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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the quarter ended April 30, 2003.
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. 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)
PUERTO RICO 66-0567491
(State of incorporation) (I.R.S. Employer Identification No.)
Road 156 km 58.2 Valle Tolima, Caguas, Puerto Rico, 00725
(Address of principal executive office)
(787) 758-0000
(Telephone number)
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] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 126-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date: 1,204,557 shares of Common
Stock, $0.01 par value, as of April 30, 2003.
CORTELCO SYSTEMS PUERTO RICO, INC.
FORM 10-Q
QUARTER ENDED APRIL 30, 2003
INDEX
Page
----
Part I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Balance Sheets as of April 30, 2003
and July 31, 2002 ............................................ 3
Condensed Statements of Operations for the Three Months
and Nine Months ended April 30, 2003 and 2002 ................ 4
Condensed Statement of Changes in Stockholders' Equity
for the Nine Months ended April 30, 2003 ..................... 5
Condensed Statements of Cash Flows for the Nine Months
ended April 30, 2003 and 2002 ................................ 6
Notes to Condensed Financial Statements .......................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................... 15
Item 3. Qualitative and Quantitative Disclosure about Market Risk ....... 27
Item 4. Controls and Procedures ......................................... 27
Part II: OTHER INFORMATION
SIGNATURES
2
CORTELCO SYSTEMS PUERTO RICO, INC.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED BALANCE SHEETS (Unaudited)
April 30, 2003 and July 31, 2002
(Dollars in thousands) April 30, July 31,
2003 2002
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 69 $ 333
Trade accounts receivable, net of allowance
for doubtful accounts of $671 and $864, respectively 1,633 2,016
Due from affiliated entities 317 187
Current portion of investment in sales-type leases, net
of unearned interest income and allowance for
doubtful accounts 24 82
Inventories 2,267 2,989
Prepaid expenses 105 296
------------- -------------
Total current assets 4,415 5,903
Investment in sales-types leases, net of unearned interest
income and allowance for doubtful accounts 45 47
Property and equipment, net 459 489
Goodwill 382 382
------------- -------------
Total $ 5,301 $ 6,821
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 1,067 $ 1,262
Due to affiliated entities 176 147
Other accrued liabilities 465 671
Deferred revenue 250 315
Note payable 25 50
------------- -------------
Total current liabilities 1,983 2,445
------------- -------------
Commitments and Contingencies
Stockholders' equity:
Preferred stock, par value $0.01 per share; authorized,
10,000,000 shares, no shares issued -- --
Common stock, par value $0.01 per share, 5,000,000 shares
authorized; 1,204,557 shares issued and outstanding 12 12
Capital in excess of par value 6,865 6,865
Retained earnings(deficit) (3,559) (2,501)
------------- -------------
Total stockholders' equity 3,318 4,376
------------- -------------
Total $ 5,301 $ 6,821
============= =============
See notes to condensed financial statements
3
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED STATEMENTS OF OPERATIONS (Unaudited)
For the Three Months and Nine Months Ended April 30, 2003 and 2002
(Dollars in thousands, except per share data)
Three Months Ended Nine Months Ended
April 30, April 30,
------------------------------ ------------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Net revenues:
Products $ 818 $ 998 $ 2,971 $ 5,545
Services 756 771 2,574 2,587
------------- ------------- ------------- -------------
Total net revenues 1,574 1,769 5,545 8,132
------------- ------------- ------------- -------------
Cost of revenues:
Products 798 974 2,598 4,819
Services 815 435 1,856 1,343
------------- ------------- ------------- -------------
Total cost of revenues 1,613 1,409 4,454 6,162
------------- ------------- ------------- -------------
Gross profit (loss) (39) 360 1,091 1,970
------------- ------------- ------------- -------------
Operating expenses:
Selling, general,
& administrative 590 1,035 2,168 3,039
Special charges -- 50 -- 50
Separation costs -- 178 -- 428
------------- ------------- ------------- -------------
Total operating expenses 590 1,263 2,168 3,517
------------- ------------- ------------- -------------
Loss from operations (629) (903) (1,077) (1,547)
Interest income 6 2 19 10
------------- ------------- ------------- -------------
Loss before income tax (623) (901) (1,058) (1,537)
Income tax -- -- -- --
------------- ------------- ------------- -------------
Net loss $ (623) $ (901) $ (1,058) $ (1,537)
============= ============= ============= =============
Basic and diluted net loss
per common share $ (0.52) $ (0.75) $ (0.88) $ (1.28)
============= ============= ============= =============
See notes to condensed financial statements
4
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
For the Nine Months Ended April 30, 2003
(Dollars in thousands, except per share data)
----------------------------------------------------------------------
Common Stock Capital in Retained
-------------------------- Excess of Earnings
Shares Amount Par Value (Deficit) Total
----------- ----------- ----------- ----------- -----------
