Back to GetFilings.com
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
================================================================================
FORM 10-K
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended July 31, 2003
or
[ ] 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.)
Parque Industrial Caguas Oeste, Road 156 Km 58.2, Valle Tolima, Caguas PR
00727-0137
(Address of principal executive offices)
(787) 758-0000
(Telephone number)
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] NO[ ]
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. [x]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
YES[ ] NO[x]
The aggregate market value of the shares of common stock held by
non-affiliates of the registrant was approximately $50,017 based upon the
closing sale price as quoted on the OTC Bulletin Board on 09/30/03. 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 2003
Annual Meeting of Shareholders are incorporated by reference in Part III.
================================================================================
TABLE OF CONTENTS
Page
----
PART I...................................................................................................... 1
ITEM 1. BUSINESS.................................................................................... 1
ITEM 2. PROPERTIES.................................................................................. 4
ITEM 3. LEGAL PROCEEDINGS .......................................................................... 4
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......................................... 5
PART II..................................................................................................... 6
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS....................... 6
ITEM 6. SELECTED FINANCIAL DATA..................................................................... 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS....... 9
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.................................. 21
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................................. 21
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........ 49
ITEM 9A. CONTROLS AND PROCEDURES...................................................................... 49
PART III.................................................................................................... 50
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......................................... 50
ITEM 11. EXECUTIVE COMPENSATION...................................................................... 50
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.............................. 50
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS........................................ 50
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES...................................................... 50
PART IV..................................................................................................... 51
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON 8-K................................. 51
SIGNATURES 52
i
PART I
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of the
federal securities laws. Forward-looking statements are those that express
management's views of future events, developments, and trends. In some cases,
these statements may be identified by terminology such as "may," "will,"
"should," "expects," "plans," "intends," "anticipates," "believes," "estimates,"
"predicts," "potential," or "continue" or the negative of such terms and other
comparable expressions. Forward-looking statements include statements regarding
our anticipated or projected operating performance, financial results, liquidity
and capital resources. These statements are based on management's beliefs,
assumptions, and expectations, which in turn are based on the information
currently available to management. Information contained in these
forward-looking statements is inherently uncertain, and our actual operating
performance, financial results, liquidity, and capital resources may differ
materially due to a number of factors, most of which are beyond our ability to
predict or control. 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 forward-looking statements contained in this report to
reflect any future events or developments. The following discussions should be
read in conjunction with our financial statements and the notes included thereto
in Item 8.
ITEM 1. BUSINESS
INTRODUCTION
Cortelco Systems Puerto Rico, Inc. (the "Company", "CSPR") is a value-added
reseller of numerous third-party brands of voice and data communications systems
as well as cellular telephones and airtime. CSPR provides value through our
sales distribution network and our service. The products the Company sells help
enterprises communicate more effectively with customers and increase customer
satisfaction and loyalty. The Company conducts most of our business in Puerto
Rico, and also sells voice and data communications systems elsewhere in the
Caribbean and Latin America.
CSPR was 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, the Company was spun-off from eOn as a separate entity to the stockholders
of eOn.
The Company 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 Cellular segment is not
considered significant and the Company expects that in the near future to not
report as a segment.
Through our Communications Systems segment, the Company installs, programs, and
services 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 CSPR resells cellular telephones either separately or in conjunction
with buying and reselling cellular airtime from cellular carriers, predominantly
Verizon (former "Celulares Telefonica or Puerto Rico Telephone Company -PRTC").
CSPR also receives sales commissions from cellular carriers for signing up
customers with the carriers, in which case the Company does 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.
1
INDUSTRY OVERVIEW
The Company's markets are generally characterized by numerous competitors that
often distribute many of the same products that CSPR distributes. Therefore,
price competition is often intense for many of the products that CSPR
distributes. 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
The Company is continually assessing the addition of new brands of voice and
data communications equipment to distribute in the markets CSPR serves.
Historically, the Company derived virtually all of the revenues from sales in
Puerto Rico. CSPR expects to increase sales to customers outside of Puerto Rico.
The Company does not presently generate material revenues from customers located
outside Puerto Rico. Additionally, CSPR will continue to assess possible
acquisitions of other companies or assets to increase our product offering and
our base of service customers.
ACQUISITION OF CERTAIN ASSETS OF OCHOA TELECOM
During May 2001, the Company 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, CSPR executed a promissory note in favor of Ochoa Telecom in
the amount of $1,400,000. The principal balance on this note was $25,000 at July
31, 2003. 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
The Company sells, installs, and services the voice and data communications and
cellular products of a number of equipment manufacturers, including Mitel, eOn,
Cortelco, Avaya, Lucent, Nortel, Hitachi, Nec, Nokia, Ericsson, and Motorola
among others. CSPR also resells cellular airtime purchased from cellular
carriers, predominantly Verizon. CSPR does not make any of the products that it
sells but assembles, integrates and programs the communication system equipment
that the Company sells.
CUSTOMERS
Our customers include both enterprises in our voice and data communications
systems business and individual retail customers in our cellular business. The
Company does not derive a significant portion of our revenues from any single
customer.
SALES AND MARKETING
The Company sells 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 CSPR sells are
installed directly by us, while approximately half of the sales of our cellular
phones and airtime are done through our dealer network. CSPR advertises our
voice and data communications products primarily through trade shows and hosted
marketing presentations.
CUSTOMER SERVICE AND SUPPORT
The Company earned approximately $3.4 million of our revenue in fiscal 2003 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's
manufacturer trains our personnel in the products that the Company distributes
and service through training courses offered. A key factor in
2
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.
INTELLECTUAL PROPERTY
The Company does not have any patents, trademarks, or licenses in the conduct of
our business. The Company conducts most of the operations under the trade names
"Cortelco" and "Cellular Outlet" which are well known by customers in Puerto
Rico. Under Puerto Rican law, CSPR has a proprietary interest in these
tradenames for so long as the Company continues to actively use these
tradenames.
COMPETITION
The market the Company serves in the communications industry is highly
competitive. Competitive factors include (1) market acceptance of the products,
services and technology solutions that the Company provides, (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 Puerto Rico Telephone
("PRT"), which is significantly larger than any competitor in the market.
However, recently PRT 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. PRT has traditionally been the reseller, installer, and a
service company in Puerto Rico for Nortel Networks, the largest voice
communications equipment provider in Puerto Rico. As PRT exits the reseller and
service business for customer premise voice products, the Company will compete
with other resellers in the attempt to acquire the maintenance contracts for
PRT's 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. CSPR is one of the largest resellers in the Puerto
Rico market. The Company believes that its size offers a competitive advantage
in continuing to grow the 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,
CSPR's relative size may be a competitive disadvantage but the Company has more
flexibility to charge lower rates for its services because it has reduced its
overhead.
There also are a number of large, integrated national companies engaged in
providing commercial services in the service lines in which the Company intends
to focus, some of which also manufacture and sell directly the products that the
Company services and sells. 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, CSPR has a competitive disadvantage compared to these larger competitors
but the Company is working to find an institutional line of credit to compete
with this kind of market.
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 the Company offers is manufactured or
supplied by others. This presents a competitive disadvantage to us since CSPR
incurs the risk of 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, 2003, the Company had approximately 72 employees, including 18 in
sales and marketing, 38 in customer service and support, and 16 in finance and
administration, including regular and contract employees.
3
EXECUTIVE OFFICERS
The following table sets forth information as to the persons who serve as our
executive officers. The Company's board of directors may appoint additional
executive officers from time to time.
Name Age Title
- ---- --- -----
Sergio R. Moren 58 Director, President, and Chief Executive Officer
Francisco Sanchez 56 Chief Financial Officer, and Vice President - Finance and
Administration
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.
GOVERNMENTAL REGULATION
The Company is 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.
The Company's business could be adversely affected if these agencies modify or
adopt new regulations. Such regulations could impact the cost of the products
CSPR sells or limit the types of products that it may sell, thus reducing our
revenues.
ITEM 2. PROPERTIES
Effective in February 2003, the Company moved its operation to facilities in
Caguas Puerto Rico. This movement represented a saving in rent expense of
approximately $175,000 for this fiscal year 2003 and approximately $376,000 for
the next fiscal year. CSPR leases one building of approximately 8,200 square
feet for office and assembly process from Municipality of Caguas. The lease on
this facility expires in November 2007. Adjacent to this building, the Company
leases another building of approximately 5,800 square feet for warehouse from
Puerto Rico Industrial Development Company (PRIDCO). The lease on this facility
expires in ten years. Virtually all of our employees work at this facility,
other than those that work at the direct sales cellular outlets operated by us.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company may be a party to legal proceedings incidental to
our business. The Company does 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 the Company breached the terms of the
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, the Company filed a Third
Party Complaint against City Cellular, Inc. and Edgardo Correa, who is the
President of Cellu-Tel, Inc. and City Cellular, Inc. CSPR alleged in the Third
Party Complaint that City Cellular is a business conduit (an "alter ego") of
plaintiff Cellu-Tel, Inc. The Company has also alleged that City Cellular has
continued to conduct the business of plaintiff. The Company also believes
4
that City Cellular has received the benefits and income that plaintiff would
have received, if any. Therefore, CSPR believes 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. The Company intends to
follow through with discovery proceedings regarding the Third Party Complaint.
