department of Education. There have been no defaults on the underlying securities and investment income on these ARS holdings continues to be received in a timely manner. If these securities do not have successful resets prior to April 30, 2008 (the end of our third fiscal quarter), we will need to consider reclassifying them to long term investments at their then fair value and an impairment charge may be required. If auctions continue to fail, the Company expects to be able to borrow against these securities if needed to meet operating requirements. For the immediate future, the Company will maintain a more conservative investment portfolio given the uncertainties in the credit markets and expects investment income to reflect the conservative nature of these investments.
Our operating activities resulted in a net cash outflow of $1,881,000 for the six months ended January 31, 2008 compared to a net cash outflow of $144,000 for the same period of the previous year. The net operating cash outflow for the current period primarily reflects net loss (adjusted for non-cash items), higher inventory and lower accounts payable - related party, partially offset by lower accounts receivable. The net operating cash outflow for the prior year period primarily reflects net loss (adjusted for non-cash items) and lower accrued expenses and higher inventories partially offset by lower trade accounts receivable.
Our investing activities resulted in a net cash inflow of $476,000 for the six months ended January 31, 2008 compared to a net cash inflow of $603,000 for the same period of the previous year. Cash provided by investing activities for the six months ended January 31, 2008 was a result of proceeds from the disposal of marketable securities partially offset by the $900,000 investment in Symbio Group and purchases of property and equipment. Cash provided by investing activities for the same period of the previous year was a result of net marketable securities disposals and proceeds from the disposal of discontinued operations, partially offset by purchases of property and equipment.
Our financing activities resulted in a cash inflow of $10,000 for the six months ended January 31, 2008 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 prior period were due to purchases under the Employee Stock Purchase Plan and employee stock options exercised.
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 $5,270,000 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, 2007; resulting in an accumulated deficit of $45,065,000. During the six months ended January 31, 2008, cash and cash equivalents and short-term marketable securities decreased to $2,826,000 from $5,656,000, primarily as a result of funding the investment in the Symbio Group and funding operating losses during the quarter.
The Company had a loss from continuing operations of $1,333,000 for the six months ended January 31, 2008 versus a loss from continuing operations of $975,000 for the same period in the prior year. As of January 31, 2008, the Company had $2,826,000 in cash and cash equivalents and short-term marketable securities available to fund operations, of which $468,000 was held in international bank accounts.
The Company is dependent on available cash, short-term marketable securities and operating cash flow to finance operations and meet its other capital needs. If such sources are not sufficient, alternative funding sources may not be available. The Company believes that cash on hand and short-term marketable securities plus the additional liquidity that it expects to generate from operations will be sufficient to cover its working capital and fund expected capital expenditures over at least the next twelve months.
The Cortelco Merger Agreement will require $1,550,000 in payments at closing. The Company is looking at various financing options to cover that requirement and operations going forward.
Capital Resources
We believe that the cash and short-term marketable securities on hand plus the additional liquidity that we expect to generate from operations will be sufficient to meet the cash requirements of the business including capital expenditures and working capital needs for at least the next twelve months. Should actual results differ significantly from our current assumptions, our liquidity position could be adversely affected and we could be in a position that would require us to raise additional capital, which may not be available to us or may not be available on acceptable terms.
Commitments and Contingencies
(a) Operating Leases
On September 1, 2007, the Company entered into a Shared Space Agreement ("Agreement") with Sylantro Systems Corporation for office space in Shanghai, China. Under the terms of the Agreement, the Company shares a portion of the premises consisting of 687 square meters or 75% of the premises through November 30, 2009. The monthly rent for this space is approximately $9,800 and replaces the space that was previously occupied by our employees in Shanghai, China.
(b) Commitments
At January 31, 2008, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $566,000.
On March 31, 2006, the Company entered into an Acquisition Option Agreement ("the Agreement") with Spark Technologies, Inc. Spark designs and markets accessories for wireless telephones. Its primary product, CellStikTM, is a small memory device that allows users to backup, enter, edit and transfer their cell phone products. Under the terms of the Agreement, the Company converted notes receivable of $300,000 to 300,000 shares or 3% of Spark Common Stock and has the option to purchase all remaining outstanding Spark Common Stock, including options, by issuing 8,665,000 shares of the Company's Common Stock. The Company will have the right to give notice of its intent to exercise this option at any time prior to close of business on March 31, 2008. The eOn Board of Directors is evaluating the current status of Spark and the option. If the Company decides to exercise, the Company will file a Form S-4 with the Securities and Exchange Commission and seek the approval of the Company's shareholders.