Balance at July 31, 2002 1,204,557 $ 12 $ 6,865 $ (2,501) $ 4,376
Net loss (1,058) (1,058)
----------- ----------- ----------- ----------- -----------
Balance at April 30, 2003 1,204,557 $ 12 $ 6,865 $ (3,559) $ 3,318
=========== =========== =========== =========== ===========
See notes to condensed financial statements
5
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
For the Nine Months Ended April 30, 2003 and 2002
(Dollars in thousands)
Nine Months Ended
April 30,
------------------------
2003 2002
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,058) $ (1,537)
---------- ----------
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 87 144
Provision for slow moving inventory 500 --
Changes in operating assets and liabilities:
Decrease (increase) in:
Trade accounts receivables 383 1,791
Due from affiliated entities (130) 190
Inventories 222 558
Prepaid expenses 191 143
Increase (decrease) in:
Trade accounts payable (195) (1,009)
Due to affiliated entities 29 (31)
Accrued liabilities (206) (117)
Deferred revenue (65) (116)
---------- ----------
Total adjustments 816 1,553
---------- ----------
Net cash provided by (used in) operating activities (242) 16
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (57) (78)
Net decrease in investment in sales-type leases 60 11
---------- ----------
Net cash provided by (used in) investing activities 3 (67)
---------- ----------
CASH FLOWS USED IN FINANCING ACTIVITIES:
Payment on promissory note (25) (587)
---------- ----------
NET CHANGE IN CASH AND CASH EQUIVALENTS (264) (638)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 333 959
---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 69 $ 321
========== ==========
See notes to condensed financial statements
6
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)
For the Nine Months Ended April 30, 2003 and 2002
BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been
prepared by Cortelco Systems Puerto Rico, Inc. ("CSPR" or the "Company"). It is
Management's opinion that these statements include all adjustments, consisting
of only normal recurring adjustments, necessary to present fairly the financial
position, results of operations, and cash flows as of April 30, 2003 and for all
periods presented.
CSPR, a Puerto Rico corporation, was a wholly-owned subsidiary of eOn
Communications Corporation ("eOn") through July 30, 2002. Effective July 31,
2002, CSPR was spun-off from eOn to the eOn stockholders. Each holder of eOn
common stock received one share of CSPR common stock for every ten shares of eOn
common stock held as of July 22, 2002, which was the record date of the
distribution. After such spin-off, CSPR became an independent entity
headquartered in San Juan, Puerto Rico. CSPR's operations include the sale of
cellular telephones and cellular airtime and of integrated communications and
data equipment in Puerto Rico.
Certain information and footnote disclosures normally included in the
annual financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted. It is suggested that these condensed financial statements be read in
conjunction with the financial statements and notes as of July 31, 2002 and 2001
and for the periods then ended, which are included in the Annual Report on Form
10-K for the year ended July 31, 2002 filed with the Securities and Exchange
Commission.
SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Product Warranties - The Company provides warranties to its customers to replace
or repair certain products from the date of purchase or the date of installation
depending on the contract terms. Costs associated with these warranty programs
are estimated and accrued at the time of sale on the basis of expected net
future costs. Under the Financial Accounting Standards Board ("FASB")
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others, an
interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB
interpretation No. 34, the Company is required to recognize, at the inception of
a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The initial recognition and initial measurement
provisions of this interpretation are applicable on a prospective basis to
guarantees issued or modified after December 31, 2002. The Company has not yet
determined the impact that this interpretation will have on its results of
operations or financial position.
7
Inventory Obsolescence - CSPR carries inventories at the lower of cost or
market. This policy depends on the timely identification of those items included
in inventory for which the market price may have declined below carrying value,
such as slow-moving or obsolete items, and we record any necessary write-offs.
The Company performs an analysis of slow-moving or obsolete inventory on a
quarterly basis, and any necessary write-offs, which could potentially be
significant, are included as a deduction from earnings in the period in which
the evaluations are completed.
Allowance for Doubtful Accounts - The allowance for doubtful accounts is an
amount that management believes will be adequate to absorb losses on existing
accounts receivable that are considered uncollectible based on evaluations of
collectibility of accounts receivable and prior credit experience. Because of
uncertainties inherent in the estimation process and the future availability of
additional information, management's estimate of credit losses inherent in the
existing accounts receivable and the related allowance may change in the near
term.
