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 Architectures (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 newly formed subsidiary, eOn IP Voice, Inc. ("EIPV") purchased certain accounts receivable, inventory and fixed asset 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.

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

On 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 companies are discussing a possible restructuring of the merger agreement, but no agreement has been executed. There is no assurance that the new agreement will be reached or that the merger transaction will be closed.

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's management efforts are focused on improved financial results, improved customer service and support, and enhancing core technology utilization.

From 2003 until 2006, Cortelco provided management expertise to Cortelco Systems Puerto Rico, Inc. (CPROF.OB) and, as a result, CSPR has demonstrated sustained profitability starting in 2004. eOn anticipates that it will continue to utilize Cortelco's management expertise on an outsourcing basis irrespective of whether the proposed Cortelco merger closes.

Effective April 1, 2008, the Company closed its engineering facility in India. Also on April 1, Mitch Gilstrap, COO and Vijay Sharma, CTO, left the Company.

On June 13, 2008, David Lee purchased the Company's 300,000 share investment in Spark for $300,000.

CRITICAL ACCOUNTING POLICIES

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties and that could potentially result in materially different results under different assumptions and conditions. We believe that our critical accounting policies are limited to those described below. For a detailed description of our accounting policies, see Footnote 2, "Summary of Significant Accounting Policies," in the notes to the consolidated financial statements.

Revenue Recognition

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



                                               Type of Revenues Earned
                                                      Professional       Maintenance
Product Line                    Equipment/Software      Services          Contracts

Millennium PBX System           Individual sale

eQueue Contact Center System    Individual sale      Individual sale   Individual sale

VOIP Telephones                 Individual sale

Because the eQueue system is very flexible in its applications, some customers contract for professional services to tailor their system to specific requirements. Professional services are invoiced separately upon completion. eQueue customers can also elect to enter into maintenance contracts to receive software updates and free technical support. Revenue is booked quarterly for each maintenance period as provided. The VOIP phones can be deployed with either the Millennium or eQueue systems to provide lower call costs as well as flexible telecom management across multiple locations. These phones may be sold with a new system, but are often sold subsequent to the system sale.

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

Product Warranties

We generally provide customers a one year product warranty from the date of purchase. We estimate the costs of satisfying warranty claims based on analysis of past claims experience and provide for these future claims in the period that revenue is recognized. The cost of satisfying warranty claims, which approximates 2% - 3% of product revenues, has historically been comprised of materials and direct labor costs. We perform 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.

Inventory Obsolescence

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

Allowance for Uncollectible Accounts Receivable

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

Stock-Based Compensation

We adopted the provisions of, and account for stock-based compensation in accordance with, Statement of Finanical Accounting Standards No. 123R ("SFAS 123R"), Share Based Payment on August 1, 2006. We elected the modified-prospective method, under which prior periods are not revised for comparative purposes. Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period.

We currently use the Black-Scholes option pricing model to determine the fair value of stock options and employee stock purchase plan shares. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

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 our 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 period. The Company has not historically declared any cash dividends on our common stock. We currently intend to retain any earnings to finance the operation and expansion of our business and therefore do not expect to pay cash dividends on our common stock in the foreseeable future. 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.

If factors change and we employ different assumptions for estimating stock-based compensation expense in future periods or if we decide to use a different valuation model, the future periods may differ significantly from what we have recorded in the current period and could materially affect our operating income, net income and net income per share.

The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, characteristics not present in our option grants and employee stock purchase plan shares. Existing valuation models, including the Black-Scholes and lattice binomial models, may not provide reliable measures of the fair values of our stock-based compensation. Consequently, there is a risk that our estimates of the fair values of our stock-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, expiration, early termination or forfeiture of those stock-based payments in the future. Certain stock-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that are significantly higher than the fair values originally estimated on the grant date and reported in our financial statements. There currently is no market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these valuation models, nor is there a means to compare and adjust the estimates to actual values.

The guidance in SFAS 123R and Staff Accounting Bulletin 107 ("SAB 107") is relatively new. The application of these principles may be subject to further interpretation and refinement over time. There are significant differences among valuation models, and there is a possibility that we will adopt different valuation models in the future. This may result in a lack of consistency in future periods and may materially affect the fair value estimate of stock-based payments. It may also result in a lack of comparability with other companies that use different models, methods and assumptions.

