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FORM 10-K

For the transition period from      to      

Commission File Number 000-49626

CORTELCO SYSTEMS PUERTO RICO, INC.

(Exact name of registrant as specified in its charter)

1550 Ponce de Leon Avenue, Suite 100, San Juan, Puerto Rico 00926

(787) 758-0000

Securities registered pursuant to Section 12(b) of the Act: None

     Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.01 par value per share

(Title of each class)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x   NOo

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

     The aggregate market value of the shares of common stock held by non-affiliates of the registrant was approximately $535,896 based upon the closing sale price as quoted on the OTC Bulletin Board on 09/30/02. The number of outstanding shares of the registrant’s $0.01 par value common stock was 1,204,557 shares as of that date.

DOCUMENTS INCORPORATED BY REFERENCE

     Certain portions of the registrant’s Proxy Statement for the 2002 Annual Meeting of Shareholders are incorporated by reference in Part III.

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TABLE OF CONTENTS

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PART I

FORWARD-LOOKING STATEMENTS

This report contains unaudited forward-looking statements within the meaning of the federal securities laws. Unaudited 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. Unaudited 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 unaudited 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. We also direct your attention to the risk factors affecting our business that are discussed elsewhere in Item 7. We disclaim any obligation to update any of the unaudited forward-looking statements contained in this report to reflect any future events or developments. The following discussions should be read in conjunction with our consolidated financial statements and the notes included thereto in Item 8.

ITEM 1. BUSINESS

Introduction

Cortelco Systems Puerto Rico, Inc. (the “Company”) is a value-added reseller of numerous third-party brands of voice and data communications systems as well as cellular telephones and airtime. We provide value through our sales distribution network and our service. The products we sell help enterprises communicate more effectively with customers and increase customer satisfaction and loyalty. We conduct most of our business in Puerto Rico, although we also sell voice and data communications systems elsewhere in the Caribbean and Latin America.

We were incorporated in March 1999 under the laws of the Commonwealth of Puerto Rico. At the time of incorporation, our sole stockholder was Cortelco Puerto Rico, Inc. (“CPR”). Prior to becoming a wholly-owned subsidiary of eOn Communications Corporations (“eOn”) in April 1999, CPR contributed substantially all of its operations and certain assets and liabilities to us. On July 31, 2002, we were spun-off from eOn as a separate entity to the stockholders of eOn.

Our reportable segments are Communications Systems and Cellular Airtime Services, each of which offers different products and services. Each segment requires different technology and marketing strategies. The Communications Systems segment offers communications solutions that address voice and data network switching while the Cellular Airtime Services segment resells cellular airtime and cellular telephones in Puerto Rico.

Through our Communications Systems segment we install, program, and service voice and data communications systems such as customer premise PBX’s, call center voice switches and applications, as well as reselling computers and local area networks to enterprises and businesses of all sizes. PBX’s are private telephone switching systems, usually located on a customer’s premises, which provide telephone services within the customer’s premises, as well as access to the public switched network. Through our Cellular Airtime Services segment we resell cellular telephones either separately or in conjunction with buying and reselling cellular airtime from cellular carriers, predominantly the Puerto Rico Telephone Corporation (“PRTC”). We also receive sales commissions from cellular carriers for signing up customers with the carriers, in which case we do not buy and resell the actual cellular airtime. No bundling of cellular telephones and cellular airtime takes place as the telephone suppliers and the airtime providers are different entities.

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Industry Overview

Our markets are generally characterized by numerous competitors that often distribute many of the same products that we distribute. Therefore, price competition is often intense for many of the products that we distribute. As other value-added resellers sometimes offer the same equipment as us, the quality of customer service provided is often the differentiating factor in winning new customers.

Our Strategy

We are continually assessing the addition of new brands of voice and data communications equipment to distribute and new cellular products to offer in the markets we serve. Historically, we derived virtually all of our revenues from sales in Puerto Rico. We expect to increase sales to customers outside of Puerto Rico as we continue to establish our distribution channels elsewhere in the Caribbean and Latin America. Additionally, we will continue to assess possible acquisitions of other companies or assets to increase our product offering and our installed base of service customers.

Acquisition of Certain Assets of Ochoa Telecom

During May 2001, we acquired certain assets consisting of accounts receivable, inventory, computers, and the installed customer base of Ochoa Telecom, Inc., a company engaged in the sale, installation, and maintenance of integrated voice communications equipment in Puerto Rico. In connection with this acquisition, we executed a promissory note in favor of Ochoa Telecom in the amount of $1,400,000. The principal balance on this note was $50,000 at July 31, 2002. Assets acquired from Ochoa Telecom collateralize the note payable. The purchase price of these assets, including acquisition costs, exceeded the fair value of the assets by $382,000, and we accounted for this as goodwill at the time of the acquisition.

Products and Services

We sell, install, and service the voice and data communications and cellular products of a number of equipment manufacturers, including eOn, Avaya, Lucent, Nortel, Hitachi, Mitel, NEC, Cortelco, Nokia, Ericsson, and Motorola among others. We also resell cellular airtime that we purchase form cellular carriers, predominantly PRTC. We do not make any of the products that we sell.

Customers

Our customers include both enterprises in our voice and data communications systems business and individual retail customers in our cellular business. We do not derive a significant portion of our revenues from any single customer.

Sales and Marketing

We sell our voice and data communications systems and our cellular products both through a direct sales force and through a network of authorized dealers. Most of the voice and data communications systems we sell are installed directly by us, while approximately half of the sales of our cellular phones and airtime are done through our dealer network. We advertise our voice and data communications products primarily through trade shows and hosted marketing presentations, while most advertising for our cellular products is done through newspapers and other print media.

Customer Service and Support

We earned approximately $3.3 millions of our revenue in fiscal 2002 from the servicing of voice and data communications systems previously installed. Customers generally sign maintenance agreements which detail the services provided and the fees charged for delivering such services. The equipment manufacturers train our personnel in the products that we distribute and service through training courses offered. A key factor in assessing whether to distribute additional equipment brands or acquire assets of other distributors is the size of an installed base of customers in the markets and the technical expertise required to service the equipment.