Going Concern and Management Plan - The accompanying condensed financial
statements have been prepared on a going concern basis, which contemplates the
realization of assets and the settlement of liabilities and commitments in the
normal course of business. The Company's significant revenue decrease and
resulting loss from operations in fiscal year 2002 and in the nine months ended
April 30, 2003, and its lack of financing resources raise substantial doubt
about the Company's ability to continue as a going concern. Management plans
include continuing its reduction of operating costs and expenses while striving
for an increase in sales. Effective in February 2003, the Company moved its
operations to a new location, resulting in savings of approximately $87,500 for
the current quarter as well as approximately $87,500 for the next quarter. To
increase sales, CSPR jointly with OEM suppliers is developing an aggressive plan
that includes visits to our current customer base in order to offer new
technologies to help them in the productivity, security and reductions of their
telecommunications expenses. Some of these products are IP Office, Unify
Messenger and Digital Video Recording (DVR). Also, the Company is increasing its
maintenance service contracts with designated salespersons to generate
maintenance contracts for new customers and continuing the renewal of the
existing customers' contracts. The Company's goal is to improve cash flows and
to ultimately generate operating profits. To improve cash flows, management
created a task force composed of representatives of the finance and sales
departments. The task force is oriented to analyze disputed balances, visit the
customers, and resolve issues in order to improve the collection process of past
due invoices. The finance department together with the operations department
created a task force to sell any excess or slow moving inventory to the
secondary market. 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 the Company 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. The condensed financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
8
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued Statement of Financial Accounting Standards
("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 April 30, 2003 and July 31, 2002, 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. 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
9
Company is required to implement SFAS No. 146 for exit or disposal activities
that are initiated after December 31, 2002. The Company has not yet determined
the impact that this statement will have on its results of operations or
financial position.
REVENUE RECOGNITION
The Company recognizes revenues from the communications systems segment
upon completion of installation services and acceptance by the customer due to
the customized nature of each installation. The Company recognizes revenues upon
shipment of equipment to customers for communications systems and cellular
telephones shipped to dealers because, at that point, the Company has no further
obligations to our dealers to either deliver additional products or perform
services. Also the Company recognizes revenues upon shipment for cellular
telephones sold to retail customers and recognizes cellular sales commission
revenues when retail contracts are submitted to cellular carriers and recognizes
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, the Company sells and services
communications systems purchased from eOn, as well as various third-party
communications systems from various manufacturers.
SPECIAL CHARGES
To reduce costs and improve productivity, the Company adopted a
restructuring plan in the second quarter of fiscal year 2001. The plan, which
included headcount reductions and office space consolidation, was effectively
amended in fiscal year 2002. The majority of the restructuring plan was
completed by July 31, 2002. The remaining expenditures for the restructuring
plan are expected to be substantially complete by July 2003.
The following table summarizes the activity relating to the special charges
during the first, second and third quarter of fiscal 2003 and the associated
liabilities at April 30, 2003 (in thousands):
July 31, 2002 Fiscal Year 2003 April 30, 2003
Liability Expenditures Liability
Balance Q1 Q2 Q3 Balance
------------ ------ ------ ------ --------------
Termination benefits $288 $34 $38 $45 $171
The liability for restructuring charges of $171,000 as of April 30, 2003,
is included in other accrued liabilities.
SEPARATION COSTS
During fiscal 2002, legal and accounting fees associated with our
separation from eOn were classified as a separate component of operating
expenses under the caption "Separation costs." The Company does not expect to
incur any additional such costs during the balance of fiscal year 2003.
10
INCOME (LOSS) PER COMMON SHARE
The Company reports its earnings per share ("EPS") using Financial
Accounting Standards Board ("FASB") Statement No. 128, Earnings Per Share ("SFAS
128"). SFAS 128 requires dual presentation of basic and diluted EPS. Basic EPS
is computed by dividing income (loss) attributable to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
On July 31, 2002, CSPR issued 1,194,557 shares of common stock to effect
the spin-off to eOn shareholders. The weighted average number of shares
outstanding for the period ended April 30, 2002 has been adjusted to give 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 computations of basic and diluted loss per share were as follows:
Three Months Ended Nine Months Ended
April 30, April 30,
-------------------- --------------------
2003 2002 2003 2002
-------- -------- -------- --------
(In thousands, except (In thousands, except
per share data) per share data)
Basic and diluted loss per share:
Net loss $ (623) $ (901) $(1,058) $(1,537)
======== ======== ======== ========
Weighted average number of common
shares outstanding 1,204,557 1,204,557 1,204,557 1,204,557
Net loss per share $ (0.52) $ (0.75) $ (0.88) $ (1.28)
========= ========= ========= =========
INVENTORIES
Inventories consist of the following:
April 30, July 31,
2003 2002
---------- ---------
(In thousands)
Purchased components $ 1,042 $ 1,487
Components and materials related to
installation in process 90 36
Parts and materials for sales 1,135 1,466
--------- ---------
Total inventories $ 2,267 $ 2,989
========== ==========
11
ACCOUNTING FOR GOODWILL
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.