The Company believes that this litigation is without merit and will not have a
material adverse effect on our business.
In 2001, Jorge Gonzalez-Nogueras and Luis Luhring-Arizmendi filed a lawsuit in
the 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 separate the cases that was
granted by the Court. The Company has commenced with the discovery process and
deposed Mr. Gonzalez. Cortelco is strongly defending this case because all
allegations of conspiracy are plainly false. In the Luhring case, it is still in
discovery proceedings. Interrogatories were served and the deposition is pending
upon the availability of Mr. Luhring. Although CSPR cannot opine as to the
outcome of this case, the Company believes that any potential liability should
be limited to the discrimination claims, and only if he is able to prove that he
was illegally mistreated and discriminated by the Company.
In 2001, Jorge Berrios filed a lawsuit against us in Court of First Instance,
Caguas, Puerto Rico. The plaintiff, whose employment was terminated, alleges
that his dismissal was unjustified and violated applicable employment laws. He
claims compensation in the amount of $300,000 in damages and $32,910.16 as a
statutory severance payment. The suit is being settled in two payments of
$10,000 at the end of 2003.
In January 2002, Edwin Colberg filed a lawsuit in the Court of First Instance,
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. In March 2002,
Cortelco filed a lawsuit against Edwin Colberg, Godwin Aldarondo, former legal
counselor of Cortelco, Envision Technologies, Inc., a competitive business
created by Colberg and Aldarondo, and various former employees of Cortelco that
have a repayment contracts with the Company. Cortelco claims 10 million in
damage by violation of fiduciary duties, use of trade secrets, confidential
information, wrongful intent of creating a competitive business, and wrongful
interference with contracts. Colberg retired his suit and filed a counter suit
in the Envision case. The total claim is in the amount of $7,348,000. Discovery
proceedings are being conducted. The Company has conducted an investigation of
the allegations and concluded from our investigation that no discrimination of
any type occurred. The Company believes 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.
In September 2002 the Company was included as a Third Party Defendant in a
lawsuit against Ochoa Telecom, Inc. filed in the Court of First Instance,
Bayamon, Puerto Rico. Plaintiffs allege Ochoa dismissed them without just cause
and Cortelco is a successor employer. Plaintiffs also request damages for
alleged fraud in their employment terminations. Cortelco recognized plaintiff's
seniority at the workplace and the Court entered partial judgment dismissing the
cause of action of plaintiffs that work with Cortelco. The Court also dismissed
the damage claims of the 14 plaintiffs and only 5 remain at the case concerning
their unjust dismissal. A pretrial hearing is scheduled at the end of 2003. At
the moment no assessment can be determined.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
5
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. The Company is 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
services, 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.
The following table sets forth the quarterly high and low bid quotations per
share of common stock on the OTC Bulletin Board as reported for the periods
indicated. These prices also represent inter-dealer quotations without retail
mark-ups, markdowns, or commissions and may not necessarily represent actual
transactions.
HIGH LOW
FISCAL YEAR ENDED JULY 31, 2003
First Quarter $0.75 $0.25
Second Quarter 0.25 0.15
Third Quarter 0.30 0.10
Fourth Quarter 0.25 0.07
As of September 30, 2003, there were 211 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 2003, the Company did not declare any dividends on our capital
stock. The Company currently intends to retain any earnings to finance the
operation and expansion of our business and, therefore, does not expect to pay
cash dividends on the common stock in the foreseeable future.
6
SECURITIES AUTHORIZED FOR ISSUANCE UNDER THE COMPANY'S EQUITY COMPENSATION PLAN
The following table summarizes the Company equity compensation plan as of July
31, 2003:
EQUITY COMPENSATION PLAN
Number of securities to Weighted-average Number of securities remaining
be issued upon exercise exercise price of available for future issuance under
of outstanding options, outstanding options, equity compensation plans (excluding
Plan category warrants and rights warrants and rights securities reflected in column (a))
- ------------- ------------------- ------------------- ------------------------------------
(a) (b) (c)
Equity compensation - - 350,000
plans approved by
security holders
Equity compensation - - -
plans not approved
by security holders
Total - - 350,000
ITEM 6. SELECTED FINANCIAL DATA
The Company was incorporated in March 1999 under the laws of the Commonwealth of
Puerto Rico. At the time of incorporation, the 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. Such
information for the year 2003 has been derived from the 2003 Financial Statement
audited by Horwath Velez & Co. PSC, the Company's current 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 the Company 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.
7
CORTELCO PUERTO
RICO, INC.
CORTELCO SYSTEMS PUERTO RICO, INC. (PREDECESSOR)
-------------------------------------------------------------------
PERIOD
FROM PERIOD
APRIL FROM
8 TO AUGUST 1 YEAR
JULY TO APRIL ENDED
YEAR ENDED JULY 31, 31, 7, JULY 31,
--------------------------------------------------------------------
2003 2002 2001 2000 1999 1999 1998
--------------------------------------------------------------------
In thousands, except per share data:
Statement of Operations Data:
Net revenues .............................. $ 7,701 $ 10,384 $ 22,181 $ 24,262 $ 7,073 $ 11,109 $ 14,278
Cost of revenues .......................... 6,686 8,152 17,450 18,701 5,213 7,974 9,633
-------- -------- -------- -------- -------- -------- --------
Gross Profit ...................... 1,015 2,232 4,731 5,561 1,860 3,135 4,645
-------- -------- -------- -------- -------- -------- --------
Operating Expense:
Selling, general and
Administrative .................... 2,789 4,108 5,329 5,012 1,550 1,871 4,131
Separation costs ........................... - 458 - - - - -
Special charges ........................... - 320 62 - - - -
-------- -------- -------- -------- -------- -------- --------
Total operating expenses .......... 2,789 4,886 5,391 5,012 1,550 1,871 4,131
-------- -------- -------- -------- -------- -------- --------
Income (loss) from operations ............. (1,774) (2,654) (660) 549 310 1,264 514
Interest income ........................... (26) (26) (15) (21) (20) (23) (42)
Interest expense .......................... 1 5 - 67 16 367 348
Other (income)/expense .................... - - - - - (21) (17)
-------- -------- -------- -------- -------- -------- --------
Income (loss) from operations before income
taxes .................................. (1,749) (2,633) (645) 503 314 941 225
Income tax expense ........................ - - - 30 10 152 -
-------- -------- -------- -------- -------- -------- --------
Net income (loss) ......................... (1,749) $ (2,633) $ (645) $ 473 $ 304 $ 789 $ 225
======== ======== ======== ======== ======== ======== ========
Basic and diluted net income (loss) per
share .................................. $ (1.45) $(263.30) $ (64.50) $ 47.30 $ 30.40
Weighted-average number of shares
outstanding used in computing basic and
diluted net income (loss) per share .... 1,205 10 10 10 10
Pro forma basic and diluted net income
(loss) per share ....................... - $ (2.19) $ (0.54) $ 0.39 $ 0.25
Cash dividends per common stock, basic and
diluted ................................ - - - - -
Shares used in computing pro forma basic
and diluted net income (loss) per unit.. - 1,205 1,205 1,205 1,205
JULY 31, JULY 31,
2003 2002 2001 2000 1999 1998
------------------------------------------------ --------
Balance Sheet Data:
Cash and cash equivalents................ $ 63 $ 333 $ 959 $ 644 $ 71 $ 100
Working capital.......................... 1,801 3,458 3,375 4,499 2,729 1,776
Goodwill, net............................ 382 382 382 - - -
Total assets............................. 4,734 6,821 10,752 11,729 8,793 5,823
Long-term debt........................... - - - - - 3,400
Total stockholders' equity (deficiency).. 2,627 4,376 4,403 5,015 2,518 (380)
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 the Company also sells
communications systems in the Caribbean and Latin America. Our 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 89.6%
of our revenues in fiscal year 2003 and 96.9% of the operating loss of the
Company, while Cellular Service represented 10.4% of revenues as compared to 18%
in fiscal year 2002 and 47% in fiscal year 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. The Company
anticipates that these revenues will continue decreasing and will represents a
smaller percentage of the total revenues than in fiscal year 2003. As
Communications Systems revenues will constitute almost the total amount of its
revenue in the future, it is important that the Company continues 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.
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, 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 Communication System segment 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 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.
The Company recognizes revenues from the communications systems it installs upon
completion of the installation services and acceptance by the customer due to
the customized nature of each installation. CSPR 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 various third-party communications systems
from various manufacturers, including eOn. CSPR recognizes warranty revenue over
the term of the warranty period. The costs related to warranties exercised are
recognized directly as cost of sales when incurred.
