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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934. For the quarter ended January 31, 2004.
[ ] 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 Ind. Caguas Oeste Road 156 km 58.2, Caguas, Puerto Rico, 00725-0137
(Address of principal executive office)
(787) 758-0000
(Telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 126-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date: 1,204,557 shares of Common
Stock, $0.01 par value, as of January 31, 2004.
CORTELCO SYSTEMS PUERTO RICO, INC.
FORM 10-Q
QUARTER ENDED JANUARY 31, 2004
INDEX
Page
----
Part I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Balance Sheets as of January 31, 2004
and July 31, 2003 .............................................. 1
Condensed Statements of Operations for the Three Months
And Six Months ended January 31, 2004 and 2003 .................. 2
Condensed Statement of Changes in Stockholders' Equity
for the Six Months ended January 31, 2004 ....................... 3
Condensed Statements of Cash Flows for the Six Months
ended January 31, 2004 and 2003 ................................. 4
Notes to Condensed Financial Statements ........................... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ...................................... 15
Item 3. Qualitative and Quantitative Disclosure about Market Risk........... 25
Item 4. Controls and Procedures............................................. 25
Part II: OTHER INFORMATION
SIGNATURES
CORTELCO SYSTEMS PUERTO RICO, INC.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED BALANCE SHEETS (Unaudited)
January 31, 2004 and July 31, 2003
(Dollars in thousands)
January 31, July 31,
2004 2003
ASSETS
Current assets:
Cash $ 40 $ 63
Trade accounts receivable, net of allowance of
$710 and $539, respectively 1,776 2,171
Due from affiliate entities 327 313
Inventories 594 1,247
Prepaid expenses 199 114
------- -------
Total current assets 2,936 3,908
Property and equipment, net 380 444
Goodwill 382 382
------- -------
Total $ 3,698 $ 4,734
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable 1,109 $ 1,265
Due to affiliated entities 106 152
Other accrued liabilities 334 394
Deferred revenue 243 271
Note payable 25 25
------- -------
Total current liabilities 1,817 2,107
------- -------
Commitments and Contingencies
Stockholders' equity:
Preferred stock, par value $0.01 per share;
authorized, 10,000,000 shares, no shares issued -- --
Common stock, par value $0.01 per share, 5,000,000
Shares authorized; 1,204,557 shares issued
and outstanding 12 12
Capital in excess of par value 6,865 6,865
Deficit (4,996) (4,250)
------- ------
Total stockholders' equity 1,881 2,627
------- ------
Total $ 3,698 $4,734
======= ======
See notes to condensed financial statements
1
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED STATEMENTS OF OPERATIONS (Unaudited)
For the Three Months and Six Months Ended January 31, 2004 and 2003
(Dollars in thousands, except per share data)
Three Months Ended Six Months Ended
January 31, January 31,
------------------ ------------------
2004 2003 2004 2003
------- ------- ------- -------
Net revenues:
Products $ 894 $ 800 $ 2,109 $ 2,153
Services 799 934 1,610 1,818
------- ------- ------- -------
Total net revenues 1,693 1,734 3,719 3,971
------- ------- ------- -------
Cost of revenues:
Products 973 694 1,962 1,800
Services 797 517 1,266 1,041
------- ------- ------- -------
Total cost of revenues 1,770 1,211 3,228 2,841
------- ------- ------- -------
Gross profit (loss) (77) 523 491 1,130
------- ------- ------- -------
Operating expenses:
Selling, general,
& administrative 649 761 1,247 1,579
------- ------- ------- -------
Total operating expenses 649 761 1,247 1,579
------- ------- ------- -------
Operating loss (726) (238) (756) (449)
Interest income (6) (7) (10) (13)
------- ------- ------- -------
Loss before taxes (720) (231) (746) (436)
Income tax -- -- -- --
------- ------- ------- -------
Net loss $ (720) $ (231) $ (746) $ (436)
======= ======= ======= =======
Basic and diluted net loss
per common share $ (0.60) $ (0.19) $ (.62) $ (0.36)
======= ======= ======= =======
See notes to condensed financial statements
2
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
For the Six Months Ended January 31, 2004
(Dollars in thousands, except per share data)
Capital
Contribution
Note
Common Stock Capital in Receivable
------------------ Excess of From Related
Shares Amount Par Value Party Deficit Total
--------- ------- ---------- ------------ -------- ------
Balance at
July 31, 2003 1,204,557 $ 12 $ 7,169 $ (304) $(4,250) $2,627
Net loss (746) (746)
--------- ----- -------- --------- ------- ------
Balance at
January 31, 2004 1,204,557 $ 12 $ 7,169 $ (304) $(4,996) $1,881
========= ===== ======== ========= ======= ======
See notes to condensed financial statements
3
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
For the Six Months Ended January 31, 2004 and 2003
(Dollars in thousands)
Six Months Ended
January 31,
----------------------
2004 2003
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (746) $ (436)