Goodwill of $382,000 had been recorded in conjunction with the assets
acquisition of Ochoa Telecom in May 14, 2001. 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. The adoption of SFAS No. 142 did not
have a significant impact on the Company's results of operations or financial
position during fiscal year 2002 or in the nine months ended April 30, 2003. As
of April 30, 2003 and July 31, 2002, the Company has net unamortized goodwill of
$382,000.
CONTINGENCIES
CSPR is currently subject to one lawsuit regarding an alleged breach of
contract, three lawsuits regarding employment issues, and a fifth lawsuit in
which the Company was included as a Third Party Defendant. In the breach of
contract case, the plaintiff alleges that CPRS 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. Regarding the fifth lawsuit, the Company believes
that this litigation is without merit and filed a motion for the court to order
our dismissal. CSPR has analyzed each lawsuit with our legal advisors, and the
Company does not believe that any of these cases will result in an unfavorable
outcome that would have a material adverse effect upon our business.
SEGMENT INFORMATION
CSPR's 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.
12
Segment information for
THREE MONTHS ENDED APRIL 30, 2003
Cellular
Communications Airtime
Systems Services Total
------------ ------------ -----------
(In thousands)
Revenues $ 1,390 $ 184 $ 1,574
Loss from operations (616) (13) (629)
Interest income 6 -- 6
Provision for income taxes -- -- --
Net loss (610) (13) (623)
THREE MONTHS ENDED APRIL 30, 2002
Cellular
Communications Airtime
Systems Services Total
-------------- ------------ -----------
(In thousands)
Revenues $ 1,358 $ 411 $ 1,769
Loss from operations (817) (86) (903)
Interest income 2 -- 2
Provision for income taxes -- -- --
Net loss (815) (86) (901)
13
Segment information for
NINE MONTHS ENDED APRIL 30, 2003
Cellular
Communications Airtime
Systems Services Total
-------------- -------------- --------------
(In thousands)
Revenues $ 4,882 $ 663 $ 5,545
Loss from operations (1,043) (34) (1,077)
Interest income 19 -- 19
Provision for income taxes -- -- --
Net loss (1,024) (34) (1,058)
Total assets 4,933 368 5,301
Capital expenditures (57) -- (57)
Depreciation and amortization 84 3 87
NINE MONTHS ENDED APRIL 30, 2002
Cellular
Communications Airtime
Systems Services Total
-------------- -------------- --------------
(In thousands)
Revenues $ 6,592 $ 1,540 $ 8,132
Loss from operations (1,402) (145) (1,547)
Interest income 10 -- 10
Provision for income taxes -- -- --
Net loss (1,392) (145) (1,537)
Total assets 6,521 834 7,355
Capital expenditures (78) -- (78)
Depreciation and amortization 138 6 144
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
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. The Company
also directs your attention to the risk factors affecting our business that are
discussed elsewhere at the end of this Item. CSPR disclaims 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 unaudited financial statements and the notes
included thereto.
OVERVIEW
The Company is 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. The Company's
products help enterprises communicate more effectively with customers and
increase customer satisfaction and loyalty. The Company sells both to
enterprises in our voice and data communications business and to individual
retail customers in our cellular business.
The Company's 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. The Communications Systems segment represented 82%
of our revenues in fiscal year 2002 and 90% of the operating loss of the
Company, while Cellular Service represented 18% of revenues and 10% of the
operating loss. Cellular Services revenues were 12% of our total revenues for
the nine months ended April 30, 2003 and we anticipate that these revenues will
continue to represent a smaller percentage of the total revenues than in fiscal
year 2002. As Communications Systems revenues will constitute a larger portion
of our revenue in the future than in fiscal year 2002, it is important that we
continue to add to our product and service offering and increase our installed
base of customers. In the period ended April 30, 2003, Communications Systems
segment has our highest gross margins, greater than Cellular Airtime Services
segment.
While the Company's recent losses have primarily been due to our
Communications Systems segment, CSPR anticipates increasing the revenues in the
Communications Systems segment while trying to closely control our selling,
15
general, and administrative expenses. The Company 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. The Company's
recent losses in the Communications System segment were mainly a result of
expanding our sales and administrative infrastructure following our rapid growth
in fiscal year 1999 and the first half of fiscal year 2000. In fiscal year 2001,
CSPR restructured the 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, CSPR will continue to seek
acquisition opportunities that allow us to increase our maintenance revenues in
the Communications Systems segment.
THREE MONTHS ENDED APRIL 30, 2003 AND 2002
The following discussion provides information about the Company's
operations, as an independent company for the three months ended April 30, 2003
and as a wholly-owned subsidiary of eOn for the three months ended April 30,
2002.