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Intellectual Property

We do not have any patents, trademarks, or licenses in the conduct of our business. We conduct most of our operations under the trade names “Cortelco” and “Cellular Outlet” which are well known by customers in Puerto Rico. Under Puerto Rican law, we have a proprietary interest in these tradenames for so long as we continue to actively use these trade names.

Competition

The market we serve in the communications industry is highly competitive. Competitive factors include (1) market acceptance of the products, services and technology solutions that we provide, (2) pending and future legislation affecting the communications industry, (3) name recognition and market share, (4) our ability to provide integrated communication and data solutions for customers in a dynamic industry, and (5) the introduction of new technologies.

The dominant competitor in the Puerto Rico market is PRTC, which is significantly larger than any competitor in the market. However, recently PRTC has begun to reduce its voice equipment installation and service business in order to apply its resources to other markets that it deems more attractive. PRTC has traditionally been the reseller, installer, and service company in Puerto Rico for Nortel Networks, the largest voice communications equipment provider in Puerto Rico. As PRTC exits the reseller and service business for customer premise voice products, we will compete with other resellers in the attempt to acquire the maintenance contracts on their customers. Buyers of enterprise voice communications systems are generally very sensitive to price and, to a lesser degree, customer service. Therefore, having the lowest sales price is often the key to winning a customer initially and resellers will often compete aggressively on price in order to win customers for maintenance purposes. We are one of the largest resellers in the Puerto Rico market. We believe that our size offers a competitive advantage in continuing to grow our Communications Systems segment as the large resellers are better able to compete on sales price due to discounts received from equipment manufacturers for larger volume purchases.

Some of our competitors in the communications business are small, owner-operated companies typically located and operated in a single geographic area. Certain of these smaller competitors may have lower overhead cost structures and, consequently, may be able to charge lower rates for their services. Therefore, our relative size may be a competitive disadvantage because we have higher overhead cost structures, and lack as much flexibility to charge lower rates for our services.

There also are a number of large, integrated national companies engaged in providing commercial services in the service lines in which we intend to focus, some of which also manufacture and sell directly the products that we service and sell. Certain of our larger competitors may have greater financial resources to finance acquisition and internal growth opportunities and may be willing to pay higher prices than us for acquisition opportunities. As a result, we have a competitive disadvantage compared to these larger competitors.

Future competition may be encountered from other newly formed or existing public or private service companies with aggressive acquisition and marketing programs. Certain products and services that we offer are manufactured or supplied by others. This presents a competitive disadvantage to us since we incur the risk of partial reliance upon third-party systems and services, as well as risks associated with the need to integrate services and solutions across networks, platforms and equipment manufactured or supplied by various companies.

Employees

As of July 31, 2002, we had approximately 80 employees, including 33 in sales and marketing, 33 in customer service and support, and 14 in finance and administration.

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Executive Officers

The following table sets forth information as to the persons who serve as our executive officers. Our board of directors may appoint additional executive officers from time to time.

SERGIO R. MOREN became President, Chief Executive Officer, and a Director of the Company in April 1999. From February 1998 until April 1999, Mr. Moren was President of CPR. From January 1996 to February 1998, Mr. Moren was Vice President of Integrated Technologies, a contract manufacturer. Prior to 1996, Mr. Moren held executive positions in manufacturing, sales and marketing at ITT Industries, Inc., an engineering and manufacturing company, including President and General Manager of ITT Qume Caribe, a division of ITT Industries. Mr. Moren received a master’s degree from Harvard University and a B.S. from Santa Maria University.

FRANCISCO SANCHEZ became Chief Financial Officer of the Company in July 2000 and became Vice President — Finance and Administration in April 1999. Mr. Sanchez served as a director of the Company from January 2002 to September 2002. He was Vice President — Finance and Administration of CPR from July 1998 until April 1999. From June 1987 to 1998, Mr. Sanchez was Caribbean Region Comptroller for H.B. Fuller Company. From June 1978 to May 1987, Mr. Sanchez held executive positions, Assistant Comptroller in manufacturing, sales and marketing at ITT Industries, Inc. Mr. Sanchez received a master’s degree from Metropolitan University and a BBA from Puerto Rico University.

JOSE ALVAREZ became Vice President — Operations and General Manager of Cellular Division of the Company in August 2001. From August 2000 to August 2001, Mr. Alvarez was an Executive Vice President of eOn. From February 2000 to August 2000, Mr. Alvarez was Director of Operations, Export Sales & Cellular Division, of eOn. From June 1999 to February 2000, Mr. Alvarez was Operations Director of the Company. From January 1991 to February 1999, Mr. Alvarez was President of Almacenes Gonzalez, a retail shoe company. Mr. Alvarez received a master’s degree from Northeastern University and an undergraduate degree from the College of the Holy Cross.

MANUEL DEL TORO became Vice President of Sales and Marketing of the Company in September 2001. From December 2000 to September 2001, Mr. del Toro was a telecommunications and marketing consultant. Mr. del Toro worked with Telefonica de Larga Distancia of Puerto Rico, Inc., a telecommunications company, from July 1992 to December 2000. From July 1973 to 1989, Mr. del Toro was Director of Sales and Marketing of Cortelco Puerto Rico, Inc., then a subsidiary of ITT Corporation. Mr. del Toro received a Bachelor of Arts as Architect Designer at the University of Puerto Rico.

Governmental Regulation

We are not directly regulated by any governmental agency. However, the Federal Communications Commission and Junta Reglamentadora de Telecomunicaciones de Puerto Rico have regulations which address consumer products that connect to the public telephone network. In addition, the Federal Communications Commission regulates electronic emissions of consumer products such as cellular telephones. Our business could be adversely affected if these agencies modify or adopt new regulations. Such regulations could impact the cost of the products we sell or limit the types of products that we may sell, thus reducing our revenues.

ITEM 2. PROPERTIES

Our corporate headquarters is located in approximately 20,000 square feet of a facility located in San Juan, Puerto Rico. We lease this facility from Cortelco Puerto Rico, Inc., a wholly-owned subsidiary of Cortelco Systems Holding Corporation, our former owner and an affiliate through common stock ownership. The lease on this facility expires in April 2004. Virtually all of our employees work at this facility, other than those that work at the direct

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sales cellular outlets operated by us. We are planning to move the operation to a less expensive facility in the municipality of Caguas, Puerto Rico, about 20 minutes from the present facility. This move will allow us to reduce rent expense and potentially receive tax exemption grants to operate under the line assembly process known as the light manufacturing concept.

