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 customers to use the eOn products 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).

The Company completed its acquisition of Cortelco on April 1, 2009. For additional information, refer to the amended and restated Merger Agreement among the Company, Cortelco Holding, and a subsidiary of the Company, setting forth the terms and conditions of the acquisition, filed as an exhibit to the Company 8-K dated as of December 18, 2008. Cortelco, Cortelco Holding's wholly owned subsidiary, provides customer premise equipment (CPE) commercial grade telephone products primarily for use in businesses, government agencies, colleges and universities, telephone companies, and utilities. Cortelco has formed strategic alliances with distributors and provides the support needed to supply customers with quality sales, marketing, customer service, technical support, and training.

The Company incurred a net loss of $339,000 for fiscal year 2009. The increase in revenue and gross margin resulting from the acquisition of Cortelco was partially offset with inputed interest on the note payable to Cortelco's shareholders. Imputed interest is dependent on Cortelco's projected earnings and resulting payments pursuant to the note payable to Cortelco's former shareholders. Cash flows generated by Cortelco subsequent to the merger will first be used to pay the obligation under the merger agreement until the full $11,000,000 is satisfied.

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 four 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

Cortelco Products               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 0.6% - 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 Financial 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 2009, 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, to the extent that it is more likely than not that deferred tax assets may not be realized, management has provided for an allowance on its net deferred tax assets. The Company currently provides for income taxes only to the extent of expected cash payments of taxes, primarily state and foreign income taxes.

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 2009 and 2008:

                                                         For the Years Ended July 31,
                                                          2009                   2008
Net revenue                                                  100.0 %                100.0 %
Cost of revenue                                               55.1 %                 45.1 %

Gross profit                                                  44.9 %                 54.9 %
Operating expenses:
Selling, general and administrative                           34.1 %                 55.7 %
Research and development                                       8.7 %                 37.8 %
Other expense                                                  1.1 %                  4.0 %

Total operating expense                                       43.9 %                 97.5 %

Income (loss) from continuing operations                       1.0 %               (42.6) %
Interest (expense) income, net                               (4.4) %                  1.7 %
Equity earnings of an unconsolidated equity
investee                                                       0.3 %                  0.0 %

Loss before income taxes and discontinued
operations                                                   (3.1) %               (40.9) %
Income taxes                                                   0.0 %                  0.0 %

Loss before discontinued operations                          (3.1) %               (40.9) %
Discontinued operations                                        0.0 %                (8.5) %

Net Loss                                                     (3.1) %                (49.4 %)

NET REVENUE

Revenue is comprised of product revenue generated by our Millennium and Cortelco product lines and product and maintenance and professional service revenue generated by our eQueue product line. Net revenue increased approximately 52% to $10,645,000 for the year ended July 31, 2009 from $6,994,000 for the previous fiscal year. The increase reflects $4,231,000 in Cortelco revenue subsequent to the acquisition on April 1, 2009, partially offset by 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 phones and systems. Gross profit increased approximately 25% to $4,782,000 for the year ended July 31, 2009 compared to $3,839,000 for the previous fiscal year. The increase in gross profit reflects inclusion of Cortelco's gross profit and increased Millennium gross profit partially offset by lower eQueue product, maintenance and professional service revenues. Our gross margins were 45% and 55% for fiscal years 2009 and 2008, respectively. The decrease in margin percentage reflects lower maintenance and professional services revenue, which historically have higher margins. The inclusion of Cortelco activity beginning April 1, 2009, which historically has a lower margin, also contributed to the decline in gross margin percentages.

SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE

Selling, general and administrative expenses were $3,633,000 for the year ended July 31, 2009, a decline of 7% from $3,893,000 in the prior fiscal year. The decrease reflects lower personnel costs, lower travel and entertainment expenses and lower overhead expenses, partially offset by the inclusion of Cortelco's expenses subsequent to April 1, 2009.

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 development of the new eConn IP-PBX/ACD with continued enhancements for our eQueue and Millennium product lines. Research and development expenses were $926,000 for the year ended July 31, 2009, which represents a decrease of approximately 65% from $2,641,000 in fiscal year 2008. The decrease primarily reflects lower personnel costs, travel, and overhead expenses. The Company capitalized approximately $243,000 of software development costs related to a new IP PBX that is under development. Amortization of the capitalized cost is expected to begin in the second fiscal quarter of 2010 when the product is available for general release to customers. The Company closed its engineering facility in India effective April 1, 2008 and incurred approximately $244,000 in severance expenses in fiscal year 2008.

