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EONC > SEC Filings for EONC > Form 10-Q on 13-Dec-2011All Recent SEC Filings

Show all filings for EON COMMUNICATIONS CORP

Form 10-Q for EON COMMUNICATIONS CORP


13-Dec-2011

Quarterly Report


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 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.


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Overview

eOn Communications Corporation ("eOn" or the "Company") is a provider of communications solutions. Backed with over 20 years of telecommunications engineering expertise, the Company's solutions enable its customers to use technologies to communicate more effectively. eOn's offerings are built on reliable open architectures that enable easy adoption of 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.

CSPR's core business includes the design, implementation and maintenance of solutions in the area of voice, data center and security. CSPR's other lines of business include the reselling of telephone lines, internet access, disaster recovery, business continuity and private cloud computing solutions. CSPR has partnered with strategic suppliers and utilizes a direct sales force to sell its services and products, most of which are installed by CSPR technicians.

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 and a note payable 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 October 31, 2011, the Company has made payments of approximately $2,786,000 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.

On June 9, 2010, the Company executed a Stock Purchase Agreement to purchase 501,382 shares of common stock of CSPR from David S. Lee, eOn's Chairman. The acquisition of CSPR stock was completed on June 9, 2010. The consideration for the CSPR shares consists of (i) 90,959 Company shares of stock, issued to Mr. Lee effective June 9, 2010, (ii) a cash payment of $185,511.34, payable in three annual installments, with the initial installment due on June 9, 2011,
(iii) and the right to share in sales proceeds received by the Company if the Company sells the CSPR shares on or before June 9, 2013 for a price that is more than the Company paid for the shares. The number of eOn shares issued to Mr. Lee was calculated based on the average closing price of eOn Shares for thirty
(30) trading days ending on June 8, 2010. The Company has the right to require Mr. Lee to repurchase the CSPR 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 as the majority shareholder of CSPR.

Critical Accounting Policies and Estimates

There were no material changes during the three months ended October 31, 2011 to the critical accounting policies reported in our Annual Report on Form 10-K for the fiscal year ended July 31, 2011.

Results of Operations

For the Three Months Ended October 31, 2011 compared to the Three Months Ended October 31, 2010

Net Revenue

Net revenue increased by approximately 7% to $6,230,000 for the three months ended October 31, 2011 compared to $5,829,000 for the same period of the previous year. The increase was attributable to increased revenues of approximately $694,000 in the Cortelco product line and $97,000 in the CSPR product line compared to the same period of the previous year. The increase is partially offset by revenue declines in the Company's other product lines.

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 $1,728,000 for the three months ended October 31, 2011 from $1,709,000 for the same period of the previous year. Increases in Cortelco, CSPR and


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Millennium gross profit was partially offset by a decline in eQueue gross profit for the three months ended October 31, 2011 when compared to the same period of the previous year. The cost of revenue in the previous year included approximately $15,000 in amortization of eConn IP-PBX software costs. There was no software amortization in the three months ended October 31, 2011. Gross profit percent decreased to approximately 28% for the three months ended October 31, 2011 compared with gross profit percent of approximately 29% for the same period of the previous year, primarily the result of product mix. The gross profit percentage on Cortelco and CSPR 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 decreased approximately 14% to $1,275,000 for the three months ended October 31, 2011, from $1,486,000 for the same period of the previous year. The decrease is primarily due to declines in subcontract, salaries and related expenses, travel and facility expenses when compared to the same period of the previous year. Prior period expenses include approximately $11,000 of amortization related to technology that was fully amortized in fiscal 2011.

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 19% to $108,000 for the three months ended October 31, 2011 from $133,000 for the same period of the previous year. Research and development expense for the current quarter reflect reductions in compensation and related expenses and overhead expenses when compared to the same period of the previous year. In the three months ended October 31, 2010, the Company capitalized approximately $156,000 of software development. There was no capitalized software development in the same period of the current year.

Other Operating Expense (Income), net

Other expense is primarily comprised of bank service charges, stock compensation expense, franchise taxes, currency differences, proceeds from scrap sales, and gains or losses from disposal of fixed assets. Other income was $9,000 for the three months ended October 31, 2011 compared to expense of $33,000 for the same period of the previous year. Other income for the current year includes proceeds from scrap sales of approximately $19,000.

Interest Income (Expense), net

Interest benefit was $12,000 for the three months ended October 31, 2011 compared to interest expense of $158,000 for the same period of the previous year. Interest benefit in the current period includes $15,000 of imputed interest income on the Cortelco Note, of which approximately $144,000 in interest benefit is a result of changes in the estimated timing of future principal payments.

Income Tax Expense

Income tax expense for the three months ended October 31, 2011 and 2010 totaled $8,000 and $0, respectively. Income tax expense in the current period consists of current state income tax expense in states in which net operating loss carry forwards were not available to offset taxable income. 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 October 31, 2011.

Liquidity and Capital Resources

As of October 31, 2011, the Company had cash and cash equivalents of $1,476,000 and working capital of $7,842,000.

Our operating activities resulted in a net cash outflow of $47,000 for the three months ended October 31, 2011 compared to a net cash outflow of $17,000 for the same period of the previous year. The net operating cash outflow for the current period primarily reflects net income (adjusted for non-cash items), higher inventories and other prepaid assets partially offset by lower trade accounts receivable. The net operating cash outflow for the prior year period primarily reflects net loss (adjusted for non-cash items) and lower accounts payable partially offset by lower inventories and trade accounts receivable.