ITEM 3. LEGAL PROCEEDINGS

From time to time, we may be a party to legal proceedings incidental to our business. We do not believe that any of these proceedings will have a material adverse effect on our business or financial condition.

In 1997, Cellu-Tel, Inc. filed a lawsuit against us in Superior Court, San Juan, Puerto Rico. The complaint alleges that we breached the terms of our contract by ceasing to supply services to the plaintiff. The plaintiff seeks damages of approximately $854,430. Discovery proceedings are being conducted. As a result of the information obtained during discovery, we filed a Third Party Complaint against City Cellular, Inc. and Edgardo Correa, who is the President of Cellu-Tel, Inc. and City Cellular, Inc. We alleged in the Third Party Complaint that City Cellular is a business conduit (an “alter ego”) of plaintiff Cellu-Tel, Inc. We have also alleged that City Cellular has continued to conduct the business of plaintiff. We also believe that City Cellular has received the benefits and income that plaintiff would have received, if any. Therefore, we believe that City Cellular is directly responsible to Cellu-Tel. City Cellular has answered the Third Party Complaint and denied the allegations and raised several defenses. We intend to follow through with discovery proceedings regarding the Third Party Complaint. We believe that this litigation is without merit and will not have a material adverse effect on our business.

In 2001, Jorge Basmeson, a former employee of the Company, filed a lawsuit against us in Court of First Instance, Superior Court, San Juan Section, Puerto Rico. The plaintiff, whose employment we terminated, alleges that his dismissal was unjustified and violated applicable discrimination laws. The plaintiff seeks damages of approximately $600,000. The suit was settled for $15,000 on May 28, 2002.

In 2001, Jose Gonzalez-Nogueras and Luis Luhring-Arizmendi filed a lawsuit against us in Court of First Instance, San Juan, Puerto Rico. The plaintiffs were terminated from employment upon diverse circumstances. Mr. Gonzalez resigned voluntarily alleging that he had problems adjusting to the operational system and corporate culture of the Company. Mr. Luhring was recruited for 90 days as a probationary employee. Before ending his probationary period, the Company decided not to offer Mr. Luhring permanent employment. The plaintiffs seek $5,074,321 for Mr. Gonzalez and $3,072,000 for Mr. Luhring, for alleged damages and loss of business. The Company filed a motion requesting an extension of time to answer the complaint and filed a motion to severe the cases that was granted by the Court, and up to this date Counsel for Plaintiffs has not yet filed the new Complaints to re-initiate the proceedings. We believe that all of these allegations are false, and that this litigation is without merit and will not have a material adverse effect on our business.

In 2001, Jorge Berrios filed a lawsuit against us in Court of First Instance, Caguas, Puerto Rico. The plaintiff alleges that he was unjustly dismissed from employment. He claims compensation in the amount of $300,000 in damages and $32,910.16 as a statutory severance payment. This case is in the initial stage, with the Company having filed an answer to the complaint. Very recently Plaintiff retained new legal representation. The Company is strongly defending its case, because the dismissal of Berrios was based upon good cause for his repeated negligence, which caused the company thousand of dollars in losses. We believe that this litigation is without merit and will not have a material adverse effect on our business.

In January 2002, Edwin Colberg filed a lawsuit against us in the Court of First Instance, Superior Part, San Juan, Puerto Rico. The plaintiff alleges that he was unjustly dismissed from employment, that the Company discriminated against him on the basis of his age, and that he suffered mental anguish as a result of his dismissal. His total claim is in the amount of $7,348,000. Discovery proceedings are being conducted. We have conducted an investigation of the allegations and concluded from our investigation that no discrimination of any type occurred. We believe that our actions were justified by business reasons, and that this litigation is without merit and will not have a material adverse effect on our business.

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Price Range of Common Stock and Dividends

There currently is no established public trading market for any class of our capital stock. We are not currently offering any shares of our capital stock publicly, nor have we publicly proposed to conduct such an offering. Shares of our common stock are reported on the OTC Bulletin Board under the symbol “CPROF.”

The OTC Bulletin Board is a quotation service that displays quotes, last-sale prices and volume information regarding over-the-counter (OTC) equity securities. An OTC equity security generally is any equity security that is not listed or traded on a national securities exchange nor is authorized for quotation on The NASDAQ Stock Market.

The OTC Bulletin Board is only a quotation medium, not an issuer listing service, and should not be confused with The NASDAQ Stock Market. Market makers for OTC Bulletin Board securities generally are required only to match up willing buyers and sellers. Generally, market makers are not required to purchase securities directly from willing sellers or sell securities directly to willing buyers. For this and other reasons, the trading markets for OTC equity securities are generally significantly less liquid than the trading markets for securities listed on a national securities exchange or authorized for quotation on The NASDAQ Stock Market and, therefore, there may be a substantial delay in execution of trades. In addition, an active trading market in the Company common stock may not develop.

As of September 30, 2002, there were 215 shareholders of record of our common stock and, to the best of our knowledge, approximately 5,000 beneficial owners whose shares of common stock were held in the names of brokers, dealers, and clearing agencies.

During fiscal 2002, we did not declare any dividends on our capital 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.

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Securities Authorized for Issuance Under the Company’s Equity Compensation Plan

The following table summarizes our equity compensation plan as of July 31, 2002:

Equity Compensation Plan Information

ITEM 6. SELECTED FINANCIAL DATA

We were incorporated in March 1999 under the laws of the Commonwealth of Puerto Rico. At the time of incorporation, our sole stockholder was Cortelco Puerto Rico, Inc. Prior to becoming a wholly-owned subsidiary of eOn in April 1999, Cortelco Puerto Rico, Inc. contributed substantially all of their operations and certain assets and liabilities to us.

You should read the following selected financial data set forth below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical financial statements and related notes included elsewhere in this report.