NET REVENUES
Net revenues decreased 11.1% to $1.6 million in the three months ended
April 30, 2003 from $1.8 million in the three months ended April 30, 2002. The
results primarily reflects increased revenue of approximately $32,000 in
Communications Systems segment and a decrease of approximately $227,000 in
Cellular Airtime Services segment due to a general decline in demand.
COST OF REVENUES AND GROSS PROFIT (LOSS)
Cost of revenues consists primarily of purchases from equipment
manufacturers and other suppliers and costs incurred for final assembly, quality
assurance and installation of our systems. For cellular contracts submitted to
the carriers from our authorized dealers, any commissions paid to the dealer are
also included as a component of cost of revenues. Gross profit (loss) decreased
110.8% to ($39,000) in the three months ended April 30, 2003 from $360,000 in
the three months ended April 30, 2002. CSPR's gross margins were (0.025%) in the
three months ended April 30, 2003 and 20.4% in the three months ended April 30,
2002. The decrease in gross margin was primarily due to the net effect of
reductions of costs and productivity improvements resulting from the
restructuring plan adopted by the Company offset by the recording of an
additional provision for slow moving inventory of approximately $500,000 in the
third quarter of fiscal year 2003.
SELLING, GENERAL AND ADMINISTRATIVE
The operating expenses consist mainly of salaries of our sales, marketing,
service, and administrative personnel and associated overhead. CSPR recognizes
these expenses as incurred. As the Company distributes the products of third
parties and does not sell any products that the Company designs or develops, the
Company does not incur any costs for research and development. While prior to
the
16
spin-off we 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, CSPR anticipates that it
will incur additional general and administrative expenses due to the public
company reporting requirements that were previously performed by our parent.
However, selling, general and administrative expenses decreased 40% to $0.6
million in the quarter ended April 30, 2003 from $1.0 million in the quarter
ended April 30, 2002. The decrease was primarily due to reductions in personnel,
facilities, and associated overhead resulting from the implementation of the
Company's restructuring plan.
SPECIAL CHARGES
During the three months ended April 30, 2002, the Company incurred
approximately $50,000 in the restructuring plan. CSPR incurred no special cost
in the three months ending April 30,2003 and expects to incur no additional such
costs during the balance of fiscal year 2003.
SEPARATION COSTS
During the three months ended April 30, 2002, CSPR incurred approximately
$178,000 in legal and accounting fees associated with the separation from eOn.
The Company incurred no separation cost in the three months ending April 30,
2003 and expects to incur no additional such costs during the balance of fiscal
year 2003.
INTEREST AND OTHER INCOME AND EXPENSES
No material amount was recorded in the three months ended April 30, 2003 or
the three months ended April 30, 2002.
INCOME TAX BENEFIT (EXPENSE)
No income tax benefit was recognized in the three months ended April 30,
2003 or the three months ended April 30, 2002 because CSPR cannot conclude that
it is more likely than not that its deferred tax assets will be realized in the
future.
NINE MONTHS ENDED APRIL 30, 2003 AND 2002
The following discussion provides information about the Company's
operations, as an independent company for the nine months ended April 30, 2003
and as a wholly-owned subsidiary of eOn for the nine months ended April 30,
2002.
NET REVENUES
Net revenues decreased 32.1% to $5.5 million in the nine months ended April
30, 2003 from $8.1 million in the nine months ended April 30, 2002, reflecting
economical recession factors that affect many of our multinational customers and
the market for voice and data communication systems in Puerto Rico. The decrease
experienced by the Cellular Airtime Services segment is due to a general decline
in demand.
17
COST OF REVENUES AND GROSS PROFIT
Cost of revenues consists primarily of purchases from equipment
manufacturers and other suppliers and costs incurred for final assembly, quality
assurance and installation of our systems. Gross profit decreased 50% to $1.0
million in the nine months ended April 30, 2003 from $2.0 million in the nine
months ended April 30, 2002. The decrease resulted basically from decreased
revenues in Cellular Airtime Services segment and in the Communications Systems
segment. Company's gross margins were 19.7% in the nine months ended April 30,
2003 and 24.2% in the same period last year. The decrease in gross margin was
primarily due to the net effect of reductions of costs and productivity
improvements resulting from the restructuring plan adopted by the Company offset
by the recording of an additional provision for slow moving inventory of
approximately $500,000 in the third quarter of fiscal year 2003.