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 spin-off the Company essentially operated as a stand-alone
9
entity from our parent due to our location in Puerto Rico, with separate audits,
legal counsel, corporate officers, and accounting and administrative functions,
the Company has not previously operated as a stand-alone public company. CSPR
incurred additional general and administrative due to public company reporting
requirements that were previously performed by our parent. However, the Company
continues searching for low cost alternatives to control the operating expenses
related to public reporting.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED JULY 31, 2003, COMPARED TO FISCAL YEAR ENDED JULY 31,
2002
NET REVENUES
Net revenues decreased 25.9% to $7.7 million in fiscal 2003 from $10.4 million
in fiscal 2002. The results primarily reflected decreased revenues of
approximately $1.1 million from the Cellular Airtime Services segment and $1.6
revenues from the Communications Systems segment. Communications Systems segment
revenues include $1.5 million and $1.0 during fiscal year 2003 and fiscal year
2002, respectively, from sales attributable to the portion of the business CSPR
acquired from Ochoa Telecom, an installer of integrated communications systems,
in May 2001. See "Business-Acquisition of Certain Assets of Ochoa Telecom".
COST OF REVENUES AND GROSS PROFIT
Cost of revenues consists primarily of purchases from its equipment
manufacturers and other suppliers and costs incurred for final assembly, quality
assurance and installation of the systems. For cellular contracts submitted to
the carriers from the authorized dealers, any commissions paid to the dealer are
also included as a component of cost of revenues. Gross profit decreased 54.5%
to $1.0 million in fiscal year 2003 from $2.2 million in fiscal year 2002. Cost
of revenues includes $1.2 million for inventory obsolescence charges in fiscal
year 2003 and $0.4 million in fiscal year 2002 as a result the Company's gross
margins decreased 13.2% in fiscal year 2003 compare to 21.5% in fiscal year
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
31.7% to $2.8 million in fiscal year 2003 from $4.1 million in fiscal year 2002.
The decrease was primarily due to the movement to new less expensive facilities
and decreased headcount in the Communications Systems and Cellular Airtime
Services segments beginning in fiscal year 2002 and fiscal year 2001. See
"Special Charges".
SEPARATION COSTS
Separation costs were $0.5 million in fiscal year 2002, representing legal and
accounting fees associated with our separation from eOn. The Company incurred no
separation costs in fiscal year 2003.
SPECIAL CHARGES
To reduce costs and improve productivity, the Company adopted a restructuring
plan that resulted in employee reductions in the second quarter of fiscal year
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% during fiscal year 2002.
CSPR incurred no special charges in fiscal year 2003.
10
The following table provides detail about the special charges movement during
fiscal year 2003 and the associated liabilities (in thousands):
July 31, 2003 Fiscal Year 2003 July 31, 2002
Liability Expenditures Liability
Balance Q1 Q2 Q3 Q4 Balance
----------------------------------------------
Termination benefits $288 $34 $38 $45 $20 $151
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 year 2003 and 2002. In addition, we
had no significant interest expense in either year fiscal 2003 or fiscal year
2002 as the Company retired its credit facility in conjunction with the initial
public offering of eOn in February 2000.
INCOME TAX EXPENSE
The Company recognized no income tax benefit in fiscal year 2003 or fiscal year
2002 because CSPR cannot conclude that it is more likely than not that deferred
tax assets will be realized in the future.
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 year 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 the Company
acquired from Ochoa Telecom, an installer of integrated communications systems,
in May 2001. See "Business-Acquisition of Certain Assets of Ochoa Telecom". 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. The
Company's 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 year 2002.
11
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% 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. The Company incurred no
separation costs in fiscal 2001.
SPECIAL CHARGES
To reduce costs and improve productivity, the Company 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%.
The following table provides detail about the special charges recorded during
fiscal year 2002 and the associated liabilities at July 31, 2002 (in thousands):
Fiscal Year 2002 July 31, 2002
Expenditures Liability
Charges Q1 Q2 Q3 Q4 Balance
----------------------------------------------
Termination benefits 320 - - - $32 $288
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, the
Company had no interest expense in either fiscal 2002 or fiscal 2001 as its
retired our credit facility in conjunction with the initial public offering of
eOn in February 2000.
INCOME TAX EXPENSE
The Company recognized no income tax benefit in fiscal 2002 or fiscal 2001
because CSPR 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, 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
12
funds from the initial public offering. The last funds received from eOn were in
November 2000 and the Company has funded all cash requirements and loan
repayments to eOn of $2.25 million since that date from operating revenues.
However, if the business begins to grow, CSPR may need additional capital. Such
capital may not be available on favorable terms and conditions.
The Company's significant revenue decreases and resulting losses from operations
in fiscal years 2003 and 2002, and its lack of financing resources raise 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 $175,000 for the fiscal
year 2003 and approximately $376,000 for the next fiscal year. 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 the Company needs 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, it
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.
Net cash used in operating activities was approximately $144,000 for the fiscal
year 2003 and net cash provided by operating activities was approximately
$209,000 for fiscal year 2002. Cash used by operating activities in the fiscal
year 2003 resulted primarily from the net loss from operations and a decrease in
accrued liabilities partially offset by a decrease in the level of inventory,
prepaid expense and a increase in the provision for obsolete inventories and
depreciation.
Net cash used by investing activities was approximately $101,000 for the fiscal
year 2003 and net cash used in investing activities was approximately $98,000
for the fiscal year 2002. Cash used by investing activities in 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 $737,000 in
fiscal years 2003 and 2002, respectively. Cash used in financing activities in
fiscal year 2003 and fiscal year 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-K,
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 56.3% and 58.1% of CSPR revenues for fiscal year 2003 and 2002,
respectively, were from sales of PBX customer equipment and additions. The
Company's PBX revenues declined 65.2% from fiscal year 2001 to
13
fiscal year 2003 due mainly to a decline in the overall PBX market. These
revenues comprise approximately 51.3% 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
Mitel, Nortel Networks, Avaya, 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.
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'
time, personnel, financial, and other resources. The Company generally
recognizes revenues on the date of shipment for communications systems and
cellular telephones shipped
14
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
- - 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
15
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, Mitel,
Avaya, Nortel, Hitachi, Toshiba, Nec, Cortelco, 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
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 less than 1% of our
total revenues during fiscal year 2003. 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 less
than 1% of our total revenues during fiscal year 2003. Because of the operations
and relationships in other parts of the Caribbean, and our reliance on
16
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 CSPR 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 $16 million. Regarding the fifth lawsuit, the Company recognized
plaintiff's seniority at the workplace and the court entered partial judgement
dismissing the cause of action at plaintiffs that work with CSPR. The Company
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
17
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.
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 490,000 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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued the
Statement of Financial Accounting Standards ("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 implemented 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)
18
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 implemented 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. The Company implemented
SFAS No. 145 on August 1, 2002. Adoption of 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 or
SFAS No. 144. The Company implemented SFAS No. 146 for exit or disposal
activities initiated after December 31, 2002. Adoption of SFAS No. 146 did not
have a significant effect on the financial condition or results of operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. This Statement amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The Company has not implemented SFAS No. 123 because it still follows
Accounting Principle Board Opinion No. 25, Accounting for Stock Issued to
Employees, which is an acceptable alternative. Accordingly, SFAS No. 148 is not
applicable until the Company implements SFAS No. 123.
In April 2003, the FASB issued SFAS No. 149, Amendment of SFAS No. 133 on
Derivative Instruments and Hedging Activities. This SFAS amends and clarifies
financial accounting and reporting for derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities. The Company implemented SFAS No. 149 during the fourth quarter of
fiscal year 2003. Adoption of SFAS NO. 149 did not have a significant effect on
the Company's financial position and results of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liability and Equity. This SFAS
established standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires than an issuer classify a financial instruments that is within its
scope as a liability (or and asset in some circumstances). Many of those
instruments were previously classified as equity. Some of the provisions of this
SFAS are consistent with the current definition of liabilities in FASB Concepts
Statement No. 6. Elements of Financial Statement. The remaining provision of
this Statement are consistent with the Board's proposal to revise that
definition to encompass certain obligations that a reporting entity can or must
settle by issuing its own equity shares, depending on the nature of the
relationship established between the holder and the issuer. The Company
implemented SFAS No. 150 during the fourth quarter of fiscal year 2003. Adoption
of SFAS No. 150 did not have a significant effect on the Company's financial
position and results of operations.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees and clarifies that a guarantor is required
to recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken and issuing the guarantee. The disclosure requirements
are effective for fiscal years ending after December 15, 2002. The initial
recognition and initial measurement provisions of FIN 45
19
are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of this accounting pronouncement is not expected
to have a material impact on the Company's financial position or results of
operations.