Adjustments to reconcile net loss to net cash
by (used in) operating activities:
Depreciation and amortization 74 72
Provision for doubtful accounts receivable 200
Changes in operating assets and liabilities:
Decrease (increase) in:
Trade accounts receivables 195 80
Due from affiliated entities (14) (29)
Inventories 653 256
Prepaid expenses (85) 110
Increase (decrease) in:
Trade accounts payable (157) (146)
Due to affiliated entities (46) 55
Accrued liabilities (60) (145)
Deferred revenue (28) (50)
-------- --------
Total adjustments 732 203
-------- --------
Net cash used in operating activities (14) (233)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (9) (48)
Net decrease in investment in sales-type leases 0 42
-------- --------
Net cash used in investing activities (9) (6)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment on promissory note -- (25)
-------- --------
NET CHANGE IN CASH (23) (264)
CASH BEGINNING OF PERIOD 63 333
-------- --------
CASH END OF PERIOD $ 40 $ 69
======== ========
See notes to condensed financial statements
4
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)
For the Six Months Ended January 31, 2004 and 2003
BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been
prepared by Cortelco Systems Puerto Rico, Inc. ("CSPR" or the "Company"). It is
Management's opinion that these statements include all adjustments necessary to
present fairly the financial position, results of operations, and cash flows as
of January 31, 2004 and for all periods presented, including certain inventory
adjustment herein disclosed.
CSPR, a Puerto Rico corporation, was a wholly-owned subsidiary of eOn
Communications Corporation ("eOn") through July 30, 2002. Effective July 31,
2002, CSPR was spun-off from eOn to the eOn stockholders. Each holder of eOn
common stock received one share of CSPR common stock for every ten shares of eOn
common stock held as of July 22, 2002, which was the record date of the
distribution. After such spin-off, CSPR became an independent entity
headquartered in San Juan, Puerto Rico. CSPR's operations include principally
the sale of integrated communications and data equipment in Puerto Rico. The
Company's operations also include the sales of cellular telephones and cellular
airtime, but these are no longer significant.
Certain information and footnote disclosures normally included in the
annual financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted. It is suggested that these condensed financial statements be read in
conjunction with the financial statements and notes as of July 31, 2003 and 2002
and for the periods then ended, which are included in the Annual Report on Form
10-K for the year ended July 31, 2003 filed with the Securities and Exchange
Commission.
SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Cash - Cash includes cash deposited in high-credit qualified financial
institutions.
Fair value of financial instruments - The carrying amounts of cash is a
reasonable estimate of it 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.
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
5
information, management's estimate of credit losses inherent in the existing
accounts receivable and the related allowance may change in the near term.
Maintenance contracts - Maintenance contract revenues are recognized over the
remaining life of each contract (usually one year) based on the straight-line
method.
The following table summarizes the activity relating to the unexpired
maintenance contracts during the second quarter of this fiscal year.
October 31, 2003 January 31, 2004
Liability Liability
Balance Additions Deductions Balance
---------------------------------------------------------
Maintenance Contracts $ 218 $ 26 $ 69 $ 175
Product Warranties - The Company gives a one-year warranty to certain products
sold. The Company recognizes an accrued warranty liability when it sells a
product. 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 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 following table summarizes the activity relating to the warranty reserve
during the second quarter of this fiscal year.
October 31, 2003 January 31, 2004
Liability Liability
Balance Additions Deductions Balance
---------------------------------------------------------
Warranty Reserve $ 69 $ 36 $ 37 $ 68
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.
Going Concern and Management Plan - The accompanying condensed financial
statements have been prepared on a going concern basis, which contemplates the
realization of assets and the settlement of liabilities and commitments in the
normal course of business. The Company's significant revenue decrease and
resulting loss from operations in prior fiscal years, 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 profits. 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 this fiscal year 2004. 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
6
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 working toward
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. 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.
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.