The selected statement of operations data presented below for the years ended July 31, 2002, 2001 and 2000, and for the period from commencement of operations April 8, 1999 through July 31, 1999, and the selected balance sheet data as of July 31, 2002, 2001 and 2000, are derived from our historical financial statements audited by Deloitte & Touche LLP, independent auditors. The selected balance sheet data as of July 31, 1999 are derived from our historical financial statements. The selected statement of operations data of our predecessor company, Cortelco Puerto Rico, Inc., for the period from August 1, 1998 through April 7, 1999 are derived from historical financial statements of Cortelco Puerto Rico, Inc. audited by Deloitte & Touche LLP. The selected statement of operations data of Cortelco Puerto Rico, Inc. for the year ended July 31, 1998, and the selected balance sheet data as July 31, 1998, are derived from historical financial statements of Cortelco Puerto Rico, Inc.

The pro forma net income (loss) per share data gives effect to eOn’s distribution to eOn’s shareholders of all the Company’s shares held by eOn on the basis of one share of the Company’s stock for every ten shares of eOn common stock outstanding as if such distribution had occurred as of the beginning of the earliest period presented.

The selected financial information of our predecessor company, Cortelco Puerto Rico, Inc., included herein is not necessarily indicative of our results of operations, financial position, and cash flows as if we had operated as a stand-alone entity at such times nor is it indicative of our results of operations, financial position, and cash flows in the future.

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Overview

We are a value-added reseller of numerous third-party brands of voice and data communication systems as well as cellular telephones and airtime. Most of our business is conducted in Puerto Rico, although we also sell communications systems in the Caribbean and Latin America. Our products help enterprises communicate more effectively with customers and increase customer satisfaction and loyalty. We sell both to enterprises in our voice and data communications business and to individual retail customers in our cellular business.

Our reportable segments are Communications Systems and Cellular Airtime Services, each of which offers different products and services. Each segment requires different technology and marketing strategies. The Communications Systems segment offers communications solutions that address voice and data network switching while the Cellular Airtime Services segment resells cellular airtime and cellular telephones in Puerto Rico. The Communications Systems segment revenues are comprised mostly of sales of PBX customer premise equipment. Cellular Airtime Services revenues were 18% of our total revenues in fiscal 2002 as compared to 47% in fiscal 2001. Revenue derived from Cellular Airtime Services was exceptionally high in fiscal year 2001 because of the significant revenues that resulted from a new cellular carrier trying to gain market share in Puerto Rico in the first half of that fiscal year. We anticipate that these revenues will continue to decline. As Communications Systems revenues will constitute a larger portion of our revenue in the future than in fiscal 2001, it is important that we continue to add to our product and service offering and increase our installed base of customers. Service revenues from our Communications Systems segment have our highest gross margins, greater than the resale of third-party communications systems equipment or our Cellular Airtime Services segment.

We anticipate increasing the revenues in the Communications Systems segment while trying to closely control our selling, general, and administrative expenses. We will continually look for ways to increase our installed base of customers via acquisitions or by distributing new types of voice and data communications products as our highest gross margins are from service revenues in our Communications Systems segment. Our recent losses were mainly a result of expanding our sales and administrative infrastructure following our rapid growth in fiscal 1999 and the first half of fiscal 2000. In fiscal 2001, we restructured our business to address the downward cycle in the telecommunications industry and began to look for ways to increase our higher margin business by acquiring certain assets of Ochoa Telecom in Puerto Rico. While the telecommunications market has continued to be depressed in Puerto Rico due to macroeconomic factors in the country, we will continue to seek acquisition opportunities that allow us to increase our maintenance revenues in the Communications Systems segment.

We recognize revenues from the communications systems we install upon completion of the installation services and acceptance by the customer due to the customized nature of each installation. We recognize revenues upon shipment for communications systems and cellular telephones shipped to dealers because, at that point, we have no further obligations to our dealers to either deliver additional products or perform services. We also recognize revenues upon shipment for cellular telephones sold to retail customers. We recognize cellular sales commission revenues when retail contracts are submitted to cellular carriers and revenues for resold cellular airtime when the customer uses the airtime. Revenues from communications systems service contracts are recognized over the life of the individual contracts. Currently, we sell and service communications systems from eOn, as well as various third-party communications systems from various manufacturers.

Our operating expenses consist mainly of salaries of our sales, marketing, service, and administrative personnel and associated overhead. We recognize these expenses as incurred. As we distribute the products of third parties and do not sell any products that we design or develop ourselves, we do not incur any costs for research and development. While we have essentially operated as a stand-alone entity from our parent due to our location in Puerto Rico, with separate audits, legal counsel, corporate officers, and accounting and administrative functions, we have not previously operated as a stand-alone public company. Therefore, we anticipate that we will incur additional general and administrative expenses due to public company reporting requirements that were previously performed by our parent.

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Net revenues in quarters ending January 31 generally decline from the previous quarter, reflecting seasonal factors that affect some of our customers and the market for voice and data communication systems in Puerto Rico. Customers in such markets as call centers and retail outlets have seasonal buying patterns and do not purchase substantial amounts of equipment during the quarters ending January 31. An increase in total net revenues from October 31, 1999 to January 31, 2000, however, was due mainly to single-line telephone sales to the Puerto Rico Telephone Company and is not indicative of the usual seasonal pattern of our business.

Results of Operations

     Fiscal Year Ended July 31, 2002, Compared To Fiscal Year Ended July 31, 2001

Net Revenues

Net revenues decreased 53.2% to $10.4 million in fiscal 2002 from $22.2 million in fiscal 2001. The results primarily reflected decreased revenues of approximately $8.5 million from the Cellular Airtime Services segment and $3.3 revenues from the Communications Systems segment. Communications Systems segment revenues include $1.0 million and $0.4 during fiscal 2002 and fiscal 2001, respectively, from sales attributable to the portion of our business we acquired from Ochoa Telecom, an installer of integrated communications systems, in May 2001. See “Business-Our Strategy.” The Cellular Airtime Services revenues decreased in the current year due mainly to a general decline in demand and significant revenues in the prior year associated with a new cellular carrier that was trying to build market share in Puerto Rico during the first half of fiscal year 2001.