In November 2002, the EITF released Issue Abstract No. 00-21, Accounting for
Revenue Arrangements with Multiple Deliverables." This consensus requires that
revenue arrangements with multiple deliverables be divided into separate units
of accounting if the deliverables in the arrangements meet specific criteria. In
addition, arrangement consideration must be allocated among the separate units
of accounting based on their relative fair values, with certain limitations. The
Company will be required to adopt the provision of this consensus are applicable
for revenue arrangements entered into after June 30, 2003. The adoption of this
accounting pronouncement is not expected to have a material impact on the
Company's financial position or results of operations.
QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly financial data for the years ended July 31, 2003 and 2002 is
summarized as follows:
FIRST SECOND THIRD FOURTH
2003 QUARTER QUARTER QUARTER QUARTER
(In Thousands, Except Per Share Data)
Net revenues $ 2,237 $ 1,734 $ 1,574 $ 2,156
Gross profit 607 523 (39) (76)
Net loss (205) (231) (623) (690)
Net loss per common share -
basic and diluted $ (0.17) $ (0.19) $ (0.52) $ (0.57)
FIRST SECOND THIRD FOURTH
2002 QUARTER QUARTER QUARTER QUARTER
(In Thousands, Except Per Share Data)
Net revenues $ 3,880 $ 2,484 $ 1,769 $ 2,251
Gross profit 1,030 570 359 273
Net loss (66) (570) (901) (1,096)
Net loss per common share -
basic and diluted (6.60) (57.00) (90.10) (109.60)
Pro forma net loss per common share - basic
and diluted $ (0.05) $ (0.47) $ (0.75) $ (0.91)
20
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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. CSPR
does not have any derivative instruments and does not engage in hedging
transactions.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CORTELCO SYSTEMS PUERTO RICO, INC.
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Financial Statements of Cortelco Systems Puerto Rico, Inc.:
Independent Auditors' Report - Horwath Velez & Co. PSC ............................ 22
Independent Auditors' Report - Deloitte & Touche LLP .............................. 23
Balance Sheets as of July 31, 2003 and 2002 ....................................... 24
Statements of Operations for the Years Ended July 31, 2003, 2002 and 2001 ......... 25
Statements of Changes in Stockholder's Equity for the Years Ended July 31, 2003,
2002 and 2001 .................................................................. 26
Statements of Cash Flows for the Years Ended July 31, 2003, 2002 and 2001 ......... 27
Notes to the Financial Statements.................................................. 29
Financial Statement Schedule II-Valuation and Qualifying Accounts.................. 48
All other schedules have been omitted since the required information is not
presented or not present in amount sufficient to required submission of the
schedules, or because the information required is included in the financial
statements or notes thereto.
21
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Cortelco Systems Puerto Rico, Inc.
We have audited the accompanying balance sheet of CORTELCO SYSTEMS PUERTO RICO,
INC. as of July 31, 2003, and the related statements of operations, changes in
stockholders' equity and cash flows for the year then ended. Our audit also
included the financial statement schedule listed in the Index as Schedule II for
the year ended July 31, 2003. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and financial statement schedule based on our audit.
The financial statements of CORTELCO SYSTEMS PUERTO RICO, INC. as of July 31,
2002 and for the years ended July 31, 2002 and 2001, and the financial statement
schedule listed in the Index as Schedule II for each of the two years in the
period ended July 31, 2002 were audited by other auditors whose report dated
August 26, 2002, expressed an unqualified opinion on those statements and
included a going concern emphasis paragraph.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Cortelco Systems Puerto Rico,
Inc. at July 31, 2003, and the results of its operations and its cash flows for
the year then ended in conformity with accounting principles generally accepted
in the United States of America. Also, our opinion, such financial statement
schedule, when considered in relation to the basic financial statements taken
as a whole, presents fairly in all material respects the information set forth
therein.
As discussed in Note 1 to the financial statements, effective July 31, 2002,
Cortelco Systems Puerto Rico, Inc. was spun-off from eOn Communications
Corporation and became an independent entity headquartered in Puerto Rico.
The accompanying financial statements have been prepared assuming that Cortelco
Systems Puerto Rico, Inc. will continue as a going concern. As discussed in Note
2 to the financial statements, Cortelco Systems Puerto Rico, Inc.'s has suffered
recurring losses from operations as a result of significant market loss that
combined with a lack of financial resources raise doubt about its ability to
continue as a going concern. Management's plans concerning these matters are
also described in Note 2. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ HORWATH VELEZ & CO, PSC
October 15, 2003
Puerto Rico Society of Certified Public Accountants
Stamp number 1927342 was
affixed to the original of this report.
22
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Cortelco Systems Puerto Rico, Inc.:
We have audited the accompanying balance sheet of Cortelco Systems Puerto Rico,
Inc. as of July 31, 2002 and the related statements of operations, changes in
stockholders' equity and cash flows for each of the two years in the period
ended July 31, 2002. Our audits also included the financial statement schedule
of valuation and qualifying accounts for each of the two years in the period
ended July 31, 2002. These financial statements and financial statement schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and financial statement
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Cortelco Systems Puerto Rico, Inc. at July
31, 2002 and the results of its operations and its cash flows for each of the
two years in the period ended July 31, 2002 in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, such financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects, the information set forth therein.
As discussed in Note 1 to the financial statements, effective July 31, 2002,
Cortelco Systems Puerto Rico, Inc. was spun-off from eOn Communications
Corporation and became an independent entity headquartered in San Juan, Puerto
Rico.
The accompanying financial statements as of July 31, 2002 and for each of the
two years in the period then ended have been prepared assuming that Cortelco
Systems Puerto Rico, Inc. will continue as a going concern. As discussed in Note
2 to the financial statements, Cortelco Systems Puerto Rico, Inc.'s significant
revenue decrease in 2002 and resulting loss from operations and its lack of
financing resources raise substantial doubt about its ability to continue as a
going concern. Management's plans concerning these matters are also described in
Note 2. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
DELOITTE & TOUCHE LLP
San Juan, Puerto Rico
August 26, 2002
Stamp No. 1924533
affixed to original.
23
CORTELCO SYSTEMS PUERTO RICO, INC.
BALANCE SHEETS - JULY 31, 2003 AND 2002
(DOLLARS IN THOUSANDS)
2003 2002
---------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 63 $ 333
Trade accounts receivable, net 2,145 2,016
Due from affiliated entities 313 187
Current portion of investment in sales-type leases 26 82
Inventories 1,247 2,989
Prepaid expenses 114 296
---------- ----------
Total current assets 3,908 5,903
INVESTMENT IN SALES-TYPE LEASES - 47
PROPERTY AND EQUIPMENT, net 444 489
GOODWILL 382 382
---------- ----------
$ 4,734 $ 6,821
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable $ 1,265 $ 1,262
Due to affiliated entities 152 147
Other accrued liabilities 394 671
Deferred revenue 271 315
Note payable 25 50
---------- ----------
Total current liabilities 2,107 2,445
---------- ----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, par value $.01 per share; authorized
10,000,000 shares, no shares issued - -
Common stock, par value $.01 per share;
5,000,000 shares authorized, 1,204,557
shares issued and outstanding in 2003 and 2002 12 12
Capital in excess of par value, net of capital
contribution note receivable from related party of $304 6,865 6,865
Accumulated deficit (4,250) (2,501)
---------- ----------
Total stockholders' equity 2,627 4,376
---------- ----------
$ 4,734 $ 6,821
========== ==========
See notes to financial statements.
24
CORTELCO SYSTEMS PUERTO RICO, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
2003 2002 2001
---------- ---------- ----------
NET REVENUES:
Products $ 4,290 $ 7,017 $ 19,337
Services 3,411 3,367 2,844
---------- ---------- ----------
Total net revenues 7,701 10,384 22,181
---------- ---------- ----------
COST OF REVENUES:
Products 3,699 6,038 15,921
Services 1,787 1,708 1,351
Inventory write-down adjustments 1,200 406 178
---------- ---------- ----------
Total cost of revenues 6,686 8,152 17,450
---------- ---------- ----------
Gross profit 1,015 2,232 4,731
---------- ---------- ----------
OPERATING EXPENSES:
Selling, general and administrative 2,789 4,108 5,329
Special charges - 320 62
Separation costs - 458 -
---------- ---------- ----------
Total operating expenses 2,789 4,886 5,391
---------- ---------- ----------
Loss from operations (1,774) (2,654) (660)
Interest income, net (25) (21) (15)
---------- ---------- ----------
Loss before provision for income taxes (1,749) (2,633) (645)
Provision for income taxes - - -
---------- ---------- ----------
Net loss $ (1,749) $ (2,633) $ (645)
========== ========== ==========
Basic and diluted net loss per share $ (1.45) $ (263.30) $ (64.50)
========== ========== ==========
Weighted-average number of shares outstanding 1,205 10 10
========== ========== ==========
Pro forma basic and diluted net loss per share $ - $ (2.19) $ (0.54)
========== ========== ==========
Pro forma weighted-average number of shares
outstanding - 1,205 1,205
========== ========== ==========
See notes to financial statements.