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
7
Securities Authorized for Issuance Under the Company's Equity Compensation Plan
The following table summarizes the Company equity compensation plan as of
January 31, 2004:
Number of
securities to be Number of securities
issued upon Weighted-average remaining available for
exercise of exercise price of future issuance under equity
outstanding outstanding compensation plans
options, warrants options, warrants (excluding securities
Plan category and rights and rights reflected in column (a)
- -----------------------------------------------------------------------------------------
(a) (b) (c)
Equity
compensation plans
approved by
security holders -- -- 350,000
Equity
compensation plans
not approved by
security holders -- -- --
Total -- -- 350,000
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.
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
8
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.
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 did not 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 did not have a material
impact on the Company's financial position 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 that an issuer
9
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.
REVENUE RECOGNITION
The Company recognizes revenues from the communications systems segment
upon completion of installation services and acceptance by the customer due to
the customized nature of each installation. The Company recognizes revenues upon
shipment of equipment to customers for communications systems and cellular
telephones shipped to dealers because, at that point, the Company has no further
obligations to our dealers to either deliver additional products or perform
services. Also the Company recognizes revenues upon shipment for cellular
telephones sold to retail customers and recognizes cellular sales commission
revenues when retail contracts are submitted to cellular carriers and recognizes
revenues for resold cellular airtime when the customer uses the airtime.
Revenues from communications systems service contracts are recognized over the
life of the individual contracts. Currently, the Company sells and services
communications systems purchased from various third-party communications systems
from various manufacturers, including eOn.
SPECIAL CHARGES
To reduce costs and improve productivity, the Company adopted a
restructuring plan in the second quarter of fiscal year 2001. The plan, which
included headcount reductions and office space consolidation, was effectively
amended in fiscal year 2002. The majority of the restructuring plan was
completed by July 31, 2002. The remaining expenditures for the restructuring
plan are expected to be substantially complete by July 2004.
The following table summarizes the activity relating to the special
charges during the first two quarters of fiscal 2004 and the associated
liabilities at January 31, 2004 (in thousands):
July 31, 2003 January 31, 2004
Liability Liability
Balance Expenditures Balance
---------------------------------------------
Termination benefits $151 $33 $118
The liability for restructuring charges of $118,000 as of January 31,
2004, is included in other accrued liabilities.
10
INCOME (LOSS) PER COMMON SHARE
The Company reports its earnings per share ("EPS") using Financial
Accounting Standards Board ("FASB") Statement No. 128, Earnings Per Share ("SFAS
128"). SFAS 128 requires dual presentation of basic and diluted EPS. Basic EPS
is computed by dividing income (loss) attributable to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
The computations of basic and diluted loss per share were as follows:
Three Months Ended Six Months Ended
January 31, January 31,
----------------------- -----------------------
2004 2003 2004 2003
--------- ---------- ---------- ----------
(In thousands, except (In thousands, except
per share data) per share data)
Basic and diluted loss per share:
Net loss $ (721) $ (231) $ (747) $ (436)
========= ========== ========== ==========
Weighted average number of common
shares outstanding 1,204,557 1,204,557 1,204,557 1,204,557
Loss from operations
per share $ (0.60) $ (0.19) $ (0.62) $ (0.36)
========= ========= ========= =========
ACCOUNT RECEIVABLES
The Company's management evaluated the efforts being placed and the limited
success in collecting accounts receivable in arrears, mainly those related to
the cellular business being phased out and other disputed balances. Based on
this, CSPR increased the allowance for doubtful accounts by $200,000,
eliminating the remaining credit risk of those accounts.
INVENTORIES
Inventories consist of the following:
January 31, July 31,
2004 2003
----------- --------
(In thousands)
Purchased components $ 290 $ 710
Components and materials related to
installation in process 55 85
Parts and materials for sales 249 452
---------- -------
Total inventories $ 594 $ 1,247
========== =======
11
The Company's management has taken measures to protect its future by
narrowing the line of product offerings. In connection with this change in
product strategy, the Company recognized $600,000 of inventory adjustments, of
which $258,000 were charged to the product cost center and $242,000 to the
service cost center as a cost of revenue, to better match the value of returned
parts related to warranty claims with their future utilization in other warranty
and maintenance jobs, and to write down slow-moving and obsolete items. Economic
conditions in Puerto Rico as well as technological changes necessitated the need
for the Company to become more focused on core businesses. The Company plans to
sell its excess inventory in the secondary market that generally requires a
sizable discount for liquidation.