Cost of Revenues and Gross Profit

Cost of revenues consists primarily of purchases from our equipment manufacturers and other suppliers and costs incurred for final assembly, quality assurance and installation of our systems. Gross profit decreased 53.2% to $2.2 million in fiscal 2002 from $4.7 million in fiscal 2001. The decrease resulted primarily from decreased revenues in Cellular Airtime Services, offset partially by a greater percentage of higher margin Communications Systems revenues and higher margins on Communications Systems revenues in the current year. Our gross margins were 21.5% in fiscal 2002 and 21.3% in fiscal 2001. The gross margin in fiscal 2001 reflected a significantly higher mix of lower margin Cellular Airtime Services revenue. Cost of revenues includes $0.4 million for inventory obsolescence charges in fiscal 2002.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of salaries and benefit costs, advertising, and facilities and other overhead expenses incurred to support our business. Selling, general and administrative expenses decreased 22.9% to $4.1 million in fiscal 2002 from $5.3 million in fiscal 2001. The decrease was primarily due to decreased headcount in the Communications Systems and Cellular Airtime Services segments in fiscal 2002 compared to fiscal 2001. See “Special Charges”. These expenses as a percentage of revenues increased to 39.6% in fiscal 2002 from 24.0% in fiscal 2001, as expense reductions from our restructuring plans were not proportionate to the decline in revenues.

Separation Costs

Separation costs were $0.5 million in fiscal 2002, representing legal and accounting fees associated with our separation from eOn. We incurred no separation costs in fiscal 2001.

Special Charges

To reduce costs and improve productivity, we adopted a restructuring plan that resulted in employee reductions in the second quarter of fiscal 2001 and the second and third quarters of fiscal year 2002. The major component of the plan, and all of the charges, was comprised of severance payments related to reductions in our workforce of approximately 29%.

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The following table provides detail about the special charges recorded during fiscal year 2002 and the associated liabilities at July 31, 2002 (in thousands):

Net workforce reductions under the plan will reduce our future employee expense. The decrease in costs as a result of the restructuring activities outlined above primarily impact wages and benefits in our selling, general and administrative expenses.

Interest Income

Interest income was nominal in both fiscal 2002 and 2001. In addition, we had no interest expense in either fiscal 2002 or fiscal 2001 as we retired our credit facility in conjunction with the initial public offering of eOn in February 2000.

Income Tax Expense

We recognized no income tax benefit in fiscal 2002 or fiscal 2001 because we cannot conclude that it is more likely than not that deferred tax assets will be realized in the future.

    Fiscal Year Ended July 31, 2001, Compared To Fiscal Year Ended July 31, 2000

Net Revenues

Total revenues decreased 8.6% to $22.2 million in fiscal 2001 from $24.3 million in fiscal 2000. These results primarily reflected decreased revenues from the Communications Systems segment of $3.3 million, offset partially by increased revenues from the Cellular Airtime Services segment of approximately $1.2 million. Fiscal 2001 Communications Systems results included $0.4 million in revenues from Ochoa products. The decreased Communications Systems revenues in fiscal 2001 reflected the significant revenues in fiscal 2000 that resulted from Year 2000 upgrades, while increased Cellular Airtime Services revenues reflected the addition of new third-party cellular products distributed in Puerto Rico.

Cost of Revenues and Gross Profit

Gross profit decreased 14.9% to $4.7 million in fiscal 2001 from $5.6 million in fiscal 2000. The decrease resulted primarily from decreased revenues and additional inventory reserves incurred in the current year due to product obsolescence. Our gross margins were 21.3% in fiscal 2001 and 22.9% in fiscal 2000. Cost of revenues includes $0.2 million for inventory obsolescence charges for fiscal 2001 and $0.0 million for fiscal 2000.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased 6.3% to $5.3 million in fiscal 2001 from $5.0 million in fiscal 2000. The increase was primarily due to increased payroll, benefit, and advertising costs associated with Cellular Airtime Services revenues through our direct sales channel. These expenses as a percentage of total revenues were 24.0% in fiscal 2001 and 20.7% in fiscal 2000.

Interest Income and Expense, Net

Interest income was nominal during fiscal years 2001 and 2000. In addition, we had no interest expense in fiscal year 2001 compared to $0.1 million in expense for fiscal 2000. The decrease in expense was due to the retirement of our credit facility in conjunction with the initial public offering of stock of eOn in February 2000.

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Special Charges

To reduce costs and improve productivity, eOn and the Company adopted a restructuring plan in fiscal 2001. The major component of the plan and all of the charges comprised estimated severance payments related to reductions in our workforce of approximately 30%.

The following table provides detail about the special charges recorded during fiscal year 2001 and the associated liabilities at July 31, 2001 (in thousands):

The adjustment reflected above relates to a reduction in the estimated total severance costs associated with the restructuring plan.

Net workforce reductions under the plan will reduce our future employee expense. The employee reductions took place in the second quarter of fiscal 2001. The decrease in costs as a result of the restructuring activities outlined above will primarily impact wages and benefits in our selling, general and administrative expense.

Income Tax Expense

We recognized no income tax benefit in fiscal year 2001 because we cannot conclude that it is more likely than not that deferred tax assets will be realized in the future.

Liquidity and Capital Resources

Prior to the initial public offering of eOn, we funded our operations primarily through cash generated from operations and periodic borrowings under our former revolving credit facility. Subsequent to the initial public offering, eOn periodically provided funds through parent-subsidiary loans as our credit facility was retired with funds from the initial public offering. The last funds received from eOn were in November 2000 and we have funded all cash requirements and loan repayments to eOn of $2.25 million since that date from operating revenues.

Net cash provided by operating activities was $0.2 million in fiscal 2002. Cash provided by operating activities in fiscal 2002 was due primarily to increase collections of receivables, offset by a decrease in accounts payable and the net loss from operations.

Net cash used in investing activities was $0.1 million in fiscal 2002, primarily due to expenditures for office automation.

Net cash used in financing activities was $0.7 million in fiscal 2002, resulting from repayment of part of the note payable issued in conjunction with the Company’s acquisition of certain assets from Ochoa in May 2001. During fiscal 2002, the net amounts previously advanced from eOn to the Company were reclassified as capital contributions and no further repayment of the amounts is required. Cash provided from financing activities during fiscal 2001 represents $0.5 million in net advances from eOn.

The Company’s significant revenue decrease and resulting loss from operations in fiscal 2002 and its lack of financing resources raise substantial doubt about its ability to continue as a going concern. Management plans include the reduction of operating costs and the increase in sales to customers outside of Puerto Rico as the Company continues to establish distribution channels elsewhere in the Caribbean and Latin America. In addition, the Company will continue to assess possible acquisitions of other companies or assets to increase its products offering and its installed base of service customers. The Company’s goal is to improve cash flows and to ultimately generate operating profits. However, no assurances can be given that the Company will be successful in achieving profitability and positive cash flows.