25
CORTELCO SYSTEMS PUERTO RICO, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN THOUSANDS)
CAPITAL
CONTRIBUTION
NOTE
CAPITAL IN RECEIVABLE RETAINED
COMMON EXCESS OF FROM RELATED EARNINGS
STOCK PAR VALUE PARTY (DEFICIT) TOTAL
---------- ---------- ------------ ---------- ----------
Balance, August 1, 2000 $ 1,000 $ 3,238 $ - $ 777 $ 5,015
Capital contribution by parent - 33 - - 33
Net loss - - - (645) (645)
---------- ---------- ---------- ---------- ----------
Balance, July 31, 2001 1,000 3,271 - 132 4,403
Capital contribution by parent,
net of note receivable - 2,910 (304) - 2,606
Reclassification due to change in the
par value and additional shares of
common stock issued (988) 988 - - -
Net loss - - - (2,633) (2,633)
---------- ---------- ---------- ---------- ----------
Balance, July 31, 2002 12 7,169 (304) (2,501) 4,376
Net loss - - - (1,749) (1,749)
---------- ---------- ---------- ---------- ----------
Balance, July 31, 2003 $ 12 $ 7,169 $ (304) $ (4,250) $ 2,627
========== ========== ========== ========== ==========
See notes to financial statements.
26
CORTELCO SYSTEMS PUERTO RICO, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN THOUSANDS)
2003 2002 2001
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,749) $ (2,633) $ (645)
---------- ---------- ----------
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization 142 193 146
Provision for doubtful accounts 8 72 87
Inventory write-downs 1,200 406 178
Loss on disposition of equipment 5 8 -
Changes in operating assets and liabilities:
Decrease (increase) in:
Trade accounts receivable (60) 2,056 2,422
Due from affiliated entities (101) 75 (188)
Inventories 542 408 559
Prepaid expenses 182 84 (97)
Other assets - 25 -
Increase (decrease) in:
Trade accounts payable 3 (619) (1,830)
Due to affiliated entities 5 189 645
Other accrued liabilities (277) 36 (110)
Deferred revenue (44) (91) 69
Income tax payable - - (40)
---------- ---------- ----------
Total adjustments 1,605 2,842 1,841
---------- ---------- ----------
Net cash provided by (used in) operating activities (144) 209 1,196
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (127) (143) (154)
Net decrease (increase) in investment in
sales-type leases 26 45 (84)
Payments for the acquisition of distribution rights - - (30)
---------- ---------- ----------
Net cash used in investing activities (101) (98) (268)
---------- ---------- ----------
Continued.
27
STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN THOUSANDS)
2003 2002 2001
---------- ---------- ----------
CASH FLOWS USED IN FINANCING ACTIVITIES;
Payments on promissory note (25) (737) (613)
---------- ---------- ----------
Net change in cash and cash equivalents (270) (626) 315
CASH AND CASH EQUIVALENTS, beginning of year 333 959 644
---------- ---------- ----------
CASH AND CASH EQUIVALENTS, end of year $ 63 $ 333 $ 959
========== ========== ==========
See notes to financial statements.
28
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Cortelco Systems Puerto Rico, Inc. ("the Company"), a Puerto Rico
corporation, was a wholly-owned subsidiary of eOn Communications
Corporation ("eOn") through July 30, 2002. Effective July 31, 2002, the
Company was spun-off from eOn to the eOn stockholders. Each holder of
eOn common stock received one share of the Company 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, the
Company became an independent entity originally headquartered in San
Juan, Puerto Rico that subsequently moved to Caguas, Puerto Rico. The
Company's operations include the sale of integrated communications and
data equipment and of cellular telephones and cellular airtime in
Puerto Rico.
The significant accounting policies followed by the Company in the
preparation of the accompanying financial statements and the methods of
applying these policies are summarized below:
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 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.
CASH AND CASH EQUIVALENTS:
Cash and cash equivalents include cash in banks and other highly liquid
investments with an original maturity of three months or less. Cash and
cash equivalents are deposited in high-credit qualified financial
institutions.
FAIR VALUE OF FINANCIAL INSTRUMENTS:
The carrying amounts of cash and cash equivalents are a reasonable
estimate of their fair value.
The carrying amounts of accounts receivable, accounts and notes
payable, accrued expenses, and deposit liabilities approximate fair
value due to their short-term maturities.
It is impracticable to determine the fair value of the amounts due by
and to affiliated entities because they are unsecured, bear no
interest, and have no definite due date.
29
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED):
FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED):
The carrying amount of the investments in sales-type leases
approximates fair value due to the relative short-term nature of the
remaining balance.
COMMUNICATION SYSTEMS AND PARTS:
Revenues from communication systems and parts include the sales of
integrated communications equipment and all the related installation
and implementation services. Revenues are earned and recognized when
the installation services are complete and the customer accepts and
takes title to the equipment. The Company recognizes revenues from the
communications systems it installs upon completion of the installation
services and acceptance by the customer due to the customized nature of
each installation. The Company recognizes revenue upon shipment for
communications systems and cellular telephones shipped to dealers
because, at that point, there is no further obligation to the dealers
to either deliver additional products or perform services. The Company
also recognizes revenues upon shipment for cellular telephones sold to
retail customers. Service revenues for maintenance contracts are
recognized over the life of the service contracts on a straight-line
basis.
CELLULAR LINE ACTIVITIES:
Revenues from cellular line activities are comprised principally of
sales commissions on cellular line contracts and line access services
placed with various carriers, principally the Puerto Rico Telephone
Corporation ("PRTC"). These commissions are recognized into revenue
when retail contracts are submitted to carriers as the Company has no
further obligation to the carrier. For those contracts submitted to the
carriers from authorized dealers, the full amount of the commission
revenues are recognized and any commissions paid to the dealer are
included as a component of cost of revenues. Revenues for the resale of
cellular telephones are recognized upon shipment and revenues from the
resale of cellular airtime are recognized upon actual use by the
customer. In instances where the telephone is sold in conjunction with
the resale of cellular airtime, the amounts recognized as revenue for
the telephone and airtime, respectively, are based on the relative fair
value of each element underlying the arrangement.
30
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED):
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.
LEASE AND MAINTENANCE CONTRACTS:
Lease contracts portfolio consists of sales-type lease contracts of
integrated voice-data communication systems with terms of 12 to 48
months, including maintenance contracts. Currently, the Company is
running off its established lease portfolio balances and referring
customers to commercial financial institutions for this service.
Interest income and maintenance contract revenues are recognized over
the remaining life of the leases, based on the interest method and
straight-line method, respectively.
PRODUCT WARRANTY:
The Company gives a one year warranty to certain products and services
sold. The Company recognizes an accrued warranty liability when it
sells a product or service. This amount is an estimate of the cost of
labor to be performed if that warranty is exercised, based on
experience. If the Company is required to perform on its warranty, it
sends the product to the manufacturer, that normally warrants the
product. The Company only incurs in cost of labor of technicians and
freight.
The Company recognizes a warranty revenue over the term of the warranty
period. The costs related to warranties exercised are recognized
directly as cost of sales when incurred.
31
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED):
INVENTORIES:
Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out ("FIFO") method. Returned
equipment and inventory, mostly related to warranty claims and
replacements of outdated communication systems, is recorded at net
realizable value. Because of uncertainties inherent in the estimation
process and the future availability of additional information,
management's estimate of the obsolescence in the existing inventory may
change in the near term.
PROPERTY AND EQUIPMENT:
Property and equipment is recorded at cost. Depreciation and
amortization is provided using the straight-line method over the
shorter of the asset's estimated useful life or lease term as follows:
ESTIMATED USEFUL LIFE (YEARS)
-----------------------------
Office and production equipment 3-5
Furniture and fixtures 10
Internal use software 3-5
Leasehold improvements 5 or lesser of lease life or asset
category life
When assets are sold, retired or otherwise disposed of, their cost and
related accumulated depreciation are removed from the accounts, and any
gain or loss is credited or charged to income. Significant improvements
to leased property are capitalized and amortized over the term of the
lease. Maintenance and repairs are expensed.
IMPAIRMENT OF LONG-LIVE ASSETS:
The Company periodically reviews long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable from the estimated future net
cash flows expected to result from the use of the asset. Any indicated
impairment would be measured as the amount by which the carrying amount
of the asset exceeds its fair value. Long-lived assets to be disposed
of are reported at the lower of carrying amount or fair value less cost
to sell. No indications of impairment are evident as a result of such
review.
32
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED):
ACCOUNTING FOR INCOME TAXES:
Deferred income taxes are accounted for using the asset and liability
method of accounting. Under this method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable
to differences between the financial statement carrying amounts of
existing assets and liabilities and the respective tax bases and
operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using the enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
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 net 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.
GOODWILL:
Goodwill represents the excess of cost paid for certain net assets over
the book value of the assets acquired. Goodwill is not amortized but is
tested for impairment at least annually.
