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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the quarter ended April 30, 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: 1,604,557 shares of Common
Stock, $0.01 par value, as of April 30, 2004.
ii
CORTELCO SYSTEMS PUERTO RICO, INC.
FORM 10-Q
QUARTER ENDED APRIL 30, 2004
INDEX
Page
----
Part I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Balance Sheets as of April 30, 2004
and July 31, 2003.................................................................... 1
Condensed Statements of Operations for the Three Months
And Nine Months ended April 30, 2004 and 2003 ....................................... 2
Condensed Statement of Changes in Stockholders' Equity
for the Nine Months ended April 30, 2004 ............................................ 3
Condensed Statements of Cash Flows for the Nine Months
ended April 30, 2004 and 2003 ....................................................... 4
Notes to Condensed Financial Statements ................................................ 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................ 11
Item 3. Qualitative and Quantitative Disclosure about Market Risk............................... 21
Item 4. Controls and Procedures................................................................. 21
Part II: OTHER INFORMATION
SIGNATURES
iii
CORTELCO SYSTEMS PUERTO RICO, INC.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED BALANCE SHEETS (Unaudited)
April 30, 2004 and July 31, 2003
(Dollars in thousands)
April 30, July 31,
2004 2003
--------- --------
ASSETS
Current assets:
Cash $ 87 $ 63
Trade accounts receivable, net of allowance of
$599 and $539, respectively 1,622 2,171
Due from affiliate entities 352 313
Inventories 601 1,247
Prepaid expenses 130 114
------- -------
Total current assets 2,792 3,908
Property and equipment, net 347 444
Goodwill 382 382
------- -------
Total $ 3,521 $ 4,734
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable 801 $ 1,265
Due to affiliated entities 258 152
Other accrued liabilities 322 394
Deferred revenue 214 271
Note payable -- 25
------- -------
Total current liabilities 1,595 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; 1,604,557 shares issued
and outstanding in 2004 and 1,204,557 in 2003 16 12
Capital in excess of par value 6,969 6,865
Deficit (5,059) (4,250)
------- -------
Total stockholders' equity 1,926 2,627
------- -------
Total $ 3,521 $ 4,734
======= =======
See notes to condensed financial statements
1
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED STATEMENTS OF OPERATIONS (Unaudited)
For the Three Months and Nine Months Ended April 30, 2004 and 2003
(Dollars in thousands, except per share data)
Three Months Ended Nine Months Ended
April 30, April 30,
------------------ ------------------
2004 2003 2004 2003
------- ------- ------- -------
Net revenues:
Products $ 912 $ 818 $ 3,021 $ 2,971
Services 797 756 2,407 2,574
------- ------- ------- -------
Total net revenues 1,709 1,574 5,428 5,545
------- ------- ------- -------
Cost of revenues:
Products 749 798 2,711 2,598
Services 488 815 1,754 1,856
------- ------- ------- -------
Total cost of revenues 1,237 1,613 4,465 4,454
------- ------- ------- -------
Gross profit (loss) 472 (39) 963 1,091
------- ------- ------- -------
Operating expenses:
Selling, general,
& administrative 538 590 1,785 2,168
------- ------- ------- -------
Total operating expenses 538 590 1,785 2,168
------- ------- ------- -------
Operating loss (66) (629) (822) (1,077)
Interest income (3) (6) (13) (19)
------- ------- ------- -------
Loss before taxes (63) (623) (809) (1,058)
Income tax -- -- -- --
------- ------- ------- -------
Net loss $ (63) $ (623) $ (809) $(1,058)
======= ======= ======= =======
Basic and diluted net loss
per common share $ (0.04) $ (0.52) $ (0.51) $ (0.88)
======= ======= ======= =======
See notes to condensed financial statements
2
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
For the Nine Months Ended April 30, 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
Capital
Contribution 400,000 4 104 108
Net loss (809) (809)
---------- ---------- ---------- ---------- ---------- ----------
Balance at
April 30, 2004 1,604,557 $ 16 $ 7,273 $ (304) $ (5,059) $ 1,926
========== ========== ========== ========== ========== ==========
See notes to condensed financial statements
3
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
For the Nine Months Ended April 30, 2004 and 2003
(Dollars in thousands)
Nine Months Ended
April 30,
------------------
2004 2003
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (809) $(1,058)
Adjustments to reconcile net loss to net cash ------- -------
used in operating activities:
Depreciation and amortization 110 87