SELLING, GENERAL AND ADMINISTRATIVE
The operating expenses consist mainly of salaries of our sales, marketing,
service, and administrative personnel and associated overhead. CSPR recognizes
these expenses as incurred. As the Company distributes the products of third
parties and does not sell any products that the Company designs or develops, the
Company does not incur any costs for research and development. Before the
spin-off from eOn, the Company essentially operated as a stand-alone entity due
to our location in Puerto Rico, with separate audits, legal counsel, corporate
officers, and accounting and administrative functions. However, CSPR has not
previously operated as a stand-alone public company. Therefore, CSPR anticipates
that it will incur additional general and administrative expenses due to public
company reporting requirements that were previously performed by our parent.
However, selling, general and administrative expenses decreased 26.7% to $2.2
million in the nine months ended April 30, 2003 from $3.0 million in the nine
months ended April 30, 2002. The decrease was primarily due to reductions in
personnel, facilities, and associated overhead resulting from the implementation
of our restructuring plan.
SPECIAL CHARGES
During the nine months ended April 30, 2002, the Company incurred costs
of approximately $50,000 to effect its restructuring plan. CSPR incurred no
special costs in the nine months ending April 30,2003 and expects to incur no
additional such costs during the balance of fiscal year 2003.
SEPARATION COSTS
Separation costs were $428,000 in the nine months ended April 30, 2002,
representing legal and accounting fees associated with the Company's separation
from eOn. CSPR incurred no separation costs in the nine months ended April 30,
2003 and expects to incur no additional such costs during the balance of fiscal
year 2003.
18
INTEREST AND OTHER INCOME AND EXPENSES
No material amount was recorded in the nine months ended April 30, 2003 or
the nine months ended April 30, 2002.
INCOME TAX BENEFIT (EXPENSE)
No income tax benefit was recognized in the nine months ended April 30,
2003 or the nine months ended April 30, 2002 because the Company cannot conclude
that it is more likely than not that its deferred tax assets will be realized in
the future.
LIQUIDITY AND CAPITAL RESOURCES
Prior to the initial public offering of eOn, the Company funded its
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. However, if our business begin to grow, we may need
additional capital. Such capital may not be available on favorable terms or at
all.
The Company's significant revenue decrease and resulting loss from
operations in fiscal year 2002 and in the nine months ended April 30, 2003, and
its lack of financing resources raise substantial doubt about its ability to
continue as a going concern. Management plans include continuing its reduction
of operating costs and expenses while striving for an increase in sales.
Effective in February 2003, the Company moved its operations to a new location,
resulting in savings of approximately $87,500 for the current quarter as well as
approximately $87,500 for the next quarter. To increase sales, CSPR jointly with
OEM suppliers is developing an aggressive plan that includes visits to our
current customer base in order to offer new technologies to help them in the
productivity, security and reductions of their telecommunications expenses. Some
of these products are IP Office, Unify Messenger and Digital Video Recording
(DVR). Also, the Company is increasing its maintenance service contracts with
designated salespersons to generate maintenance contracts for new customers and
continuing the renewal of the existing customers' contracts. The Company's goal
is to improve cash flows and to ultimately generate operating profits. To
improve cash flows, management created a task force composed of representatives
of the finance and sales departments. The task force is oriented to analyze
disputed balances, visit the customers, and resolve issues in order to improve
the collection process of past due invoices. The finance department together
with the operations department will create a task force that will be working to
sell any excess or slow moving inventory to the secondary market. 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 the Company 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.
19
Net cash used in operating activities was approximately $242,000 for the
nine months ended April 30, 2003 and net cash provided by operating activities
was approximately $16,000 for the nine months ended April 30, 2002. Cash used by
operating activities in the nine months of this fiscal year resulted primarily
from the net loss from operations partially offset by a decrease in the level of
accounts receivable, inventory, prepaid expenses, an increase in the provision
for slow moving inventory, and a decrease in accrued expenses and a liabilities.
Net cash provided by investing activities was approximately $3,000 for the
nine months ended April 30, 2003 and net cash used in investing activities was
approximately $67,000 for the same period fiscal year 2002. Cash provided by
investing activities in this nine months of the current fiscal year consisted
primarily of cash used for capital expenditures offset by a decrease in the
investment in sales-type leases.
Net cash used in financing activities was approximately $25,000 and
$587,000 in the nine months ended April 30, 2003 and 2002, respectively. Cash
used in financing activities in the nine months ended April 30, 2003 and 2002
represents repayments of part of the note payable issued for the acquisition of
certain assets acquired from Ochoa Telecom in May 2001.
ADDITIONAL RISK FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
You should carefully consider the risks set forth in this Form 10-Q,
particularly the risk that we may not be able to continue operations as
described in "Liquidity and Capital Resources" and the risk factors described
below when evaluating CSPR. If any of the following risks occur, CSPR's
business, operating results and financial condition could be seriously harmed.
Additional risks and uncertainties that CSPR is presently not aware of could
also impair its business, operating results and financial condition.