RECENT ACCOUNTING PRONOUNCEMENTS:
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
implemented 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.
33
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED):
RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED):
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 implemented 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 SFAS 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. The Company implemented SFAS No. 145 on
August 1, 2002. Adoption of 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 EXIST 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 or SFAS No. 144. The Company implemented SFAS No. 146 for
exist or disposal activities initiated after December 31, 2002.
Adoption of SFAS No. 146 did not have a significant effect on the
Company's financial condition or results of operations.
34
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED):
RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED):
In December 2002, the FASB issued SFAS No. 148, ACCOUNTING FOR
STOCK-BASED COMPENSATION - TRANSITION AND DISCLOSURE. This Statement
amends SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, to
provide alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the method used
on reported results. The Company has not implemented SFAS No. 123
because it still follows Accounting Principle Board Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, which is an acceptable
alternative. Accordingly, SFAS No. 148 is not applicable until the
Company implements SFAS No. 123.
In April 2003, the FASB issued SFAS No. 149, AMENDMENT OF SFAS NO. 133
ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This SFAS amends and
clarifies financial accounting and reporting for derivative instruments
embedded in other contracts (collectively referred to as derivatives)
and for hedging activities under FASB Statement No. 133, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. The Company implemented
SFAS No. 149 during the fourth quarter of fiscal year 2003. Adoption of
SFAS No. 149 did not have a significant effect on the Company's
financial position and results of operations.
In May 2003, the FASB issued SFAS No. 150, ACCOUNTING FOR CERTAIN
FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH LIABILITY AND
EQUITY. This SFAS established standards for how an issuer classifies
and measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or and asset in
some circumstances). Many of those instruments were previously
classified as equity. Some of the provisions of this SFAS are
consistent with the current definition of liabilities in FASB Concepts
Statement No. 6. ELEMENTS OF FINANCIAL STATEMENTS. The remaining
provision of this Statement are consistent with the Board's proposal to
revise that definition to encompass certain obligations that a
reporting entity can or must settle by issuing its own equity shares,
depending on the nature of the relationship established between the
holder and the issuer. The Company implemented SFAS No. 150 during the
fourth quarter of fiscal year 2003. Adoption of SFAS No. 150 did not
have a significant effect on the Company's financial position and
results of operations.
35
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED):
RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED):
In November 2002, the FASB issued FASB Interpretation No. 45,
"GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENTS FOR GUARANTEES,
INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS" ("FIN 45").
FIN 45 elaborates on the disclosures to be made by a guarantor in its
financial statements about its obligations under certain guarantees and
clarifies that a guarantor is required to recognize, at the inception
of a guarantee, a liability for the fair value of the obligation
undertaken an issuing the guarantee. The disclosure requirements are
effective for fiscal years ending after December 15, 2002. The initial
recognition and initial measurement provisions of FIN 45 are applicable
on a prospective basis to guarantees issued or modified after December
31, 2002. The adoption of this accounting pronouncement is not expected
to have a material impact on the Company's financial position or
results of operations.
In November 2002, the EITF released Issue Abstract No. 00-21,
"ACCOUNTING FOR REVENUE ARRANGEMENTS WITH MULTIPLE DELIVERABLES." This
consensus requires that revenue arrangements with multiple deliverables
be divided into separate units of accounting if the deliverables in the
arrangements meet specific criteria. In addition, arrangement
consideration must be allocated among the separate units of accounting
based on their relative fair values, with certain limitations. The
Company will be required to adopt the provision of this consensus are
applicable for revenue arrangements entered into after June 30, 2003.
Te adoption of this accounting pronouncement is not expected to have a
material impact on the Company's financial position or results of
operations
36
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED):
ADVERTISING:
Advertising is charge to expense as incurred.
RECLASSIFICATIONS:
Certain reclassifications have been made to the 2002 and 2001 financial
statements to conform with the 2003 presentation.
2. GOING CONCERN AND MANAGEMENT PLANS:
The accompanying 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 decreases and resulting
losses from operations in fiscal years 2003 and 2002, and its lack of
financing resources raise 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 $175,000 for the
fiscal year 2003. To increase sales, the Company jointly with OEM
suppliers is developing a plan to offer new telecommunication
technologies. Also, the Company is working to increase its revenue from
maintenance service contracts. To improve cash flows, the Company is
seeking alternatives to sell slow moving inventory in the secondary
market. 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 financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
37
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
3. TRADE ACCOUNTS RECEIVABLE:
Trade accounts receivable at July 31, consist of:
2003 2002
---------- ----------
Communication systems and parts $ 2,226 $ 2,061
Cellular lines activities:
Billed services 416 550
Unbilled services 35 232
Cellular line activation commissions 7 37
---------- ----------
2,684 2,880
Less allowance for doubtful accounts (539) (864)
---------- ----------
Total $ 2,145 $ 2,016
========== ==========
Customers' deposits on contracts for communications systems and parts,
included in the accompanying financial statements in other accrued
liabilities, amounted to approximately $46,000 and $30,000 at July 31,
2003 and 2002, respectively.
4. INVESTMENT IN SALES-TYPE LEASES:
Net investment in sales-type lease contracts at July 31, consists of:
2003 2002
---------- ----------
Future minimum lease contract receivable $ 28 $ 209
Less unearned interest income and allowance 2 80
---------- ----------
Net investment in sales-type leases 26 129
Less current portion, adjusted for unearned interest income
and allowance 26 82
---------- ----------
Noncurrent portion $ - $ 47
========== ==========
38
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
5. INVENTORIES:
Inventories at July 31, consist of:
2003 2002
---------- ----------
Purchased components, net of slow moving inventory
write-downs of approximately $558,000 and $467,000 for
2003 and 2002, respectively $ 710 $ 1,487
Component and materials related to installations in process 85 36
Parts and materials for sale, net of slow moving inventory
write-downs of approximately $861,000 and $460,000 for
2003 and 2002, respectively 452 1,466
---------- ----------
$ 1,247 $ 2,989
========== ==========
6. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment at July 31, consist of:
2003 2002
---------- ----------
Furniture and fixtures $ 417 $ 536
Leasehold improvements 85 77
Computer equipment and software 297 650
---------- ----------
799 1,263
Less accumulated depreciation and amortization (355) (924)
---------- ----------
444 339
Construction in progress - 150
---------- ----------
$ 444 $ 489
========== ==========
39
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
7. RELATED PARTY TRANSACTIONS:
During the years ended July 31, 2003, 2002 and 2001, the Company
purchased approximately $102,000, $679,000 and $1,515,000,
respectively, in merchandise from Cortelco. Inc. ("CT"), a related
party.
In fiscal year 2002, net advances due to eOn amounting to approximately
$2,200,000 (see Note 13 as to other 2002 noncash capital contributions
of $710,000) were forgiven by eOn and recorded by the Company as a
capital contribution from parent.
The Company leased its building from Cortelco Puerto Rico, Inc. under
an operating lease agreement that expired on February 28, 2003. Rent
expense related to this agreement for the years ended July 31, 2003,
2002 and 2001, amounted to $177,000, $373,000 and $304,000,
respectively.
The balances due from and due to related parties as of July 31, 2003
are non-interest bearing, unsecured, and have no definite due date.
However, the collectibility of a $275,000 receivable is dependent on
the sale of a property owned by debtor.
8. ADVERTISING EXPENSE:
Advertising expense for the years ended July 31, 2003, 2002 and 2001,
amounted to $38,000, $93,000 and $350,000, respectively.
9. INCOME TAXES:
On August 4, 2003, the Company was granted certain tax exemption
benefits under the Commonwealth of Puerto Rico Law 135 of December 2,
1997, as amended. Under the ten-year decree, beginning on December 30,
2002, the Company's process of assembling communication equipment will
enjoy preferential tax rates, as follows:
TAX BENEFIT
--------- -------------
Income 7% flat tax
Property 90% exemption
Municipal 60% exemption
Under the decree, the Company will be required to comply with certain
levels of employment. The tax decree did not result in any income tax
benefit for the year ended July 31, 2003.
40
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
9. INCOME TAXES (CONTINUED):
Thy Company has available income tax carryforward losses to offset
future taxable income (excluding income covered by the tax exemption
grant) that expire as follows:
YEAR AMOUNT
---- ----------
2008 $ 107
2009 2,384
2010 1,810
----------
$ 4,301
==========
Reconciliation between the income tax expense recognized in the
Company's statement of operations and the income tax expense (benefit)
computed by applying the Puerto Rico statutory income tax rate to
income before income taxes is as follows:
2003 2002 2001
---------- ---------- ----------
Income tax expense (benefit) at Puerto Rico
statutory rate (39%) $ (682) $ (1,027) $ (251)
Excess of write-off of bad debts over
allowance for doubtful accounts (127) 25 -
Excess of allowance for obsolete and slow-
moving inventory over write-off of inventory 192 48 -
Non-deductible (deductible) accrued expenses (92) 22 -
Other, net 3 2 (2)
Contingent reserves 706 930 253
---------- ---------- ----------
Total income tax expense $ - $ - $ -
========== ========== ==========
41
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
9. INCOME TAXES (CONTINUED):
The components of the net deferred tax asset at July 31, are as
follows:
2003 2002
---------- ----------
Deferred tax assets resulting from:
Inventory allowance $ 554 $ 361
Other accrued liabilities 198 290
Allowance for doubtful accounts 210 337
Net operating loss carryforwards 1,677 930
---------- ----------
2,639 1,918
Less valuation allowance (2,639) (1,918)
---------- ----------
$ - $ -
========== ==========
The Company cannot conclude that it is more likely than not that
deferred tax assets will be realized in the future. Accordingly, a
valuation allowance has been recorded for the total amount of the
deferred tax asset.