Our investing activities resulted in a net cash outflow of $28,000 for the three months ended October 31, 2011 compared to a net cash outflow of $177,000 for the same period of the previous year. Cash used in investing activities for the three months ended October 31, 2011 was a result of net cash used for 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 for capitalized software costs of approximately $157,000, and purchases of property and equipment.


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Our financing activities resulted in a cash inflow of $9,000 for the three months ended October 31, 2011 compared to a cash outflow of $393,000 for the same period of the previous year. Cash provided by financing activities in the current period reflects purchases under the Employee Stock Purchase Plan. Cash used in financing activities in prior period reflect payments on notes payable partially offset by 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, 2011; resulting in an accumulated deficit of $49,769,000 at that date. During the three months ended October 31, 2011, cash and cash equivalents decreased to $1,476,000 from $1,542,000 at July 31, 2011, primarily as a result of funding operations.

The Company had income from continuing operations of $358,000 for the three months ended October 31, 2011 versus net loss from continuing operations of $101,000 for the same period in the prior year. As of October 31, 2011, the Company had $1,476,000 in cash and cash equivalents available to fund operations, of which $6,000 was held in international bank accounts.

The Company is largely dependent on available cash, cash equivalents, and operating cash flow to finance operations and meet its other capital needs. Cortelco has a line of credit with available borrowings based on an asset formula involving accounts receivable and inventories up to a maximum of $1,000,000, none of which was drawn on in the current or prior fiscal year. The line of credit is secured by substantially all of Cortelco's assets. The loan's interest rate, with a floor of 4%, is floating based on LIBOR and expires December 15, 2011. Cortelco is currently negotiating the renewal of the line of credit. CSPR has a $500,000 revolving line of credit, none of which was drawn on as of October 31, 2011, secured by trade accounts receivable and bears interest at 2% over Citibank's base rate. The agreement has certain covenant requirements and expires November 30, 2012. If such sources are not sufficient, alternative funding sources may not be available. The Company believes that cash on hand 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 and cash equivalents 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.

Discontinued Operations

The Company has evaluated its wholly-owned subsidiary in China and determined that the operation has not provided a strategic benefit to the Company. In conjunction with exit of operations in China, the Company recorded inventory reserve provisions of approximately $134,000 in the fiscal year ended July 31, 2011. The Company discontinued support of the China operations in the second fiscal quarter of 2011. Consequently, current and prior period financial activity and balances are reported as discontinued operations.

Net Income (Loss)

Net income was $346,000 for the three months ended October 31, 2011 compared to a net loss was $247,000 for the three month period in the previous year due to fluctuations in gross margins and expenses explained above.

Reported net income for the current period 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.


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Non-GAAP Financial Disclosure

(In thousands, except per share amounts)



                                                            Three Months Ended
                                                             October 31, 2011
 Net income reported                                        $               346
 Imputed interest (benefit) on notes payable                                (15 )

 Net income less imputed interest                           $               331


 Net income per common share as reported                    $              0.12
 Interest imputed                                                         (0.01 )

 Net income (loss) per common share less imputed interest   $              0.11

 Weighted average shares outstanding-basic                                2,868

Concentrations, Commitments and Contingencies

(a) Customer Concentrations

At October 31, 2011, four customers accounted for approximately 47% of total accounts receivable and individually 15%, 13%, 11% and 8% of the total accounts receivable. At October 31, 2010, four customers accounted for approximately 39% of total accounts receivable and individually 11%, 11%, 9% and 8% of the total accounts receivable. For the three months ended October 31, 2011, four customers accounted for approximately 49% of total revenue and individually 17%, 14%, 13%, and 5% of total revenue. For the three months ended October 31, 2010, four customers accounted for approximately 39% of total revenue and individually 17%, 9%, 8% and 5% of total revenue.

(b) Commitments

At October 31, 2011, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $2,020,000.

Cortelco has a line of credit with available borrowings based on an asset formula involving accounts receivable and inventories up to a maximum of $1,000,000, none of which was drawn on in the current or prior fiscal year. The line of credit is secured by substantially all of Cortelco's assets. The loan's interest rate, with a floor of 4%, is floating based on LIBOR and expires December 15, 2011. Cortelco is currently negotiating the renewal of the line of credit.

CSPR has a $500,000 revolving line of credit, none of which was drawn on as of October 31, 2011, secured by trade accounts receivable and bears interest at 2% over Citibank's base rate. The agreement has certain covenant requirements and expires November 30, 2012.

(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.

The Municipal Revenue Collection Center of Puerto Rico ("CRIM") conducted a personal property tax audit for the years 1999 and 2000 which resulted in assessments of approximately $320,000 ($518,000 as of November 28, 2011, including interest and penalties). The assessments arose from CRIM's disallowances of certain credits for overpayments from 1999 and 2000, claimed in the 2001 through 2003 personal property tax returns. During the audit process, CRIM alleged that some components of the inventory reported as exempt should be taxable. The parties met several times and an informal administrative hearing was held on September 27, 2006. CSPR submitted its position in writing within the time period provided by CRIM. CSPR believes it has strong arguments to support its position that the components of inventory qualify as raw material. However, management believes a settlement may be reached for an amount less than the assessment. Accordingly, the Company has recorded a liability of $80,000 as of July 31, 2011 and October 31, 2011.


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