IF THE COMPANY IS NOT ABLE TO SUSTAIN OUR TRADITIONAL PRIVATE BRANCH EXCHANGE
(PBX) MARKET, OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION WILL BE
HARMED.
Approximately 41.7% and 37.6% of CSPR revenues for fiscal year 2002 and
2001, respectively, were from sales of PBX customer premise equipment. The
Company's 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 the Company
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 revenue.
The Company 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 CSPR is
not able to grow or 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.
20
IF THE COMPANY FAILS TO OBTAIN AND MARKET NEW TELECOMMUNICATION AND DATA
PRODUCTS OR TO ADD FEATURES TO OUR EXISTING TELECOMMUNICATION AND DATA PRODUCTS,
THE COMPANY 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 CSPR is 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.
CSPR FACES 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 the Company 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. CSPR
cannot assure you that the Company 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'
21
time, personnel, financial, and other resources. The Company generally
recognizes 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 the Company recognizes 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.
The Company incurs substantial sales and marketing expenses and spends
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
CSPR incurs related sales and marketing expense, which may cause CSPR 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, the Company believes 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 CSPR
is 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.
ANY FUTURE BUSINESS ACQUISITIONS MAY DISRUPT OUR BUSINESS, DILUTE STOCKHOLDER
VALUE OR DISTRACT MANAGEMENT ATTENTION.
As part of our ongoing business strategy, the Company may consider
additional acquisitions of, or significant investments in, businesses that offer
products, services and technologies complementary to our own. In particular,
CSPR 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
22
- - 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 THE COMPANY LOSES KEY MANAGEMENT PERSONNEL, WE MAY NOT BE ABLE TO
SUCCESSFULLY OPERATE THE BUSINESS.
CSPR's 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. The Company
employs our key personnel on an at-will basis. CSPR does not maintain key person
insurance policies on any of the members of our executive management team.
THE COMPANY 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 CSPR may not
be able to attract, assimilate or retain such personnel. If the Company cannot
attract, hire and retain sufficient qualified personnel, the Company may not be
able to successfully market, sell, or service new products.
SINCE THE COMPANY DOES NOT HAVE EXCLUSIVE AGREEMENTS WITH THE MANUFACTURERS,
MANUFACTURERS MAY ENTER INTO DEALER AGREEMENTS WITH OUR COMPETITORS, WHICH MAY
ADVERSELY AFFECT OUR BUSINESS.
CSPR distributes and services products designed and manufactured by eOn,
Avaya, Nortel, Hitachi, Mitel, Toshiba, NEC, Cortelco, Nokia, Ericsson,
Motorola, and others. However, the Company does 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.
IF THE COMPANY IS UNABLE TO ESTABLISH AND MAINTAIN SATISFACTORY RELATIONSHIPS
WITH THE MANUFACTURERS OF OUR PRODUCTS THAT THE COMPANY EXPECTS TO SELL AND
SERVICE, OUR BUSINESS WILL SUFFER.
The Company acquires all of our products that 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.
CSPR DEPENDS ON A LIMITED NUMBER OF THIRD PARTIES TO MANUFACTURE AND SUPPLY OUR
PRODUCTS, AND MAY BE UNABLE TO OPERATE THE BUSINESS IF THOSE PARTIES DO NOT
PERFORM THEIR OBLIGATIONS.
The Company expects to rely on third-party suppliers for many of the
products that it distribute and service, including telecommunications and data
systems as
23
well as cellular phones and accessories. CSPR does not have long-term agreements
in place with our suppliers and does not control the time and resources that
these third parties devote to our business. CSPR 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, CSPR 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.
THE COMPANY FACES MANY RISKS IN EXPANDING ITS INTERNATIONAL OPERATIONS INTO THE
CARIBBEAN.
Sales outside of Puerto Rico accounted for approximately 7.7% of our total
revenues during fiscal year 2002. The Company expects to increase sales to
customers outside Puerto Rico and establish additional distribution channels in
the Caribbean. However, foreign markets for our products may develop more slowly
than currently anticipated. CSPR may not be able to successfully establish
international distribution channels, or may not be able to hire the additional
personnel necessary to support such distribution channels.
CSPR FUTURE RESULTS COULD BE HARMED BY ECONOMIC, POLITICAL, REGULATORY AND OTHER
RISKS ASSOCIATED WITH THE 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 year 2002. Because of the operations
and relationships in other parts of the Caribbean, 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;
- - 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.