10. COMMITMENTS AND CONTINGENCIES:
CLAIMS:
The Company is currently subject to one claim regarding an alleged
breach of contract, and four claims (or counterclaim) regarding
employment issues. In the breach of contract case, the plaintiff
alleges that the Company breached the terms of contract by ceasing to
supply services to the plaintiff, and the plaintiff seeks damages of
approximately $855,000. In the employment cases, each of the plaintiffs
are former employees of the Company, and they each allege under various
theories of law that their dismissal from employment by the Company was
unjustified. Collectively, the employment cases allege damages of
approximately $16 million. One of the employment cases relates to a
counterclaim established by a former employee, when the Company sued
him and other parties for violations of fiduciary duties, as a result
of the alleged use of trade secrets and confidential information to
establish a competitive business. The Company has analyzed each claim
(or counterclaim) with legal advisors, and, although most of the cases
are still in the discovery stage and, accordingly, their outcome is
impracticable to determine, the Company does not believe that any of
these cases will result in a significant unfavorable outcome that would
have a material adverse effect upon the Company's business.
42
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
10. COMMITMENTS AND CONTINGENCIES (CONTINUED):
LEASES:
The Company leases its principal facilities from the Municipality of
Caguas under an operating lease agreement that expires on November 30,
2007. Rent expense related to this agreement for the year ended July
31, 2003 amounted to $21,000. The Company also leases warehouse
facilities from the Puerto Rico Industrial Development Company (PRIDCO)
under an operating lease agreement that expires on December 30, 2012.
Rent expense related to this agreement for the year ended July 31, 2003
amounted to $13,000.
Future minimum lease payments under these agreements for the next five
years are as follows:
YEAR ENDING
JULY 31, AMOUNT
-------- ------
2004 $ 70
2005 58
2006 64
2007 70
2008 26
-----
$ 288
=====
During the years ended July 31, 2003, 2002 and 2001, rent expense
related to other operating leases amounted to approximately $53,000,
$115,000 and $114,000, respectively. These leases expired mostly in
2003.
11. EMPLOYEE BENEFITS:
The Company provides its employees a savings plan (the plan). Under the
terms of the plan, employees may contribute from 1% to 10% of
compensation and an additional voluntary amount. However, effective
January 2003, the Company no longer contributes to the plan. Previously
the Company matched 50% of employee's contributions up to 6% of the
employee's compensation, as defined, with a maximum limitation of
$2,000 for any one employee.
Contributions to the savings plan during the years ended July 31, 2003,
2002 and 2001, amounted to approximately $23,000, $44,000 and $59,000,
respectively.
43
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
12. CREDIT RISK CONCENTRATION:
The Company's business activities primarily are with customers located
in Puerto Rico and its trade accounts receivable reflects a broad
customer base in the local market. The Company routinely assesses the
financial strength of its customers. As a consequence, concentration of
credit risk is limited.
13. SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest during the years ended July 31, 2003, 2002 and
2001, amounted to approximately $600, $5,000, and $300, respectively.
No income tax payments were made during the years ended July 31, 2003,
2002 and 2001.
In fiscal year 2002 eOn assigned a note receivable from a related party
amounting to approximately $304,000, which was recorded as a capital
contribution from parent. In addition, eOn forgave the Company's net
accounts payable to related parties amounting to approximately
$406,000, which too was recorded as a capital contribution from parent.
This total capital contribution of $710,000 and the net advances due to
parent of $2,200,000, which was forgiven by eOn at the time of the
spin-off (see Note 1) have been recorded as a capital contribution of
$2,910,000 in the accompanying statement of changes in stockholders'
equity for the year ended July 31, 2002. These noncash transactions are
not included in the accompanying statement of cash flows for the year
ended July 31, 2002.
14. SEGMENT INFORMATION:
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 Service segment resells cellular airtime and cellular
telephones in Puerto Rico. For the fiscal year ended July 31, 2003, the
cellular airtime service is no longer and will no longer be a
significant segment, however, segment information continues to be
presented for the purpose of consistency with prior years.
44
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
14. SEGMENT INFORMATION (CONTINUED):
The accounting policies of the segments are those described in the
summary of significant accounting policies. The following is the key
financial data of the segments:
COMMUNICATIONS CELLULAR AIRTIME
SYSTEMS SERVICES TOTAL
-------------- -------- -------
2003
Revenues $ 6,900 $ 801 $ 7,701
Loss from operations (1,719) (55) (1,774)
Interest income, net (25) - (25)
Provision for income taxes - - -
Net loss (1,694) (55) (1,749)
Goodwill 382 - 382
Total assets 4,592 142 4,734
Capital expenditures (127) - (127)
Depreciation and amortization 142 - 142
2002
Revenues $ 8,512 $ 1,872 $ 10,384
Loss from operations (2,379) (275) (2,654)
Interest income, net (21) - (21)
Provision for income taxes - - -
Net loss (2,358) (275) (2,633)
Goodwill 382 - 382
Total assets 6,371 450 6,821
Capital expenditures 143 - 143
Depreciation and amortization 158 35 193
45
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
14. SEGMENT INFORMATION (CONTINUED):
COMMUNICATIONS CELLULAR AIRTIME
SYSTEMS SERVICES TOTAL
-------------- -------- ---------
2001
Revenues $ 11,788 $ 10,393 $ 22,181
Loss from operations (693) 33 (660)
Interest income, net (15) - (15)
Provision for income taxes - - -
Net loss (678) 33 (645)
Goodwill 382 - 382
Total assets 9,274 1,478 10,752
Capital expenditures 82 72 154
Depreciation and amortization 111 35 146
Financial information relating to the Company's revenues by
geographic area is as follows:
2003 2002 2001
-------- -------- ---------
Puerto Rico $ 7,661 $ 9,579 $ 20,730
Caribbean and Latin America 40 805 1,451
-------- -------- ---------
$ 7,701 $ 10,384 $ 22,181
======== ======== =========
15. SPECIAL CHARGES:
To reduce costs and improve productivity, the Company adopted a
restructuring plan in fiscal year 2001, which was effectively amended
in fiscal year 2002. The major component of the plan and all of the
charges are comprised of estimated severance payments related to
reductions in the Company's workforce by approximately 29%.
46
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
YEARS ENDED JULY 31, 2003, 2002 AND 2001
(DOLLARS IN TABLES IN THOUSANDS)
15. SPECIAL CHARGES (CONTINUED):
The following table provides details about the special charges related
to termination benefits recorded during fiscal years 2003 and 2002 and
the associated liabilities at July 31, 2003 and 2002:
2003 2002
------ ------
Liability balance, beginning $ 288 $ -
Charges - 320
Payments (137) (32)
Other adjustments - -
----- -----
Liability balance, ending $ 151 $ 288
===== =====
16. PREFERRED AND COMMON STOCK:
The certificate of incorporation of the Company was amended on January
31, 2002 to authorize the issuance of 10,000,000 shares of preferred
stock and 5,000,000 shares of common stock, each having a par value of
one cent ($0.01). Before this amendment, the Company was only
authorized to issue 10,000 shares of common stock, each share having a
par value of $100. As a result, a reclassification of $988,000 was
recorded to reduce the par value of common stock and to increase
additional paid-in capital.
On July 31, 2002, the Company issued 1,194,557 shares of common stock
to effect the spin-off to eOn shareholders. The pro forma net income
(loss) per share data gives effect to eOn's distribution to eOn's
shareholders of all the Company's shares held by eOn on the basis of
one share of the Company's stock for every ten shares of eOn common
stock outstanding as if such distribution had occurred as of the
beginning of the earliest period presented.
The Board of Directors of the Company is authorized from time to time
to divide the preferred stock into series and to determine the number
of shares of each series and the relative designation, powers, rights
and preferences of each such series. As of July 31, 2003, there were no
outstanding shares of preferred stock.
On June 9, 2003, the Board of Directors approved the addition of
250,000 common stock shares to be reserved for an equity incentive plan
that will be established during the ensuing fiscal year.