ACCOUNTING FOR GOODWILL
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"). SFAS No. 142 eliminates the amortization of
goodwill and indefinite-lived intangible assets and initiates an annual review
for impairment. Identifiable intangible assets with a determinable useful life
will continue to be amortized. The amortization provisions apply to goodwill and
other intangible assets acquired after June 30, 2001. Goodwill and other
intangible assets acquired prior to June 30, 2001 were affected upon adoption.
Goodwill of $382,000 had been recorded in conjunction with the assets
acquisition of Ochoa Telecom in May 14, 2001. The Company adopted SFAS No. 142
effective August 1, 2001, and performed an impairment test of its existing
goodwill based on a fair value concept. The adoption of SFAS No. 142 did not
have a significant impact on the Company's results of operations or financial
position during fiscal year 2003 or in the six months ended January 31, 2004. As
of January 31, 2004 and July 31, 2003, the Company has net unamortized goodwill
of $382,000.
CONTINGENCIES
CSPR is currently subject to one lawsuit regarding an alleged breach of
contract, two lawsuits regarding employment issues, and a fourth 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. This case is in its initial stage with a
first hearing scheduled for February 2004. In the employment lawsuits, each of
the plaintiffs are former employees of our company, and they each allege under
various theories of law that their dismissal from employment by the Company was
unjustified. Collectively, the employment law cases allege damages of
approximately $13 million. Regarding the fourth lawsuit, the Company reached an
agreement with the other party defendant, Ochoa Telecom, in which it was agreed
that Ochoa will cover all of CSPR's legal fees and any judgment against CSPR
that may result from this case. CSPR has analyzed each lawsuit with our legal
advisors, and the Company does not believe that any of these cases will result
in an unfavorable outcome that would have a material adverse effect upon our
business. However, in the event of one or more unfavorable determinations
against us, such litigation could have a material adverse effect on our business
by harming earnings if the Company is liable for a significant monetary
judgment, by harming our reputation with our customers through any adverse
publicity generated from an unfavorable determination, or by adversely affecting
our relationship with current and prospective employees of our company.
12
SEGMENT INFORMATION
CSPR's reportable segments are Communications Systems and Cellular
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 Services segment, which is no longer a
significant segment, resells cellular airtime and cellular telephones in Puerto
Rico.
Unaudited segment information for the
THREE MONTHS ENDED JANUARY 31, 2004
Communications Cellular
Systems Services Total
-------------- ------------ --------
(In thousands)
Revenues $ 1,638 $ 55 $ 1,693
Income (loss) from operations (736) 10 (726)
Interest income 6 -- 6
Provision for income taxes -- -- --
Net income (loss) (730) 10 (720)
THREE MONTHS ENDED JANUARY 31, 2003
Communications Cellular
Systems Services Total
-------------- ------------ --------
(In thousands)
Revenues $ 1,488 $ 246 $ 1,734
Income (loss) from operations (290) 52 (238)
Interest income 7 -- 7
Provision for income taxes -- -- --
Net income (loss) (283) 52 (231)
SIX MONTHS ENDED JANUARY 31, 2004
Communications Cellular
Systems Services Total
-------------- ------------ --------
(In thousands)
Revenues $ 3,578 $ 141 $ 3,719
Income (loss) from operations (741) (15) (756)
Interest income 10 -- 10
Provision for income taxes -- -- --
Net income (loss) (731) (15) (746)
Total Assets 3,687 11 3,698
Capital Expenditures 9 -- 9
Depreciation and amortization 74 -- 74
13
SIX MONTHS ENDED JANUARY 31, 2003
Communications Cellular
Systems Services Total
-------------- ------------ --------
(In thousands)
Revenues $ 3,492 $ 479 $ 3,971
Loss from operations (428) (21) (449)
Interest income 13 -- 13
Provision for income taxes -- -- --
Net loss (415) (21) (436)
Total Assets 5,681 393 6,074
Capital Expenditures 48 -- 48
Depreciation and amortization 68 4 72
SUBSEQUENT EVENT
The Company has entered into a private placement agreement with
Cortelco, Inc., a company related by common ownership, to sell 400,000 newly
issued shares of common stock at $.27 per share. It is anticipated that the sale
of stock will be completed prior to the end of March 2004.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This report contains unaudited forward-looking statements within the
meaning of the federal securities laws. Unaudited forward-looking statements are
those that express management's views of future events, developments, and
trends. In some cases, these statements may be identified by terminology such as
"may," "will," "should," "expects," "plans," "intends," "anticipates,"
"believes," "estimates," "predicts," "potential," or "continue" or the negative
of such terms and other comparable expressions. Unaudited forward-looking
statements include statements regarding our anticipated or projected operating
performance, financial results, liquidity and capital resources. These
statements are based on management's beliefs, assumptions, and expectations,
which in turn are based on the information currently available to management.