Provision for doubtful accounts receivable 200 --
Inventory write downs 600 500
Changes in operating assets and liabilities:
Decrease (increase) in:
Trade accounts receivables 349 383
Due from affiliated entities (39) (130)
Inventories 46 222
Prepaid expenses (16) 191
Increase (decrease) in:
Trade accounts payable (464) (195)
Due to affiliated entities 106 29
Accrued liabilities (72) (206)
Deferred revenue (57) (65)
------- -------
Total adjustments 763 816
------- -------
Net cash used in operating activities (46) (242)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (13) (57)
Net decrease in investment in sales-type leases -- 60
------- -------
Net cash (used in) provided by investing activities (13) 3
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of promissory note (25) (25)
Sales of Capital Stock 108 --
------- -------
Net cash provided by (used in) by financing activities 83 (25)
NET CHANGE IN CASH AND CASH EQUIVALENTS 24 (264)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 63 333
------- -------
CASH AT THE END OF THE PERIOD $ 87 $ 69
======= =======
See notes to condensed financial statements
4
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)
For the Nine Months Ended April 30, 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 April 30, 2004 and for all periods presented, including certain inventory
adjustments 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, install and maintenance of integrated communications and data
equipment in Puerto Rico. The Company's operations also include the sales of
cellular telephones and cellular airtime, but this segment is being phased out
because it is no longer significant nor profitable. For that reason, the Company
has decided to not report it as a segment and will be discontinuing the
operation before July 31, 2004. Our focus will be on efforts to grow the sale of
communications and data equipment and the maintenance thereof.
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. These condensed financial statements should 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 its 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 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
5
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.
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 third quarter of this fiscal year.
January 31, 2004 April 30, 2004
Liability Liability
Balance Additions Deductions Balance
---------------- --------- ---------- --------------
Maintenance Contracts $ 175 $ 42 $ 69 $ 148
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 the cost of labor of technicians
and return 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 third quarter of this fiscal year.
January 31, 2004 April 30, 2004
Liability Liability
Balance Additions Deductions Balance
---------------- --------- ---------- ---------------
Warranty Reserve $ 68 $ 31 $ 33 $ 66
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.
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
6
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
Securities Authorized for Issuance Under the Company's Equity Compensation Plan
The following table summarizes the Company equity compensation plan as of April
30, 2004:
Number of securities Weighted-average Number of securities remaining
to be issued upon exercise price of available for future issuance
exercise of outstanding under equity compensation plans
outstanding options, options, warrants (excluding securities reflected
Plan category warrants and rights and rights 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
During the current fiscal year, the FASB has issued various FASB
Interpretations that are not applicable to the Company's financial statements,
and has not issued any further SFAS.
The SEC has also released Staff Accounting Bulletins that are not
applicable to the Company's financial statements.
REVENUE RECOGNITION
The Company recognizes revenues for equipment shipped to customers only
after completion of installation services and acceptance by the customer due to
the customized nature of each installation. Revenues from communications systems
service contracts are recognized over the life of the individual contracts.
7
Currently, the Company sells and services communications systems purchased from
various third-party communications systems from various manufacturers.
SPECIAL CHARGES
To reduce costs and improve productivity, the Company adopted a
restructuring plan in the second quarter of fiscal year 2001. The plan, which
included headcount reductions and office space consolidation, was effectively
amended in fiscal year 2002. The majority of the restructuring plan was
completed by July 31, 2002. The remaining expenditures for the restructuring
plan are expected to be substantially complete by July 2004.