47
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
($ IN THOUSANDS)
Column A Column B Column C Column D Column E
- ----------------------------------------------------------------------------------------------------------
Additions
-------------------------
Balance at Charged to Charged to
Beginning of Costs and Other Balance at
Period Expenses Accounts Deductions End of Period
------------ ----------- ---------- ---------- -------------
2001:
Allowance for doubtful accounts
and sales allowance $ 703 $ 87 -- $ (9) $ 799
Warranty reserve 264 492 -- 349 407
2002:
Allowance for doubtful accounts
and sales allowance 799 72 -- 7 864
Warranty reserve 407 426 -- 518 315
2003:
Allowance for doubtful accounts
and sales allowance 864 8 -- 333 539
Warranty reserve 315 454 -- 498 271
48
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On June 30, 2003, upon the recommendation of the Audit Committee of the Board of
Directors of Cortelco Systems Puerto Rico, Inc. (the "Company"), the Board of
Directors decided to no longer engage Deloitte & Touche LLP ("Deloitte") as the
Company's independent auditor, and engaged Horwath Velez & Co.PSC ("Horwath") to
serve as the Company's independent auditor for the fiscal year ending July 31,
2003.
Deloitte's reports on the Company's financial statements for each of the fiscal
years ended July 31, 2001 and 2002, did not contain an adverse opinion or
disclaimer of opinion, nor were they qualified or modified as to audit scope or
accounting principles, but included uncertainty paragraphs as to the Company's
ability to continue as a going concern. In addition, Deloitte's report on the
Company's financial statements for the year ended July 31, 2002 also included an
explanatory paragraph as to the spin-off of the Company from eOn effective July
31, 2002. The Company's financial statements for 2001 and 2002 were included in
the Company's Annual Report on Form 10-K for the fiscal year ended July 31,
2002.
During the Company's fiscal years ended July 31, 2002 and 2001, and the
subsequent interim period through June 30, 2003, there were no disagreements
with Deloitte on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure which, if not resolved to
Deloitte's satisfaction, would have caused them to make reference to the subject
matter in connection with their reports on the Company's financial statements
for such fiscal years.
None of the reportable events described under Item 304(a)(1)(v) of Regulation
S-K occurred within the Company's fiscal years ended July 31, 2002 and 2001, or
the subsequent interim period through June 30, 2003.
The Company has provided Deloitte with a copy of the foregoing disclosures. A
copy of Deloitte's letter to the Securities and Exchange Commission dated July
2, 2003, is filed as Exhibit 16.1 to the 8-K filed by the Company on June
30,2003.
During the Company's fiscal years ended July 31, 2002 and 2001, and the
subsequent interim period through June 30, 2003, the Company did not consult
Horwath regarding (i) either the application of accounting principles to a
specified transaction, either completed or proposed, or the type of audit
opinion that might be rendered on the Company's financial statements, or (ii)
any matter that was either the subject of a disagreement (as defined in Item
304(a)(1)(iv) of Regulation S-K and the related instructions) or a reportable
event (as described in Item 304(a)(1)(v) of Regulation S-K).
ITEM 9A. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
the Chief Executive Officer and Chief Financial Officer, we have evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rule 13a-14(c) as of the end of the period
covered by this report. Based on that evaluation, the Chief Executive Officer
and Chief Financial Officer have concluded that these disclosure controls and
procedure are effective. There were no changes in our internal control over
financial reporting during the quarter ended June 30, 2003 that have materially
affected, or are reasonably likely to materially affect, our internal controls
over financial reporting.
49
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information set forth under the captions "Election of Directors" and "Section
16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive
Proxy Statement for the 2002 Annual Meeting of Shareholders to be held on
December 20, 2002 (the "Proxy Statement"), which will be filed with the
Securities and Exchange Commission not later than 120 days after July 31, 2002,
are incorporated herein by reference in response to this item.
Information with respect to executive officers is set forth under the caption
"Executive Officers" in Part I of this report.
We have adopted a Code of Ethics that applies to all employees, which is
attached as Exhibit 14.1 to this report.
ITEM 11. EXECUTIVE COMPENSATION.
Information set forth under the caption "Executive Compensation" in the Proxy
Statement is incorporated herein by reference in response to this item.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information set forth under the caption "Stock Ownership" in the Proxy Statement
is incorporated herein by reference in response to this item.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS.
Information set forth under the caption "Certain Transactions" in the Proxy
Statement is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information set forth under the caption "Fees Paid to the Independent Auditors"
in the Proxy Statement is incorporated herein by reference.
50
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON 8-K.
(A) (1) FINANCIAL STATEMENTS
The following information appears in Item 8 of Part II of this Report:
- Independent Auditors' Report
- Balance Sheets as of July 31, 2003 and 2002
- Statements of Operations for the Years Ended July 31, 2003, 2002, and
2001
- Statements of Changes in Stockholders' Equity for the Years Ended
July 31, 2003, 2002, 2001 and 2000
- Statements of Cash Flows for the Years Ended July 31, 2003, 2002 and
2001
- Notes to Financial Statements
(2) FINANCIAL STATEMENT SCHEDULES
The following financial statement schedule is included in this report:
Schedule II - Valuation and Qualifying Accounts
All other schedules are omitted because they are not required, not applicable,
or the required information is otherwise shown in the consolidated financial
statements or the notes thereto.
(B) REPORTS ON FORM 8-K
During the fourth quarter ended July 31, 2003, the Company reported the
following events on Form 8-K:
Date Filed Item No(s). Description
- ---------- ----------- -----------
June 30, 2003 4 and 7 Disclosure of engagement of
Horwath Velez & Co PSC as
Independent accountants for
Fiscal year 2003
(C) EXHIBITS
The exhibits listed in the Exhibit Index following the signature page of this
report are filed as part of this report or are incorporated by reference herein.
51
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
CORTELCO SYSTEMS PUERTO RICO, INC.
Date: October 29, 2003 By /s/ Francisco Sanchez
------------------------------------
Francisco Sanchez, Vice President,
Chief Financial Officer, Secretary
(Principal Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Name Title Date
- --------------------------- --------------------------------- ----------------------
/s/ Sergio Moren President, Chief Executive October 29, 2003
- ---------------- Officer (Principal Executive
Sergio Moren Officer), Director
/s/ Francisco Sanchez Vice President, Chief Financial October 29, 2003
- --------------------- Officer, Secretary (Principal
Francisco Sanchez Financial Officer and Principal
Accounting Officer)
/s/ David S. Lee Director October 29, 2003
- ----------------
David S. Lee
/s/ Lanny N. Lambert Director October 29, 2003
- --------------------
Lanny N. Lambert
/s/James W. Hopper Director October 29, 2003
- ------------------
James W. Hopper
52
EXHIBIT INDEX
Documents listed below are being filed as exhibits herewith. Exhibits identified
by asterisks (*) are being incorporated herein by reference and, pursuant to
Rule 12b-32 of the General Rules and Regulations promulgated by the Commission
under the Securities Exchange Act of 1934, reference is made to such documents
as previously filed exhibits with the Commission.
Exhibit
Number Description of Document
- --------- -------------------------------------------------------------------------------------------------------------
3.1 * Amended and Restated Certificate of Incorporation of Cortelco Systems Puerto Rico, Inc. ("CSPR").
3.2 * Amended and Restated Bylaws of CSPR.
4.1 * Amended and Restated Certificate of Incorporation of CSPR (filed as Exhibit 3.1).
4.2 * Amended and Restated Bylaws of CSPR (filed as Exhibit 3.2).
4.3* Form of certificate representing common stock, par value $.01 per share, of CSPR.
10.1* Distribution Agreement dated as of January 30, 2002, between eOn and CSPR (filed as Exhibit 2.1).
10.2 * Employee Matters Agreement dated as of January 30, 2002 between eOn and CSPR (filed as Exhibit 2.2).
10.3 * Confidential Disclosure Agreement dated as of January 30, 2002 between eOn and CSPR (filed as Exhibit 2.3).
10.4 * CSPR 2002 Equity Incentive Plan.
10.5 * Lease Agreement dated as of March 1, 1999, between CSPR and Cortelco Puerto Rico, Inc.
10.6(a) * Sales Agency Agreement dated as of December 19, 1995, between Celulares Telefonica, Inc. and CSPR (Spanish).
10.6(b) * Sales Agency Agreement dated as of December 19, 1995, between Celulares Telefonica, Inc. and CSPR (English translation).
10.7 * Mitel Caribbean VAR Agreement dated as of December 7, 2001, between Mitel Networks, Inc. and CSPR.
10.8 * Asset Purchase Agreement dated as of May 14, 2001, between CSPR and Ochoa Telecom, Inc.
10.9 * Form of Dealer Agreement between eOn and CSPR.
14.1 Code of Ethics
23.1 Independent Auditors' Consent
31.1 Officer's Certification of Periodic Report pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
32.1 Officer's Certification of Periodic Report pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
* Incorporated by reference to CSPR's Registration Statement on Form 10 or
amendments thereto, filed with the Securities Exchange Commission on February
12, 2002.
53