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 was $120,000 in fiscal 2009 compared to $283,000 in fiscal year 2008. The decrease is primarily a result of losses related to the closure of the India engineering facility and losses on disposal of assets in India in fiscal year 2008.

INTEREST EXPENSE, NET

Interest expense was $466,000 in fiscal year 2009 and interest income was $117,000 in fiscal year 2008. The increase in fiscal year 2009 reflects imputed interest of $480,000 on the note payable to the former Cortelco shareholders.

INCOME TAX EXPENSE

No income tax benefit from continuing operations was recorded for the years ended July 31, 2009 and 2008 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.

LIQUIDITY AND CAPITAL RESOURCES

As of July 31, 2009, we had cash and cash equivalents of $3,010,000 and a working capital balance of $7,802,000. At July 31, 2008, our short-term investments were invested in auction rate securities. These securities were sold at par in October 2008 and are now invested in liquid treasury securities.

Our operating activities resulted in net cash inflows of $1,256,000 for fiscal year 2009 compared to net cash outflows of $2,731,000 for fiscal year 2008. The increase in net operating cash flow for the current fiscal year primarily reflects lower inventories and higher accounts payable partially offset by net loss (adjusted for non cash items) for the year and higher trade and related party accounts receivable. Net operating cash outflow for fiscal year 2008 was primarily the result of net loss (adjusted for non cash items) for the year, higher inventory and prepaid assets and lower accounts payable, partially offset by lower accounts receivable.

Our investing activities resulted in net cash inflows of $209,000 for fiscal year 2009 compared to net cash inflows of $1,776,000 in fiscal year 2008. Cash provided by investing activities during fiscal year 2009 was primarily related to net sales of marketable securities, partially offset by net cash of $400,000 used in the acquisition of Cortelco, capitalized software development costs of $243,000, an investment of approximately $136,000 in a joint venture in Hangzhou, China, and capital expenditures. Cash provided by investing activities during fiscal year 2008 consisted primarily of net sales of marketable securities and proceeds from the disposal of Spark stock, partially offset by the investment in Symbio and capital expenditures.

Our financing activities resulted in net cash inflows of $2,000 and $149,000 in fiscal years 2009 and 2008, respectively. Cash provided by financing activities during fiscal year 2009 was attributable to proceeds from the employee stock purchase plan. 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.

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.

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, 2009 resulting in an accumulated deficit of $48,856,000. The Company

recorded a net loss of $339,000 in fiscal year 2009. As of July 31, 2009, the Company had $3,010,000 in cash and cash equivalents available to fund operations, of which $83,000 was held in international bank accounts.

The Company is largely dependent on available cash and operating cash flow to finance operations and meet its other capital needs. Cortelco has a line of credit based on an asset formula involving accounts receivable and inventory up to a maximum of $2,500,000, none of which was drawn on as of July 31, 2009. The line of credit is secured by substantially all of Cortelco's assets. The loan's interest rate is floating based on LIBOR and expires June 29, 2010. If such sources are not sufficient, alternative funding sources may not be available. The Company believes that cash on hand, short-term marketable securities, and the Cortelco line of credit plus the additional liquidity that it expects to generate from operations will be sufficient to cover its working capital and fund expected capital expenditures over at least the next twelve months.

Capital Resources

The Company believes that the cash, short-term marketable securities on hand, and Cortelco's line of credit plus the additional liquidity that we expect to generate from operations will be sufficient to meet the cash requirements of the business including capital expenditures and working capital needs for at least the next twelve months. Should actual results differ significantly from our current assumptions, our liquidity position could be adversely affected and the Company could be in a position that would require the Company to raise additional capital, which may not be available to the Company or may not be available on acceptable terms.

NET LOSS

Net loss decreased to $339,000 in fiscal year 2009 compared to a net loss of $3,452,000 in fiscal year 2008 due to the acquisition of Cortelco and reduction in expenses explained above.

Reported net loss 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)
                                                             Year Ended
                                                            July 31, 2009
       Net loss reported                                   $          (339 )
       Interest imputed                                                480

       Net income less imputed interest                    $           141

       Net loss per common share as reported               $         (0.12 )
       Interest imputed                                               0.18

       Net income per common share less imputed interest   $          0.05

       Weighted average common shares outstanding                    2,735

COMMITMENTS AND CONTINGENCIES

Contractual Obligations

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