The following table summarizes the activity relating to the special
charges during the three quarters of fiscal 2004 and the associated liabilities
at April 30, 2004 (in thousands):
July 31, 2003 April 30, 2004
Liability Liability
Balance Expenditures Balance
------------- ------------ --------------
Termination benefits $151 $33 $118
The liability for restructuring charges of $118,000 as of April 30, 2004,
is included in other accrued liabilities.
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.
In this quarter ended April 30, 2004, the Company reached an agreement
with Cortelco, Inc., a company related by common ownership, and sold it 400,000
newly issued shares of common stock at $0.27 per share.
The computations of basic and diluted loss per share were as follows:
Three Months Ended Nine Months Ended
April 30, April 30,
-------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
(In thousands, except (In thousands, except
per share data) per share data)
Basic and diluted loss per share:
Net loss $ (63) $ (623) $ (809) $ (1,058)
=========== =========== =========== ===========
Weighted average number of common
shares outstanding 1,604,557 1,204,557 1,604,557 1,204,557
Loss from operations
per share $ (0.04) $ (0.52) $ (0.51) $ (0.88)
=========== =========== =========== ===========
ACCOUNT RECEIVABLES
The Company's management evaluated the efforts being placed and the
limited
8
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 in the
quarter ended January 31, 2004, eliminating the remaining credit risk of those
accounts. However management plans include continuing its collections effort by
using collections agencies and legal resources to try to collect all accounts
receivable already allowed for, especially the cellular accounts.
Inventories
Inventories consist of the following:
April 30, July 31,
2003 2004
--------- --------
(In thousands)
Purchased components $ 357 $ 710
Components and materials related to
installation in process 76 85
Parts and materials for sales 168 452
--------- --------
Total inventories $ 601 $ 1,247
========= ========
The Company's management has taken measures to protect its future by
narrowing the line of product offerings. The rapid technological change from
traditional to voice-over IP systems has necessitated the need for the Company
to become more focused on fewer brands and on increased efficiency in its core
business. In connection with this change in product strategy, the Company
recognized $600,000 of inventory adjustments in the quarter ended January 31,
2004, of which $258,000 were charged to the product cost center and $342,000 to
the service cost center as a cost of revenue. Lower inventory values provide a
better match to the value of returned parts related to warranty claims with
their future utilization in other warranty and maintenance jobs, and allows the
write down of slow-moving and obsolete items. 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 nine months ended April 30, 2004. As
of April 30, 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, a fourth lawsuit in which
the Company was included as a Third Party Defendant, and a fifth lawsuit
regarding
9
employment issues which was filed as a counterclaim at a unfair competition and
business operations claim CSPR filed against one of its competitors, Envision
Technologies. 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. At the
first court hearing in May, CSPR was given a 15-day period to submit CSPR's
expert witness report and a total of 30 days (due June 30, 2004) for both
parties to conclude all discovery proceedings. 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 would 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.
SEGMENT INFORMATION
CSPR's previously reported segments were Communications Systems and
Cellular Services. Because the Cellular Service segment is less than the 10% of
our total revenue and it is no longer significant, the Company has decided to
stop reporting it as a segment.
SUBSEQUENT EVENT
Our affiliated company, Cortelco Puerto Rico, Inc. has signed an option
agreement for the sale of the building located at 1550 Ponce de Leon, Rio
Piedras, Puerto Rico. This option is in effect until the 15th day of August
2004. If the option is exercised and the building is sold, CSPR anticipates
receiving approximately $291,000 net of CSPR's payable balance due from Cortelco
Puerto Rico, Inc. from the proceeds received from the sale of the building.
10
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 third-party brands of voice and
data communication systems. The rapid technological change from traditional to
voice-over IP systems has necessitated the need for the Company to become more
focused on fewer brands and on increased efficiency in its core business. The
Communications Systems revenues are comprised mostly of sales of PBX customer
premise new equipment and additions, including the newer IP based voice and data
communication as well as maintenance contract and services. The Company's
operations also include the sales of cellular telephones and cellular airtime.