ADDITIONAL RISK FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS

You should carefully consider the risks described below when evaluating ownership of the Company’s stock. If any of the following risks occur, the Company’s business, operating results and financial condition could be seriously

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harmed. Additional risks and uncertainties that the Company is presently not aware of could also impair its business, operating results and financial condition.

RISKS RELATED TO OUR BUSINESS

If we are unable to raise additional capital on acceptable terms, our ability to market our products and services and grow and operate our business could be harmed.

The Company's significant revenue decrease and resulting loss from operations in fiscal 2002 and its lack of financing resources raise substantial doubt about its ability to continue as a going concern. Management plans include the reduction of operating costs and the increase in sales to customers outside of Puerto Rico as the Company continues to establish distribution channels elsewhere in the Caribbean and Latin America. In addition, the Company will continue to assess possible acquisitions of other companies or assets to increase its products offering and its installed base of service customers. The Company's goal is to improve cash flows and to ultimately generate operating profits. However, no assurances can be given that the Company will be successful in achieving profitability and positive cash flows. The magnitude of our future capital requirements will depend on many factors, including, among others, investments in working capital, and the amount of income generated by operations. If we need to raise additional capital, that capital may not be available on acceptable terms, or at all. If we cannot raise necessary additional capital on acceptable terms, we may not be able to successfully market our products and services, take advantage of future opportunities, respond to competitive pressures or unanticipated requirements or even continue operating our business.

If we are not able to sustain our traditional private branch exchange (PBX) market, our business, operating results, and financial condition could be harmed.

Approximately 41.7% and 37.6% of our revenues for fiscal year 2002 and 2001, respectively, were from sales of PBX customer premise equipment. Our PBX revenues declined 56.6% from fiscal year 2000 to fiscal year 2002 due mainly to a decline in the overall PBX market and significant Year 2000 upgrade revenues. These revenues comprise approximately 56.3% of our Communications Systems segment revenues as virtually all enterprise voice communications systems sold worldwide today are PBX’s. The remainder of the segment revenues is service revenues.

We may not be able to sustain our PBX market revenues because the traditional PBX market is declining. One reason for the decline of the traditional PBX market is the emergence of voice switching platforms based on standard PCs and the continued introduction of IP based voice and data communications devices by many of the large equipment manufacturers such as Nortel Networks, Avaya, Mitel, NEC, Toshiba, Panasonic, and Siemens. If we are not able to sustain our traditional PBX revenues or properly train our personnel to sell and service the newer products developed by these companies, our business, operating results and financial condition could be harmed.

If we fail to obtain and market new telecommunication and data products or to add features to our existing telecommunication and data products, we may not be able to generate sufficient revenues to sustain our business.

Our success is highly dependent upon the continued successful timely introduction of new telecommunication and data products and new models of our existing telecommunications and data products containing additional features. The markets for our products are characterized by rapid technological change, frequent new product introductions, uncertain product life cycles and changing customer requirements. The rapid change in customers’ requirements and the constant introduction of new products by our suppliers could cause technological obsolescence of some of our inventory, which could harm our business, operating results and financial condition.

The success of new products and new models with additional features depends on a number of factors, including strategic allocation of limited financial and technical resources, accurate forecasting of consumer demand, and market and industry acceptance of our products and services. If we are unable to successfully train our sales and technical personnel to sell and service the new telecommunications and data products developed by our equipment manufacturers, our business, operating results, and financial condition could be harmed.

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We face intense competition from participants in the telecommunications and data value-added reseller markets, which may impair our revenues and ability to obtain new customers and maintain existing customers.

The telecommunications and data value-added reseller markets are intensely competitive and rapidly evolving. In addition, there are few barriers to entry into the telecommunications and data value-added reseller markets, and new entrants to these markets may develop and offer products that will compete directly with our products and services. Rapid technological innovation and intense price competition characterize the markets, and the competition for new customers and for retention of existing customers is intense.

Some of the products and services provided by us are available through competitors with long operating histories in our markets and many of these products are already familiar to and accepted by consumers. Many of the manufacturers and distributors of these competing telecommunication and data products and services have substantially greater brand recognition, market presence, distribution channels, advertising and marketing budgets and promotional and other strategic partners than us.

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.

The lengthy sales cycles of some of our products and the difficulty in predicting the timing of our sales may cause fluctuations in our quarterly operating results.

The uncertainty of our sales cycle makes the timing of sales difficult to predict and may cause fluctuations in our quarterly operating results. Our sales cycles generally vary from one to twelve months based on the size of the system to be installed and the various requirements of our potential customers. The purchase of our products may involve a significant commitment of our customers’ time, personnel, financial, and other resources. We generally recognize revenues on the date of shipment for communications systems and cellular telephones shipped to dealers and upon completion of installation for communications systems sold directly to end users. For cellular sales commission revenues we recognize revenues when retail contracts are submitted to cellular carriers. Resold cellular airtime is recognized as revenues as the airtime is actually used. Also, it is difficult to predict the timing of indirect sales because we have little control over the selling activities of our dealers and value-added resellers.

We incur substantial sales and marketing expenses and spend significant management time before customers place orders with us, if at all. Revenues from a specific customer may not be recognized in the quarter in which we incur related sales and marketing expense, which may cause us to miss our revenue or earnings expectations.

Seasonal trends may cause our quarterly operating results to fluctuate, which may adversely affect the market price of our stock.

Telecommunications product sales have traditionally been much lower in Puerto Rico, our main market, during the winter holiday season than during other times of the year due to the potential business disruption caused by installing new communications systems, and the extended winter holiday season present in Puerto Rico due to local custom. Although predicting consumer demand for our products will be very difficult, we believe that sales of telecommunications systems will be disproportionately low during this period when compared to other times of the year due to the factors above and the seasonal buying patterns of many of our customers. Any fluctuation in our quarterly operating results may cause the market price of our stock to decline, and that decline may be substantial if the fluctuation is caused by factors other than anticipated seasonal buying patterns of customers. Finally, if we are unable to accurately forecast and respond to consumer demand for our telecommunications systems, our reputation and brand may suffer, and the market price of our stock would likely fall.