Information contained in these unaudited forward-looking statements is
inherently uncertain, and our actual operating performance, financial results,
liquidity, and capital resources may differ materially due to a number of
factors, most of which are beyond our ability to predict or control. The Company
also directs your attention to the risk factors affecting our business that are
discussed elsewhere at the end of this Item. CSPR disclaims any obligation to
update any of the unaudited forward-looking statements contained in this report
to reflect any future events or developments. The following discussions should
be read in conjunction with our unaudited financial statements and the notes
included thereto.
OVERVIEW
The Company is a value-added reseller of numerous third-party brands of
voice and data communication systems as well as cellular telephones and airtime.
Most of our business is conducted in Puerto Rico, although the Company also
sells a limited amount of communications systems in the Caribbean and Latin
America. The Company's products help enterprises communicate more effectively
with customers and increase customer satisfaction and loyalty. The Company sells
to both 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 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 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, and the newer IP based voice and data communication devices. The
Communications Systems segment represented 90% of our revenues in fiscal year
2003 and 97% of the operating loss of the Company, while Cellular Service
represented 10% of revenues and 3% of the operating loss. Cellular Services
revenues were 4% of our total revenues for the six months ended January 31, 2004
and CSPR anticipates that these revenues will continue to represent a smaller
percentage of the total revenues than in fiscal year 2003. As Communications
Systems revenues will constitute a larger portion of our revenue in the future
than in fiscal year 2003, it is important that we continue to add to our product
and service offering and increase our installed base of customers. In the period
ended January 31, 2004, Communications Systems segment has our highest gross
margins, greater than Cellular Services segment.
While the Company's recent losses in fiscal year 2003 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
15
increase our installed base of customers via acquisitions or by distributing new
types of voice and data communications products as our highest gross margins are
from service revenues in our Communications Systems segment. The Company's
recent losses in the Communications System segment were mainly a result of
expanding our sales and administrative infrastructure following our rapid growth
in fiscal year 1999 and the first half of fiscal year 2000. In fiscal year 2001,
CSPR restructured the business to address the downward cycle in the
telecommunications industry and began to look for ways to increase our higher
margin business by acquiring certain assets of Ochoa Telecom in Puerto Rico.
While the telecommunications market has continued to be depressed in Puerto Rico
due to macroeconomic factors in the country, CSPR will continue to seek
acquisition opportunities that allow us to increase our maintenance revenues in
the Communications Systems segment.
THREE MONTHS ENDED JANUARY 31, 2004 AND 2003
The following discussion provides information about the Company's
operations, for the three months ended January 31, 2004 and for the three months
ended January 31, 2003.
NET REVENUES
Net revenues decreased 2.4%, or approximately $41,000, in the three
months ended January 31, 2004 compared to the same three month period in 2003.
The results primarily reflect increased revenue of approximately $150,000 in the
Communications Systems segment offset by a decrease of approximately $191,000 in
the Cellular Services segment due to a general decline in demand.
COST OF REVENUES AND GROSS PROFIT (LOSS)
Cost of revenues consists primarily of purchases from equipment
manufacturers and other suppliers and costs incurred for final assembly, quality
assurance and installation of our systems. For cellular contracts submitted to
the carriers from our authorized dealers, any commissions paid to the dealer are
also included as a component of cost of revenues. Gross profit decreased 114.7%
to a loss of $77,000 in the three months ended January 31, 2004 from a profit of
$523,000 in the three months ended January 31, 2003. CSPR's gross margins were
(4.5%) in the three months ended January 31, 2004 and 30.2% in the three months
ended January 31, 2003. The decrease in gross margin was primarily due to the
$600,000 inventory adjustment related to the change in the Company's product
strategy to become more focused on core businesses.
SELLING, GENERAL AND ADMINISTRATIVE
The operating expenses consist mainly of salaries of our sales,
marketing, service, and administrative personnel and associated overhead. CSPR
recognizes these expenses as incurred. As the Company distributes the products
of third parties and does not sell any products that the Company designs or
develops, the Company does not incur any costs for research and development.