Cellular Services revenues were 3% of our total revenues for the nine months
ended April 30, 2004 and as CSPR anticipated that these revenues will continue
to represent a smaller percentage, the Company will be discontinuing the
cellular operation before July 31, 2004 and focus all effort in its core
business. The Company as a cellular reseller cannot be competitive anymore in
price with the main carriers established in Puerto Rico which includes the five
multinational wireless companies. All of our business is conducted in Puerto
Rico, although the Company sometimes sells a limited amount of communications
systems in the Caribbean. The Company's products help enterprises communicate
more effectively with customers and increase their customer satisfaction and
loyalty.
Currently, our continuance as a going concern is dependent upon our
ability to improve profitability to the break even point, generate cash from our
account receivables on a timely basis and continued support from our suppliers.
Failing to do so the Company would have to raise capital from external sources.
CSPR does not expect to generate sufficient revenues to enable us to offset the
inventories and bad debts accounts written off (totaling $800,000) to be
profitable for fiscal year 2004. The Company may require additional funding to
continue our operations in order to achieve meaningful sales volumes. In
addition, CSPR must generate the necessary funds in order to fully implement our
business plan. Ultimately, the Company must achieve profitable operations if the
Company is to be a viable entity.
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,
11
in the quarter ended January 31, 2004, CSPR recognized $600,000 of inventory
adjustments and increased the allowance for doubtful accounts by $200,000,
eliminating the remaining credit risk of those accounts. In the inventory
adjustments, the Company plans to sell its excess inventory in the secondary
market. Regarding to the allowance for doubtful accounts, CSPR plans to continue
its collections effort by using collections agencies and legal resources.
CSPR's management plans include continuing its reductions of operating
cost and expenses while striving for an increase in sales profits. The Company
will continually look for ways to increase our installed base of customers via
improved service performance, and increased maintenance sales efforts as our
highest gross margins are from service revenues. To improve service performance,
the Company is revamping its training program to develop more highly qualified
technicians. To improve maintenance sales results, during this quarter, the
Company has reassigned three individuals from new equipment sales to the sale of
maintenance services to support and increase our customer base.
THREE MONTHS ENDED APRIL 30, 2004 AND 2003
The following discussion provides information about the Company's
operations, for the three months ended April 30, 2004 and for the three months
ended April 30, 2003.
NET REVENUES
Net revenues increased 8.58%, or approximately $135,000 in the three
months ended April 30, 2004 compared to the same three months period in 2003.
The results primarily reflect increased revenue of approximately $94,000 in new
products and additions, and approximately $41,000 in services and maintenance
contracts due to changes in management strategy and improved focus on the core
business.
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 (loss) increased to a
profit of approximately $472,000 in the three months ended April 30, 2004 from
approximately $39,000 loss in the three months ended April 30, 2003. CSPR's
gross margins were 27.6% in the three months ended April 30, 2004 and (2.5%) in
the three months ended April 30, 2003. The increase in gross margin was
primarily due to the net effect of reductions of costs and productivity
improvements resulting from the restructuring plan adopted by the Company to
offset the recording of $500,000 for slow moving inventory in the third quarter
of fiscal year 2003.
SELLING, GENERAL AND ADMINISTRATIVE
The operating expenses consist mainly of salaries of our sales, marketing,
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. Selling, general and
administrative expenses decreased 8.8% to $538,000 in the quarter ended April
30, 2004 from $590,000 in the quarter ended April 30, 2003. The decrease was
primarily due to reductions in personnel, facilities, and associated overhead
resulting from the implementation of the Company's restructuring plan.
12
INCOME TAX BENEFIT (EXPENSE)
No income tax benefit was recognized in the three months ended April 30,
2004 or the three months ended April 30, 2003 because CSPR cannot conclude that
it is whether or not that its deferred tax assets will be realized in the
future.