Unanticipated difficulties in integrating our recent purchase of certain assets could harm our business.

In May 2001, we purchased certain assets from Ochoa Telecom, a company engaged in the sale, installation, and maintenance of integrated communications equipment in Puerto Rico. The assets consisted of product inventory, accounts receivable, and some computer equipment for the certain Ochoa personnel that we hired. The purchase was financed through a note payable to Ochoa, collateralized by the assets acquired. Although sales of Ochoa

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products since the date of acquisition have contributed positively to our financial results, future operating results may be adversely affected if we are not able to realize continued operating efficiencies through the further consolidation of certain sales, administrative, and customer service functions.

Any future business acquisitions may disrupt our business, dilute stockholder value or distract management attention.

As part of our ongoing business strategy, we may consider additional acquisitions of, or significant investments in, businesses that offer products, services and technologies complementary to our own. In particular, we may pursue acquisitions and strategic alliances as a means of acquiring additional brands of communications systems to sell and service. Such acquisitions could materially adversely affect our operating results and the price of our stock. Acquisitions also entail numerous risks, including:

	•		difficulty of assimilating the operations, products and personnel of the acquired businesses;
	•		potential disruption of our ongoing business;
	•		unanticipated costs associated with the acquisition;
	•		inability of management to manage the financial and strategic position of acquired or developed products, services and technologies;
	•		inability to maintain uniform standards, controls, policies and procedures; and
	•		impairment of relationships with employees and customers that may occur as a result of integration of the acquired business.

To the extent that shares of our stock or other rights to purchase stock are issued in connection with any future acquisitions, dilution to our existing stockholders will result and our earnings per share may suffer. Any future acquisitions or strategic investments may not generate additional revenue or provide any benefit to our business, and we may not achieve a satisfactory return on our investment in any acquired businesses.

If we lose key management personnel, we may not be able to successfully operate our business.

Our future performance will be substantially dependent on the continued services of our senior management, especially our President and Chief Executive Officer, Sergio R. Moren, and other key personnel. The loss of any members of our executive management team and our inability to hire additional executive management could harm our business and results of operations. We employ our key personnel on an at-will basis. We do not maintain key person insurance policies on any of the members of our executive management team.

We may be unable to hire and retain sales, marketing, and service personnel to execute our business strategy.

Competition for highly qualified personnel is intense due to the limited number of people available with the necessary technical skills, and we may not be able to attract, assimilate or retain such personnel. If we cannot attract, hire and retain sufficient qualified personnel, we may not be able to successfully market, sell, or service new products.

Since we do not have exclusive agreements with our manufacturers, manufacturers may enter into dealer agreements with our competitors, which may adversely affect our business.

We distribute and service products designed and manufactured by eOn, Avaya, Nortel, Hitachi, Mitel, Toshiba, NEC, Cortelco, Nokia, Ericsson, Motorola, and others. However, we do not have exclusive distribution agreements with these companies and have competitors in our major markets that sell the same products. Our customers often have the option of purchasing similar communications systems from other distributors in our markets. A decision by the manufacturer to sell to other dealers in our market increases competitive pressures on the Company, and may adversely affect our business.

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If we are unable to establish and maintain satisfactory relationships with the manufacturers of our products that we expect to sell and service, our business will suffer.

We acquire all of our products that we sell from manufacturers pursuant to the terms of distribution agreements. The loss of our distribution agreements with our product manufacturers would reduce our revenues, increase obsolescence risk to our existing inventory, and materially harm our business.

We depend on a limited number of third parties to manufacture and supply our products, and we may be unable to operate our business if those parties do not perform their obligations.

We expect to rely on eOn and other third-party suppliers for many of the products that we distribute and service, including telecommunications and data systems as well as cellular phones and accessories. We do not have long-term agreements in place with our suppliers and we do not control the time and resources that these third parties devote to our business. We cannot be sure that these parties will perform their obligations as expected or that any revenue, cost savings or other benefits will be derived from the efforts of these parties. If any of our third party suppliers breaches or terminates its agreement with us or otherwise fails to perform its obligations in a timely manner, we may be delayed or prevented from delivering some of our products and services. Because our relationships with these parties are non-exclusive, they may also support products or services that compete directly with ours or offer similar or greater support to our competitors. Any of these events could require us to undertake unforeseen additional responsibilities or devote additional resources to deliver our products and services. This outcome would harm our ability to compete effectively and perform our services.

We face many risks in expanding our international operations into the Caribbean and Latin America

Sales outside of Puerto Rico accounted for approximately 7.7% of our total revenues during fiscal 2002. We expect to increase sales to customers outside Puerto Rico as we establish additional distribution channels in the Caribbean and Latin America. However, foreign markets for our products may develop more slowly than currently anticipated. We may not be able to successfully establish international distribution channels, or we may not be able to hire the additional personnel necessary to support such distribution channels.

Our future results could be harmed by economic, political, regulatory and other risks associated with our reliance on international sales and operations.

As stated above, sales outside of Puerto Rico accounted for approximately 7.7% of our total revenues during fiscal 2002. We anticipate that revenue from international sales will continue to represent a significant portion of our total revenue. Because of our operations and relationships in other parts of the Caribbean and in Latin America, and our reliance on foreign third-party manufacturing, assembly and testing operations, we are subject to the risks of conducting business outside of Puerto Rico, including:

	•		changes in a specific country’s or region’s political or economic conditions, particularly in Latin American markets;
	•		trade protection measures and import or export licensing requirements;
	•		potentially negative consequences from changes in tax laws;
	•		difficulty in managing widespread sales and customer service operations; and
	•		less effective protection of intellectual property.

We currently sell outside Puerto Rico in the Dominican Republic, Panama, and Costa Rica and continue in attempts to increase our business in these countries. All our sales are denominated in United States dollars.

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We are currently involved in litigation, which, if resolved unfavorably, could have a material adverse effect on our business.