While prior to the spin-off the Company essentially operated as a stand-alone
entity from our parent due to our location in Puerto Rico, with separate audits,
legal counsel, corporate officers, and accounting and administrative functions,
the Company has not previously operated as a stand-alone public company.
Therefore, CSPR has incurred additional general and administrative expenses due
to the public company reporting requirements that were previously performed by
our parent. However, selling,
16
general and administrative expenses decreased 14.7% to $649,000 in the quarter
ended January 31, 2004 from $761,000 in the quarter ended January 31, 2003. The
decrease was primarily due to reductions in personnel, facilities, and
associated overhead resulting from the implementation of the Company's
restructuring plan partially offset by an increase in the allowance for doubtful
accounts. The company increased the allowance for doubtful accounts by $200,000
to reflect the net realizable value of existing accounts.
INTEREST AND OTHER INCOME AND EXPENSES
No material amount was recorded in the three months ended January 31,
2004 or the three months ended January 31, 2003.
INCOME TAX BENEFIT (EXPENSE)
No income tax benefit was recognized in the three months ended January
31, 2004 or the three months ended January 31, 2003 because CSPR cannot conclude
that it is more likely than not that its deferred tax assets will be realized in
the future.
SIX MONTHS ENDED JANUARY 31, 2004 AND 2003
The following discussion provides information about the Company's
operations, for the six months ended January 31, 2004 and for the six months
ended January 31, 2003.
NET REVENUES
Net revenues decreased 6.4% to $3.7 million in the six months ended
January 31, 2004 from $4.0 million in the six months ended January 31, 2003. The
results primarily reflect increased revenue of approximately $86,000 in
Communications Systems segment offset by a decrease of approximately $338,000 in
Cellular Services segment due to a general decline in demand.
COST OF REVENUES AND GROSS PROFIT (LOSS)
Cost of revenues consists primarily of purchases from equipment
manufacturers and other suppliers and costs incurred for final assembly, quality
assurance and installation of our systems. Gross profit decreased 56.5% to
$491,000 in the six months ended January 31, 2004 from $1.1 million in the six
months ended January 31, 2003. CSPR's gross margins were 13.2% in the six months
ended January 31, 2004 and 28.5% in the six months ended January 31, 2003. The
decrease in gross margin was primarily due to the increase in the Company's
inventory adjustments, partially offset by the net effect of reductions of costs
and productivity improvements resulting from the restructuring plan adopted by
the Company.
SELLING, GENERAL AND ADMINISTRATIVE
The operating expenses consist mainly of salaries of our sales,
marketing, service, and administrative personnel and associated overhead. CSPR
recognizes these expenses as incurred. As the Company distributes the products
of third parties and does not sell any products that the Company designs or
develops, the Company does not incur any costs for research and development.
While prior to the spin-off the Company essentially operated as a stand-alone
entity from our parent
17
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. Therefore, CSPR has
incurred additional general and administrative expenses due to the public
company reporting requirements that were previously performed by our parent.
However, selling, general and administrative expenses decreased 25.0% to $1.2
million in the six months ended January 31, 2004 from $1.6 million in the six
months ended January 31, 2003. The decrease was primarily due to reductions in
personnel, facilities, and associated overhead resulting from the implementation
of the Company's restructuring plan offset by an increase in the allowance for
doubtful accounts.
INTEREST AND OTHER INCOME AND EXPENSES
No material amount was recorded in the six months ended January 31,
2004 or the six months ended January 31, 2003.
INCOME TAX BENEFIT (EXPENSE)
No income tax benefit was recognized in the six months ended January
31, 2004 or the six months ended January 31, 2003 because CSPR cannot conclude
that it is more likely than not that its deferred tax assets will be realized in
the future.
LIQUIDITY AND CAPITAL RESOURCES
Prior to the initial public offering of eOn, the Company funded its
operations primarily through cash generated from operations and periodic
borrowings under our former revolving credit facility. Subsequent to the initial
public offering, eOn periodically provided funds through parent-subsidiary loans
as our credit facility was retired with funds from the initial public offering.
The last funds received from eOn were in November 2000 and we have funded all
cash requirements and loan repayments to eOn of $2.25 million since that date
from operating revenues. However, if our business begins to grow, CSPR may need
additional capital. Such capital may not be available on favorable terms and
conditions.