NINE MONTHS ENDED APRIL 30, 2004 AND 2003
The following discussion provides information about the Company's
operations, for the nine months ended April 30, 2004 and for the nine months
ended April 30, 2003.
NET REVENUES
Net revenues decreased 2.1% to $5.4 million in the nine months ended April
30, 2004 from $5.5 million in the nine months ended April 30, 2003. The results
primarily reflect increased revenue of approximately $50,000 in new products and
additions offset by a decrease of approximately $167,000 in services and
maintenance contracts. For that reason, the Company plans to improve service
performance, and increase maintenance sales efforts
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 11.7% to
$963,000 in the nine months ended April 30, 2004 from $1.1 million in the nine
months ended April 30, 2003. CSPR's gross margins were 17.7% in the nine months
ended April 30, 2004 and 19.7% in the nine months ended April 30, 2003. The
decrease in gross margin was primarily due to the including of $600,000 of
inventory reserve in the cost of goods sold to allow for the disposition of
excess inventory.
SELLING, GENERAL AND ADMINISTRATIVE
The operating expenses consist mainly of salaries of our sales, marketing,
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. Selling, general and
administrative expenses decreased 17.6% to $1.8 million in the nine months ended
April 30, 2004 from $2.2 million in the nine months ended April 30, 2003. The
decrease was primarily due to reductions in personnel, facilities, and
associated overhead resulting from the implementation of the Company's
restructuring plan.
INCOME TAX BENEFIT (EXPENSE)
No income tax benefit was recognized in the nine months ended April 30,
2004 or the nine months ended April 30, 2003 because CSPR cannot conclude that
it is whether or 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
13
repayments to eOn of $2.25 million since that date from operating revenues.
Management plans to consistently grow the Company at a moderate rate with the
purpose of minimizing the necessity of additional capital. However, if our
business begins to grow faster, CSPR may need additional capital. Such capital
may not be available on favorable terms and conditions.
As reported in the Company's 10Q for the period ended January 31, 2004,
the Company entered into an agreement with Cortelco, Inc. to sell 400,000 shares
of common stock for $0.27 per share for total proceeds of $108,000. The sale was
completed on March 22, 2004. The proceeds of the offering are to be used to fund
current operational and overhead expense of the Company. The Board of Directors
of the Company unanimously approved the sale, after considering the lack of
alternative sources of funds, the immediate need of the Company for additional
funding to continue operations, the expense and timing associated with a
registered offering of its securities to the general public and the prices at
which the stock has traded in the open market for the past year.
The Company continues to operate at or slightly below a "break even" point
disregarding reserves for excess inventory and past receivables that are
considered uncollectable. Therefore management plans include continuing its
reduction of operating costs and expenses while striving for an increase in
sales profits. However, the Company cannot assure that we will be successful
either in increasing sales of our products or in reducing expenditures.
Moreover, even if the Company is successful in improving our current cash flow
position, CSPR nonetheless will require additional funds to meet our short-term
and long-term needs. CSPR anticipates these funds will come from the proceeds of
private placements or public offerings of debt or equity securities, but the
Company cannot assure you that we will be able to obtain such funds. In the
matter of reducing expenditures, 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, Unified
Messaging and Digital Video Recording (DVR). Also, the Company is working toward
increasing its maintenance service contracts by assigning additional
salespersons to generate maintenance contracts for new customers and continuing
the renewal of the existing customers' contracts.
The Company goal is to improve cash flow and ultimately generate operating
profits. To improve cash flow, the Company has established stricter credit terms
for our customers, requiring larger down payments for new installation and
additions. Also in addition to having two dedicated persons in the collection
department; CSPR encourages the salesperson who has the direct contact with our
customer, to help in the collection of both current and overdue accounts.