See Note 13 Stock-Based Compensation to the consolidated financial statements for further information regarding SFAS 123R.

Deferred Taxes

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Because of substantial losses from inception through fiscal year 2008, the Company has available net operating loss ("NOL") carry-forwards of approximately $25,000,000.

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

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

RESULTS OF OPERATIONS

The following table presents our operating ratios for fiscal years 2008 and 2007:

                                                          For the Years Ended July 31,
                                                          2008                    2007
Net revenue                                                  100.0 %                 100.0 %
Cost of revenue                                               45.1 %                  42.7 %

Gross profit                                                  54.9 %                  57.3 %
Operating expenses:
Selling, general and administrative                           55.7 %                  42.3 %
Research and development                                      37.8 %                  27.0 %
Other expense                                                  4.0 %                   0.1 %

Total operating expense                                       97.5 %                  69.4 %

(Loss) from continuing operations                            (42.6 )%                (12.1 )%
Interest income                                                1.7 %                   2.6 %

(Loss) before income taxes and discontinued
operations                                                   (40.9 )%                 (9.5 )%
Income taxes                                                   0.0 %                   0.0 %

(Loss) before discontinued operations                        (40.9 )%                 (9.5 )%
Discontinued operations                                       (8.5 )%                 (3.0 )%
Foreign currency translation adjustment                        1.5 %                   0.0 %

Net (loss)                                                   (47.9 )%                (12.5 )%

NET REVENUE

Revenue is comprised of product revenue generated by our Millennium product line and product and maintenance and professional service revenue generated by our eQueue product line. Net revenue decreased approximately 34% to $6,994,000 for the year ended July 31, 2008 from $10,625,000 for the previous fiscal year. The decrease reflects lower eQueue revenue from products, maintenance and professional services, and lower Millennium revenue compared to the prior year. Sales of Millennium systems and eQueue systems were adversely impacted by slowdowns in key U.S. government and education markets and increased competition.

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 37% to 3,839,000 for the year ended July 31, 2008 compared to $6,093,000 for the previous fiscal year. The decrease in gross profit reflects lower eQueue product, maintenance and professional service revenues. Our gross margins were 55% and 57% for fiscal years 2008 and 2007, respectively. The decrease in margin percentage reflects lower maintenance and professional services revenue, which historically have higher margins.

SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE

Selling, general and administrative expenses were $3,893,000 for the year ended July 31, 2008, a decline of 13% from $4,491,000 in the prior fiscal year. The decrease reflects lower personnel costs, lower travel and entertainment expenses, lower bad debt expense, and lower SFAS 123R compensation expense partially offset by higher subcontract and professional fees.

RESEARCH AND DEVELOPMENT EXPENSE

Research and development expenses are primarily comprised of personnel and related expenses for our engineering staff. Our research and development efforts are currently concentrated on enhancements for our eQueue and Millennium product lines. Research and development expenses were $2,641,000 for the year ended July 31, 2008, which represents a decrease of approximately 8% from $2,872,000 in fiscal year 2007. The decrease primarily reflects lower personnel costs and related travel expenses. The Company closed its engineering facility in India effective April 1, 2008. The decrease in development costs has been offset by approximately $244,000 in severance expenses.

OTHER INCOME AND EXPENSE, NET

Other income and expense, net is primarily comprised of bank service charges, franchise taxes, currency differences and gains or losses from disposal of fixed assets. Other expense, net was $283,000 in fiscal 2008 compared to $11,000 in fiscal year 2007. The increase is primarily a result of losses related to the closure of the India engineering facility, losses on disposal of assets in India, and currency exchange losses.

INTEREST INCOME, NET

Interest income was $117,000 and $272,000 in fiscal years 2008 and 2007, respectively. The decrease in fiscal year 2008 reflects a lower weighted average balance of marketable securities invested compared to the same period of the pervious year.

INCOME TAX EXPENSE

No income tax benefit from continuing operations was recorded for the years ended July 31, 2008 and 2007 as management was unable to conclude that it was more likely than not that the income tax benefit would be realized.