The Company's significant revenue decrease and resulting loss from
operations 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 profits. 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 this fiscal year 2004. 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 working toward increasing its
maintenance service contracts with designated salespersons to generate
maintenance contracts for new customers and continuing the renewal of the
existing customers' contracts. 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
18
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 $14,000 and
$233,000 for the six months ended January 31, 2004 and January 31, 2003,
respectively. Cash used in operating activities in the six months of this fiscal
year resulted primarily from the Company's net loss, the decrease in accounts
payable and increase in prepaid expenses, partially offset by the decrease in
accounts receivable and inventories.
Net cash used in by investing activities was approximately $9,000 for
the six months ended January 31, 2004 compared to approximately $6,000 cash used
in investing activities for the same period in fiscal year 2003. Cash used in
investing activities in this six months of the current fiscal year consisted
primarily of cash used for capital expenditures.
There were no financing activities in the six months ended January 31,
2004. Net cash used in financing activities was approximately $25,000 for the
six months ended January 31, 2003.
The Company has entered into a private placement agreement with
Cortelco, Inc., a company related by common ownership, to sell 400,000 newly
issued shares of common stock at $.27 per share. It is anticipated that the sale
of stock will be completed prior to the end of March 2004.
ADDITIONAL RISK FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
You should carefully consider the risks set forth in this Form 10-Q,
particularly the risk that we may not be able to continue operations as
described in "Liquidity and Capital Resources" and the risk factors described
below when evaluating CSPR. If any of the following risks occur, CSPR's
business, operating results and financial condition could be seriously harmed.
Additional risks and uncertainties that CSPR is presently not aware of could
also impair its business, operating results and financial condition.
IF THE COMPANY IS NOT ABLE TO SUSTAIN OUR TRADITIONAL COMMUNICATION SYSTEMS
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 communication systems sales (PBX and IP based
voice and date communications). The Company's communications systems revenues
declined 65.2% from fiscal year 2001 to fiscal year 2003 due mainly to a decline
in the overall communications market and significant Year 2000 upgrade revenues.
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. Although
CSPR is aggressively entering into the IP telephony market, we may not be able
to grow or properly train our personnel to sell and service the newer products
developed by these companies then 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
19
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 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.
20
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.
IF THE COMPANY LOOSES KEY MANAGEMENT PERSONNEL, WE MAY NOT BE ABLE TO
SUCCESSFULLY OPERATE THE BUSINESS.
CSPR's future performance will be substantially dependent on the
continued services of our senior management, especially our President and Chief
Executive Officer, Sergio R. Moren, and other key personnel. The loss of any
members of our executive management team and our inability to hire additional
executive management could harm our business and results of operations. The
Company employs our key personnel on an at-will basis. CSPR does not maintain
key person insurance policies on any of the members of our executive management
team.
THE COMPANY MAY BE UNABLE TO HIRE AND RETAIN SALES, MARKETING, AND SERVICE
PERSONNEL TO EXECUTE OUR BUSINESS STRATEGY.
Competition for highly qualified personnel is intense due to the
limited number of people available with the necessary technical skills, and CSPR
may not be able to attract, assimilate or retain such personnel. If the Company
cannot attract, hire and retain sufficient qualified personnel, the Company may
not be able to successfully market, sell, or service new products.
SINCE THE COMPANY DOES NOT HAVE EXCLUSIVE AGREEMENTS WITH THE MANUFACTURERS,
MANUFACTURERS MAY ENTER INTO DEALER AGREEMENTS WITH OUR COMPETITORS, WHICH MAY
ADVERSELY AFFECT OUR BUSINESS.
CSPR distributes and services products designed and manufactured by
eOn, Avaya, Nortel, Hitachi, Mitel, Toshiba, NEC, Cortelco, Nokia, Ericsson,
Motorola, and others. However, the Company does not have exclusive distribution
agreements with these companies and have competitors in our major markets that
sell the same products. Our customers often have the option of purchasing
similar communications systems from other distributors in our markets. A
decision by the manufacturer to
21
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.
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 that 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 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, two lawsuits regarding employment issues, and a fourth 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
22
to supply services to the plaintiff, and the plaintiff seeks damages of
approximately $854,430. This case is in its initial stage with a first hearing
scheduled for February 2004. In the employment lawsuits, each of the plaintiffs
are former employees of our company, and they each allege under various theories
of law that their dismissal from employment by the Company was unjustified.