We are currently subject to one lawsuit regarding an alleged breach of contract, and three lawsuits regarding employment issues. In the breach of contract case, the plaintiff alleges that we breached the terms of our contract by ceasing to supply services to the plaintiff, and the plaintiff seeks damages of approximately $854,430. In the employment lawsuits, each of the plaintiffs are former employees of our company, and they each allege under various theories of law that their dismissal from employment by the Company was unjustified. Collectively, the employment law cases allege damages of approximately $13 million. We have analyzed each lawsuit with our legal advisers, and we do not believe that any of these cases will result in an unfavorable outcome that would have a material adverse effect upon our business. However, in the event of one or more unfavorable determinations against us, such litigation could have a material adverse effect on our business by harming earnings if we are liable for a significant monetary judgment, by harming our reputation with our customers through any adverse publicity generated from an unfavorable determination, or by adversely affecting our relationship with current and prospective employees of our company.

Laws or regulations that govern the telecommunications industry and copyrighted works could expose us to legal action if we fail to comply or could require us to change our business.

Because our products and services provide our customers with access to the public telephone system and other methods of electronic communication, the products we sell are subject to the regulations of the Federal Communications Commission and Junta Reglamentadora de Telecomunicaciones de Puerto Rico, relating to consumer products that connect to the public telephone network and electronic emissions of consumer products.

Changes in the regulatory climate or the enforcement or interpretation of existing laws could expose us to legal action if we fail to comply. In addition, any of these regulatory bodies could promulgate new regulations or interpret existing regulations in a manner that would cause us to incur significant compliance costs or force us to alter the features or functionality of our products and services.

Product defects, system failures or interruptions may have a negative impact on our revenues, damage our reputation and decrease our ability to attract new customers.

Errors and product defects can result in significant warranty and repair problems, which could cause customer relations problems. Correcting product defects requires significant time and resources, which could delay product releases and affect market acceptance of our products. Any delivery by us of products with undetected material product defects could harm our credibility and market acceptance of our products.

The products we sell and service may have undetected faults leading to liability claims, which could harm our business.

The products we sell and service may contain undetected faults or failures. Any failures of these products could result in significant losses to our customers, particularly in mission-critical applications. A failure could also result in product returns and the loss of, or delay in, market acceptance of our products. In addition, any failure of the products we sell could result in claims against us. Our purchase agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. Although we are unaware of any specific laws or cases that would invalidate our purchase agreement limitation of liability provisions, there is a risk that such provisions may not be effective as a result of federal, state or local laws or ordinances or unfavorable judicial decisions in Puerto Rico or other countries. We maintain insurance to protect against certain claims associated with the use of our products, but our insurance coverage may not adequately cover all possible claims asserted against us. In addition, even claims that ultimately are unsuccessful could be expensive to defend and consume management time and resources.

Our charter contains certain anti-takeover provisions that may discourage take-over attempts and may reduce our stock price.

Our board of directors has the authority to issue up to 10,000,000 shares of preferred stock and to determine the preferences, rights and privileges of those shares without any further vote or action by the stockholders. The rights

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of the holders of any preferred stock that may be issued in the future may harm the rights of the holders of common stock. Certain provisions of our certificate of incorporation and bylaws may make it more difficult for a third party to acquire control of us without the consent of our board of directors, even if such changes were favored by a majority of the stockholders. These include provisions that provide for a staggered board of directors, prohibit stockholders from taking action by written consent and restrict the ability of stockholders to call special meetings.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 141, Business Combinations. SFAS No. 141 requires that all business combinations be accounted for under the purchase method only and that certain acquired intangible assets in a business combination initiated after June 30, 2001 be recognized as assets apart from goodwill. Adoption of SFAS No. 141 did not have a significant effect on the Company’s results of operations or financial position.

In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). SFAS No. 142 eliminates the amortization of goodwill and indefinite-lived intangible assets and initiates an annual review for impairment. Identifiable intangible assets with a determinable useful life will continue to be amortized. The amortization provisions apply to goodwill and other intangible assets acquired after June 30, 2001. Goodwill and other intangible assets acquired prior to June 30, 2001 will be affected upon adoption. The Company adopted SFAS No. 142 effective August 1, 2001, and performed an impairment test of its existing goodwill based on a fair value concept. It is management’s assessment that goodwill impairment did not result upon adoption. As of July 31, 2002 and 2001, the Company has net unamortized goodwill of $382,000.

In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated retirement costs. The Company was required to implement SFAS No. 143 on August 1, 2002. Adoption of SFAS No. 143 did not have a significant effect on the Company’s results of operations or financial position.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. However, SFAS No. 144 retains the fundamental provisions of SFAS No. 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used and (b) measurement of long-lived assets to be disposed of by sale. Previous guidance for financial accounting and reporting for the impairment or disposal of long-lived assets and for segments of a business to be disposed of. The Company was required to implement SFAS No. 144 on August 1, 2002. Adoption of SFAS No. 144 did not have a significant effect on the Company’s results of operations or financial position.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB No. 4, 44 and 64, Amendment of SFAS No. 13, and Technical Corrections. SFAS No. 145 rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt – an amendment of APB Opinion No. 30, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in Opinion No. 30 will now be used to classify those gains and losses. This amendment was effective on August 1, 2002. SFAS No. 145 did not have a significant effect on the Company’s financial condition or results of operations.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated With Exit or Disposal Activities. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. SFAS No. 146 also establishes that fair value is the objective for initial measurement of the liability. SFAS No. 146 applies to costs associated with an exit activity but does not involve an entity newly acquired in a business combination or with a disposal activity covered by SFAS No. 144. SFAS No. 146 does not apply to costs associated with a retirement of long-lived assets covered by SFAS No. 143. The Company is required to implement SFAS No. 146 for exit or disposal activities that are initiated after December 31, 2002, and have not yet determined the impact that this statement will have on its results of operations or financial position.

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Quarterly Financial Data (Unaudited)

Quarterly financial data for the years ended July 31, 2002 and 2001 is summarized as follows:

ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The majority of our cash equivalents are invested in variable rate instruments with frequent rate resets. Because these securities have short effective maturities, we believe the market risk for such holdings is insignificant. In addition, the vast majority of the Company’s sales are made in U.S. dollars, and consequently, we believe that our foreign exchange rate risk is immaterial. We do not have any derivative instruments and do not engage in hedging transactions.

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ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CORTELCO SYSTEMS PUERTO RICO, INC.

INDEX TO FINANCIAL STATEMENTS