Finally the Company is using collections agencies to attempt to collect those
accounts receivable, which are already allowed for. The Company expects that the
cash to pay our debt will come mainly from our trade accounts receivable net of
allowance, which is twice the amount of accounts payable trade. At this moment
the Company has been able to maintain the same credit terms with our trade
suppliers which facilities our ongoing business with them. Only two or three
smaller suppliers require COD terms. So as long as the Company can maintain our
accounts receivable collections in a timely basis, CSPR will continue to be able
to pay our suppliers. 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
14
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, and respond to competitive
pressures or any unanticipated requirements or even continuing operating our
business.
Net cash used in operating activities was approximately $46,000 and
$242,000 for the nine months ended April 30, 2004 and April 30, 2003,
respectively. Cash used in operating activities in the nine 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 investing activities was approximately $13,000 for the
nine months ended April 30, 2004 and net cash provided by investing activities
was approximately $3,000 for the same period in fiscal year 2003. Cash used in
investing activities in these nine months of the current fiscal year consisted
primarily of cash used for capital expenditures.
Net cash provided by financing activities was approximately $83,000 for
the nine months ended April 30, 2004 and net cash used in financing activities
was approximately $25,000 for the nine months ended April 30, 2003. Cash
provided by financing activities in these nine months of the current fiscal year
consisted primarily of increase of Capital Stock from the sale of 400,000 newly
issued shares of common stock at $0.27 as per agreement with Cortelco, Inc., a
company related by common ownership, partially offset by the $25,000 final
repayments of the note payable issued for the acquisition of certain assets
acquired from Ochoa Telecom in May 2001.
ADDITIONAL RISK FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
You should carefully consider the risks set forth in this Form 10-Q. 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.
OUR INDEPENDENT AUDITORS HAVE EXPRESSED SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO
CONTINUE AS A GOING CONCERN.
Our independent public accountants have expressed substantial doubt about
our ability to continue as a going concern in their report on our July 31, 2003
financial statements. Currently, our continuance as a going concern is dependent
upon our ability to improve profitability to the break even point, generate cash
from our account receivables on a timely basis and continued support from our
suppliers. Failing to do so the Company would have to raise capital from
external sources. CSPR does not expect to generate sufficient revenues to enable
us to offset the inventories and bad debts accounts written off (totaling
$800,000) to be profitable for fiscal year 2004. The Company may require
additional funding to continue our operations in order to achieve meaningful
sales volumes. In addition, CSPR must generate the necessary funds in order to
fully implement our business plan. Ultimately, the Company must achieve
profitable operations if the Company is to be a viable entity. CSPR plans to
increase our revenues in the sale of new products and in the maintenance and
service contracts that are competitive in our industry. But CSPR cannot assure
you that the Company will be able to obtain the results expected or that the
Company will be able to achieve, or maintain, a level of profitability
sufficient and a positive cash flow to meet our operating expenses, pay our
debts and continue as a going concern.
15
IF THE COMPANY IS NOT ABLE TO RESPOND TO THE RAPID CHANGES IN THE COMMUNICATION
SYSTEMS MARKET, OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION WILL BE
HARMED.
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 and Avaya. Although CSPR is aggressively entering into
the IP telephony market, we may not be able to increase our IP sales or train
our personnel rapidly enough to sell and service the newer products. If we do
not transform our sales and service quickly enough then our business, operating
results and financial condition will 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 a competitive
disadvantage, which could harm our business, operating results and financial
condition.
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. Some of the
distributors of these competing telecommunication and data products and services
have substantially greater financial resources, market presence, distribution
channels, advertising and marketing budgets 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
16
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.
The Company incurs 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.
THE LOSS OF KEY MANAGEMENT PERSONNEL, MAY ADVERSELY AFFECT OUR ABILITY TO
SUCCESSFULLY OPERATE THE BUSINESS.
Sergio Moren, CSPR's Chief Executive Officer and President resigned in
April 2004 and CSPR appointed Robert Schnabl as its interim Chief Executive
Officer and President. If CSPR is unable to find a permanent qualified
replacement for Mr. Moren, its future success could suffer. In addition, CSPR's
future performance will be substantially dependent on the continued services of
our 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.