Collectively, the employment law cases allege damages of approximately $13
million. Regarding the fourth lawsuit, the Company reached an agreement with the
other party defendant, Ochoa Telecom, in which it was agreed that Ochoa will
cover all of CSPR's legal fees and any judgment against CSPR that may result
from this case. CSPR has analyzed each lawsuit with our legal advisors, and the
Company does not believe that any of these cases will result in an unfavorable
outcome that would have a material adverse effect upon our business. However, in
the event of one or more unfavorable determinations against us, such litigation
could have a material adverse effect on our business by harming earnings if the
Company is liable for a significant monetary judgment, by harming our reputation
with our customers through any adverse publicity generated from an unfavorable
determination, or by adversely affecting our relationship with current and
prospective employees of our company.
LAWS OR REGULATIONS THAT GOVERN THE TELECOMMUNICATIONS INDUSTRY AND COPYRIGHTED
WORKS COULD EXPOSE US TO LEGAL ACTION IF THE COMPANY FAIL TO COMPLY OR COULD
REQUIRE US TO CHANGE OUR BUSINESS.
Because our products and services provide our customers with access to
the public telephone system and other methods of electronic communication, the
products CSPR sells are subject to the regulations of the Federal Communications
Commission and Junta Reglamentadora de Telecomunicaciones de Puerto Rico,
relating to consumer products that connect to the public telephone network and
electronic emissions of consumer products.
Changes in the regulatory climate or the enforcement or interpretation
of existing laws could expose us to legal action if the Company fails to comply.
In addition, any of these regulatory bodies could promulgate new regulations or
interpret existing regulations in a manner that would cause us to incur
significant compliance costs or force us to alter the features or functionality
of our products and services.
PRODUCT DEFECTS, SYSTEM FAILURES OR INTERRUPTIONS MAY HAVE A NEGATIVE IMPACT ON
OUR REVENUES, DAMAGE OUR REPUTATION AND DECREASE OUR ABILITY TO ATTRACT NEW
CUSTOMERS.
Errors and product defects can result in significant warranty and
repair problems, which could cause customer relations problems. Correcting
product defects requires significant time and resources, which could delay
product releases and affect market acceptance of our products. Any delivery by
us of products with undetected material product defects could harm our
credibility and market acceptance of our products.
THE PRODUCTS THE COMPANY SELLS AND SERVICES MAY HAVE UNDETECTED FAULTS LEADING
TO LIABILITY CLAIMS, WHICH COULD HARM OUR BUSINESS.
The products the Company sells and services may contain undetected
faults or failures. Any failures of these products could result in significant
losses to our customers, particularly in mission-critical applications. A
failure could also result in product returns and the loss of, or delay in,
market acceptance of our products. In addition, any failure of the product CSPR
sells could result in claims against us. Our purchase agreements with our
customers typically contain provisions designed to limit our exposure to
potential product liability claims. Although CSPR is unaware of any specific
laws or cases that would invalidate our purchase agreement limitation of
liability provisions, there is a risk that such provisions
23
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 490,029
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.
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ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The vast majority of the Company's sales are made in U.S. dollars, and
consequently, the Company believes that our foreign exchange rate risk is
immaterial. The Company does not have any derivative instruments and do not
engage in hedging transactions.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period preceding the filing of this Quarterly Report
on Form 10-Q, an evaluation was performed under the supervision of and with the
participation of the Company's management, including the Chief Executive Officer
(CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and
operation of the Company's disclosure controls and procedures. Based on that
evaluation, the Company's management, including the CEO and CFO, concluded that
the design and operation of the Company's disclosure controls and procedures
were effective to ensure that material information relating to CSPR is made
known to such officers by others within CSPR, particularly during the period
this quarterly report and prepared, in order to allow timely decisions regarding
required disclosure. There have been no significant changes in the Company's
internal control or in other factors that could significantly affect internal
controls subsequent to the date of their evaluation.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) Exhibits.
Exhibit
Number Description of Document
- ------- -------------------------------
31.1 Officers' Certification of Periodic Report pursuant to Section 302 of
Sarbanes-Oxley Act of 2002.
32.1 Officers' Certification of Periodic Report pursuant to Section 906 of
Sarbanes-Oxley Act of 2002.
(B) Reports On Form 8-K.
None.
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SIGNATURES
Pursuant to the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto authorized.
Cortelco Systems Puerto Rico, Inc.
Date: March 11, 2004 /s/ Francisco Sanchez
-----------------------------------------
Francisco Sanchez, Vice President
Chief Financial Officer, Secretary
Duly Authorized Officer
(Principal Financial and Accounting Officer)
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