CSPR IS CURRENTLY INVOLVED IN LITIGATION, WHICH, IF RESOLVED UNFAVORABLY, COULD
HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
CSPR is currently subject to one lawsuit regarding an alleged breach of
contract, three lawsuits regarding employment issues, and a fifth lawsuit in
which the Company was included as a Third Party Defendant. In the breach of
contract case, the plaintiff alleges that CPRS 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
24
million. Regarding the fifth lawsuit, the Company believes that this litigation
is without merit and filed a motion for the court to order our dismissal. CSPR
has analyzed each lawsuit with our legal advisors, and the Company does 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 the Company is
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 THE COMPANY 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 CSPR sells 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 the Company fails 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 THE COMPANY SELLS AND SERVICES MAY HAVE UNDETECTED FAULTS LEADING
TO LIABILITY CLAIMS, WHICH COULD HARM OUR BUSINESS.
The products the Company sells and services 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 product CSPR sells 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 CSPR is 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.
25
CSPR 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
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.
OUR STOCK IS SUBJECT TO THE REQUIREMENTS FOR PENNY STOCKS, WHICH COULD ADVERSELY
AFFECT YOUR ABILITY TO SELL AND THE MARKET PRICE OF YOUR SHARES.
The Company believes our stock fits the definition of a penny stock. The
Securities Exchange Act of 1934 defines a penny stock as any equity security
that is not traded on a national securities exchange or authorized for quotation
on The Nasdaq Stock Market and that has a market price of less than $5.00 per
share, with certain exceptions. Penny stocks are subject to Rule 15g under the
Securities Exchange Act of 1934, which imposes additional sales practice
requirements on broker-dealers who sell such securities. In general, a
broker-dealer, prior to a transaction in a penny stock, must deliver a
standardized risk disclosure document that provides information about penny
stocks and the risks in the penny stock market. The broker-dealer must provide
the customer with current bid and offer quotations for the penny stock,
information about the commission payable to the broker-dealer and its
salesperson in the transaction and monthly statements that disclose recent price
information for each penny stock in the customer's account. Finally, prior to
any transaction in a penny stock, the broker-dealer must make a special written
suitability determination for the purchaser and receive the purchaser's written
consent to the transaction prior to sale. All of these requirements may restrict
your ability to sell our stock and could limit the trading volume of our stock
and adversely affect the price investors are willing to pay for our stock.
INSIDERS HAVE SUBSTANTIAL VOTING CONTROL OVER US, WHICH COULD DELAY OR PREVENT
US FROM ENGAGING IN A CHANGE OF CONTROL TRANSACTION AND YOU FROM SELLING OUR
SHARES AT A PREMIUM TO THE SHARES' THEN CURRENT MARKET VALUE.
Our officers, directors and five percent or greater stockholders
beneficially own or control, directly or indirectly, approximately 487,869
shares, which in the aggregate represents approximately 41% voting interest in
the outstanding shares of our common stock. These stockholders have the ability
to control all matters submitted to our stockholders for approval, including the
election and removal of directors and the approval of any business combinations.
26
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE 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, the Company believes that our foreign exchange
rate risk is immaterial. The Company does not have any derivative instruments
and do not engage in hedging transactions.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period preceding the filing of this Quarterly Report on
Form 10-Q, an evaluation was performed under the supervision of and with the
participation of the Company's management, including the Chief Executive Officer
(CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and
operation of the Company's disclosure controls and procedures. Based on that
evaluation, the Company's management, including the CEO and CFO, concluded that
the design and operation of the Company's disclosure controls and procedures
were effective to ensure that material information relating to CSPR is made
known to such officers by others within CSPR, particularly during the period
this quarterly report and prepared, in order to allow timely decisions regarding
required disclosure. There have been no significant changes in the Company's
internal control or in other factors that could significantly affect internal
controls subsequent to the date of their evaluation.
27
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) Exhibits.
Exhibit No. Description
----------- -----------------------------------------------
99.1 Certificate of Chief Executive officer under 18
U.S.C. Section 1350
99.2 Certificate of Chief Financial Officers under 18
U.S.C. Section 1350
(B) Reports On Form 8-K.
None.
28
SIGNATURES
Pursuant to the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto authorized.
Cortelco Systems Puerto Rico, Inc.
Date: June 13, 2003 /s/ Francisco Sanchez
-------------- --------------------------------------------
Francisco Sanchez, Vice President
Chief Financial Officer, Secretary
Duly Authorized Officer
(Principal Financial and Accounting Officer)
29
I, Sergio Moren, Chief Executive Officer of Cortelco Systems Puerto Rico, Inc.
certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cortelco Systems
Puerto Rico, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weakness in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: June 13, 2003 /s/ Sergio Moren
--------------------------
Sergio Moren
Chief Executive Officer
30
I, Francisco Sanchez, Chief Financial Officer of Cortelco Systems Puerto Rico,
Inc. certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cortelco Systems
Puerto Rico, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date.
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weakness in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: June 13, 2003 /s/ Francisco Sanchez
-----------------------
Francisco Sanchez
Chief Financial Officer
31