17
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, Mitel, Cortelco, and others. However, the Company does not have
exclusive distribution agreements with these companies and competitors exist in
our major markets that sell most of these 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. 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 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, a fourth lawsuit in
which the Company was included as a Third Party Defendant, and a fifth lawsuit
regarding employment issues which was filed as a counterclaim at a unfair
competition and business operations claim CSPR filed against one of its
competitors, Envision Technologies. 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. The first court hearing in May, established a 15-day
period to submit CSPR's expert witness report and a total of 30 days (due June
30, 2004) for both parties to conclude all discovery proceedings. 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
18
fourth lawsuit, the Company reached an agreement with the other party defendant,
Ochoa Telecom, in which it was agreed that Ochoa would 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.
PRODUCT DEFECTS, SYSTEM FAILURES OR INTERRUPTIONS MAY HAVE A NEGATIVE IMPACT ON
OUR REVENUES, DAMAGE OUR REPUTATION AND DECREASE OUR ABILITY TO ATTRACT NEW
CUSTOMERS.
Errors and product defects can result in significant warranty and repair
problems, which could cause customer relations problems. Correcting product
defects requires significant time and resources, which could delay product
releases and affect market acceptance of our products. Any delivery by us of
products with undetected material product defects could harm our credibility and
market acceptance of our products.
THE PRODUCTS THE COMPANY SELLS AND SERVICES MAY HAVE UNDETECTED FAULTS LEADING
TO LIABILITY CLAIMS, WHICH COULD HARM OUR BUSINESS.
The products the Company sells and services may contain undetected faults
or failures. Any failures of these products could result in significant losses
to our customers, particularly in mission-critical applications. A failure could
also result in product returns and the loss of, or delay in, market acceptance
of our products. In addition, any failure of the product CSPR sells could result
in claims against us. Our purchase agreements with our customers typically
contain provisions designed to limit our exposure to potential product liability
claims. Although CSPR is unaware of any specific laws or cases that would
invalidate our purchase agreement limitation of liability provisions, there is a
risk that such provisions may not be effective as a result of federal, state or
local laws or ordinances or unfavorable judicial decisions in Puerto Rico or
other countries. CSPR maintains 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.
19
EXISTING SHAREHOLDERS MAY FACE DILUTION FROM OUR FINANCING EFFORTS.
If the Company is forced to raise additional capital from external sources
to execute our business plan by issuing debt securities, capital stock, or a
combination of these securities, the Company may not be able to sell these
securities, particularly under current market conditions. Even if CSPR is
successful in finding buyers for our securities, the buyers could demand high
interest rates or require us to agree to onerous operating covenants, which
could in turn harm our ability to operate our business by reducing our cash flow
and restricting our operating activities. If the Company was to sell our capital
stock, the Company might be forced to sell shares at a depressed market price,
which could result in substantial dilution to our existing shareholders.
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 890,029
shares, which in the aggregate represent approximately 56% 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.
20
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 does 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 was 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.
21
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
The Company entered into an agreement with Cortelco Inc. to sell 400,000
shares of common stock of the Company to Cortelco for $0.27 per share for total
proceeds of $108,000. The sale was completed on March 22, 2004.
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.
During the third quarter ended April 30, 2004, the Company reported the
following event on Form 8-K:
Date Filed or Furnished Item No Description
- ----------------------- ------- -----------
April 2, 2004 5 and 7 Press release reporting changes
in executive management and Board
of directors. Also reported the
agreement with Cortelco, Inc. to
sell 400,000 shares of common stock
of the Company
22
SIGNATURES
Pursuant to the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto authorized.
Cortelco Systems Puerto Rico, Inc.
Date: June 14, 2004 /s/ Francisco Sanchez
------------------------------------
Francisco Sanchez, Vice President
Chief Financial Officer, Secretary
Duly Authorized Officer
(Principal Financial and Accounting Officer)
23