The Agreement further provides that in the event the Company does not exercise this option, or the Company's shareholders do not approve it, the Company may require Spark or David Lee, the Company's Chief Executive Officer and a major shareholder, to repurchase the Company's Spark shares for $300,000 within 60 days. In addition, in the event that Spark discontinues operations or liquidates, David Lee is required to purchase the shares for $300,000 within 60 days.
This investment was not evaluated for impairment because (a) the Company did not
estimate the fair value of this investment in accordance with paragraphs 14 and
15 of SFAS 107, "Disclosures About Fair Value of Financial Instruments," and
(b) the Company did not identify any events or changes in circumstances that may
have a significant or adverse effect on its fair value.
(d) 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.
Recent Developments
On March 8, 2008, the Company and Cortelco entered into an outsourcing agreement whereby Cortelco will provide management for all U.S. operations for eOn. Included in the management services are sales, marketing, product management, engineering, technical support, quality assurance, accounting and information technology.
Cortelco recently directed cost reductions and revitalized revenue growth at Cortelco Systems Puerto Rico Inc. (CPROF.ob). eOn anticipates that it will continue to utilize Cortelco's management expertise on an outsourcing basis irrespective of whether the proposed Cortelco merger closes.
Additional Risk Factors That May Affect Future Results of Operations
The following risk factors and other information contained in this report should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that are not currently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occurs, our business, financial condition, and operating results could be materially adversely affected.
In addition to the other information included in this report, the following factors should be considered in evaluating our business and future prospects.
Fluctuations in our quarterly operating results could cause our stock price to decline.
Future operating results are likely to fluctuate significantly from quarter to quarter. Factors that could affect our quarterly operating results include:
• Delays or difficulties in introducing new products;
• Increasing expenses without commensurate revenue increases;
• Variations in the mix of products sold;
• Variations in the timing or size of orders from our customers;
• Delayed deliveries from suppliers; and
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.
We may continue to incur losses, which may affect our viability.
We have incurred substantial losses in prior years and continue to do so. If we are unable to increase our revenues, we may be unable to pay our expenses and continue operations as an independent company.
Our communications servers face intense competition from many companies that have targeted our markets.
The competitive arena for our products is changing very rapidly and we face intense competition in our markets. Well-established companies and many emerging companies are scrambling to develop products that improve communications, increase employee productivity and lower costs. While the industry remains fragmented, it is rapidly moving toward consolidation. Companies seeking to increase market share and their ability to compete have recently acquired a number of our current competitors. 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, Aspect Communications, and Rockwell;
• Data communication equipment suppliers, such as Cisco Systems and 3COM;
• VoIP telephone manufacturers, such as Polycom, Linksys, Grand Stream and Aastra;
• Hosted solution providers including Packet 8, Five9, Echopass and Oracle;
• Email management and web center software suppliers, such as eGain Communications, Kana Communications, and RightNow Technologies; and
• Customer relationship management ("CRM") suppliers, such as Oracle and SalesForce.com.
Many of our current and potential competitors have significantly greater financial, technical, marketing, customer service and other resources, greater name and brand recognition and a larger installed customer base than we do. Therefore, our competitors may be able to respond to new or emerging technologies and changes faster than we can. They may also be able to devote greater resources to the development, promotion and sale of their products.
Actions by our competitors could result in price reductions, reduced margins and loss of market share, any of which would damage our business. We cannot assure you that we will be able to compete successfully against these competitors.
If we cannot expand our indirect sales channel to sell our eQueue products, our ability to generate revenue would be harmed.
A significant portion of our revenue is derived from dealers and value added resellers who have no obligation to sell our products. Therefore, dealers and value added resellers could discontinue selling our products at any time in favor of our competitors' products or for any other reason. A reduction or loss of orders from our dealers and value added resellers could harm our business, operating results and financial condition.
The lengthy sales cycles of some of our products and the difficulty in . . .
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