DISCONTINUED OPERATIONS

Discontinued operations for the year ended July 31, 2008 is comprised of $604,000 of losses from eOn IP Voice, Inc. and a $13,000 gain on disposal during the third fiscal quarter of 2008. Discontinued operations for the year ended July 31, 2007 is comprised of $321,000 of losses from eOn IP Voice, Inc. beginning February 23, 2007, the date the assets were purchased, until July 31, 2007.

LIQUIDITY AND CAPITAL RESOURCES

As of July 31, 2008, we had cash and cash equivalents of $1,545,000, $1,000,000 in short-term investments, and a working capital balance of $4,616,000. At July 31, 2008, our short-term investments were invested in auction rate securities. These securities were sold at par in October 2008 and now invested in liquid treasury securities.

Our operating activities resulted in net cash outflows of $2,731,000 for fiscal year 2008 compared to net cash outflows of $867,000 for fiscal year 2007. The decrease in net operating cash flow for the current fiscal year primarily reflects net loss (adjusted for non cash items) for the year, higher inventories and prepaid assets and lower accounts payable partially offset by lower accounts receivable. Net operating cash flow for fiscal year 2007 was primarily the result of net loss (adjusted for non cash items) for the year, lower accrued expenses, higher inventory and accounts receivable, partially offset by increased related party payables and lower prepaid and other assets.

Our investing activities resulted in net cash inflows of $1,776,000 for fiscal year 2008 compared to net cash inflows of $2,159,000 in fiscal year 2007. Cash provided by investing activities during fiscal year 2008 was primarily related to net sales of marketable securities and proceeds from the disposal of Spark stock, partially offset by the investment in Symbio and capital expenditures. Cash provided by investing activities during fiscal year 2007 consisted primarily of net sales of marketable securities and final payment of proceeds from the disposal of Cortelco Shanghai, partially offset by the purchase of EIPV and capital expenditures.

Our financing activities resulted in net cash inflows of $149,000 and $30,000 in fiscal years 2008 and 2007, respectively. Cash provided by financing activities during fiscal year 2008 was attributable to proceeds from the employee stock purchase plan and proceeds from a note payable. Cash provided by financing activities during fiscal year 2007 was attributable to proceeds from the employee stock purchase plan and proceeds from the exercise of options to purchase common stock under the equity incentive plan.

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

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

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.

On February 23, 2007, the Company's newly formed subsidiary, eOn IP Voice, Inc. 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.

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

The Company has incurred substantial net operating losses since inception and negative cash flows from operating activities through July 31, 2008 resulting in an accumulated deficit of $48,517,000. During fiscal year 2008, cash and cash equivalents and short-term investments decreased from $5,656,000 to $2,545,000, largely as a result of funding operating losses during fiscal year 2008.

The Company recorded a net loss of $3,452,000 in fiscal year 2008. As of July 31, 2008, the Company had $2,545,000 in cash and cash equivalents and short-term marketable securities available to fund operations, of which $263,000 was held in international bank accounts.

The Company is dependent on available cash, short-term investments and operating cash flow to finance operations and meet its other capital needs. If such sources are not sufficient, alternative sources of funding 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 needs and fund expected capital expenditures over at least the next twelve months.

Capital Resources

We believe that the cash and short-term investment securities on hand plus the additional liquidity that we expect to generate from operations will be sufficient to meet the cash requirements of the business including capital expenditures 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

Contractual Obligations

The Company is obligated to make future payments under various contracts it has
entered into, including amounts pursuant to non-cancelable operating lease
agreements for office and warehouse space and inventory purchase obligations.
Expected future minimum contractual cash obligations for the next five years and
in the aggregate at July 31, 2008 are as follows (in thousands):



                                                           Payments Due by Period for the Years Ending July 31,
                                               Total        2009         2010        2011       2012     2013     Thereafter
Operating leases (1)                         $     309    $     183    $     108    $    18    $    -    $  -    $         -
Purchase obligations (2)                           196          196           -          -          -       -              -

Total                                        $     505    $     379    $     108    $    18    $    -    $  -    $         -

(1) Non-cancelable operating leases do not include payments due under renewals to the original lease term.

(2) Outstanding commitments for purchases of inventory under open purchase orders.

. . .