Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

OR

Commission File Number: 000-26399

eOn Communications Corporation

(Exact name of registrant as specified in its charter)

(770) 423-2200

(Registrant’s telephone number, including area code)

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 and 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 12b-2 of the Exchange Act). Yes  ¨    No  x

12,895,559 shares of common stock, $0.01 par value, were outstanding as of May 31, 2005.

Table of Contents

EON COMMUNICATIONS CORPORATION

FORM 10-Q

QUARTER ENDED APRIL 30, 2005

TABLE OF CONTENTS

2

Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. – Financial Statements

EON COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share and per share information)

See accompanying notes to the condensed consolidated financial statements.

3

Table of Contents

EON COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except share and per share information)

(Unaudited)

See accompanying notes to the condensed consolidated financial statements.

4

Table of Contents

EON COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands, except share and per share information)

(Unaudited)

See accompanying notes to the condensed consolidated financial statements.

5

Table of Contents

EON COMMUNICATIONS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

For the Three Months and Nine Months Ended April 30, 2005 and 2004

The accompanying unaudited consolidated condensed financial statements have been prepared by eOn Communications Corporation (“eOn” or the “Company”). It is management’s opinion that these statements include all adjustments, consisting of only normal recurring adjustments necessary to present fairly the financial position, results of operations, and cash flows as of April 30, 2005 and for all periods presented.

Principles of Consolidation – The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, and include the accounts of the company’s majority owned subsidiary, Cortelco Shanghai. All significant inter-company balances and transactions have been eliminated in consolidation.

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 thereto as of July 31, 2004 and 2003 and for each of the three years in the period ended July 31, 2004, which are included in the Annual Report on Form 10-K filed with the Securities and Exchange Commission.

At April 30, 2005, the Company had three stock-based compensation plans for employees and an Employee Stock Purchase Plan (ESPP), which are more fully described in the Company’s Annual Report on Form 10-K for the year ended July 31, 2004. The Company accounts for those plans under the intrinsic value method, which follows the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the stock compensation plans had an exercise price equal to or greater than the market value of the underlying common stock on the grant date. Further, the ESPP is a non-compensatory plan under APB Opinion No. 25, and, as such, no compensation cost was recognized with respect to the ESPP.

The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation:

The fair value of shares and options issued pursuant to our stock-based compensation plans at the grant date were calculated using the Black-Scholes option pricing model as prescribed by SFAS No. 123 generally using the following weighted average assumptions; dividend yield 0.0%, expected volatility 100%, average risk free interest rate approximately 4.25%, and expected life in years 7.

Revenues from our products are recognized only when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price to the customer is fixed or determinable, and collectibility is reasonably assured. Generally, revenue is recognized (1) upon shipment for equipment and software, (2) as work is performed for professional

6

Table of Contents

services, and (3) in equal periodic amounts over the term of the contract for software and hardware maintenance. The Company believes that its revenue recognition policies are compliant with Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” and Statement of Position No. 97-2, “Software Revenue Recognition.”

The Company is affiliated with the following entities through common stockholder ownership:

The following represents related party transactions:

The following represents related party balances:

Shanghai Bell

The chairman of the Board of Directors of Shanghai Bell is also the chairman of the Board of Directors of Shanghai Fortune. Shanghai Fortune is the minority shareholder of the Company’s Cortelco Shanghai subsidiary. Shanghai Bell is Cortelco Shanghai’s largest customer and a significant supplier. Cortelco Shanghai buys various telecom equipment from different Shanghai Bell divisions for resale to third parties and Cortelco Shanghai sells, and installs various telecom equipment for Shanghai Bell divisions. Accounts receivable and accounts payable are usually settled in three to six months, sometimes by offset rather than payment in local currency. Payment terms on some installation projects are extended beyond one year from completion, reflecting a negotiated repayment schedule.

Cortelco International, Inc. and Cortelco Systems Holding Corporation

Cortelco International, Inc. (“CII”) is a subsidiary of Cortelco Systems Holding Corporation (“CSHC”) and a supplier of Millenium and eQueue peripheral hardware. Accounts payable are paid on thirty to sixty day terms. The Company has had no significant transactions with CSHC.

Sparks Technologies, Inc.

During the quarter ended April 30, 2005, the Company completed the acquisition of Aelix, a developer of telecommunications systems and applications based on internet protocol (“IP”) technology. The acquisition is not significant

7

Table of Contents

to our Company’s operations. The Company issued 10,000 eOn shares upon closing the acquisition and may issue up to an additional 215,000 over the six quarters after the closing date if Aelix attains specified product release schedules and eOn achieves specified product revenues. The number of shares to be issued may be adjusted upon the occurrence of certain events.

Aelix performs engineering development projects for Sparks Technologies, Inc (“Sparks”), a California company that is wholly owned by David Lee, the Chief Executive Officer and majority shareholder of eOn. Aelix has incurred approximately $35,000 of expenses on behalf of Sparks during the quarter ending April 30, 2005 (net of approximately $7,000 incurred by Sparks engineers on behalf of eOn). Included in Accounts Receivable – Related Party is $5,000 owed Aelix by Sparks on April 30, 2005.

Cortelco Shanghai also performs engineering development projects for Sparks. Cortelco Shanghai has incurred expenses of approximately $75,000 and $160,000 on behalf of Sparks during the three and nine months ended April 30, 2005, respectively. There was no amount owed Cortelco Shanghai by Sparks at April 30, 2005.

Sparks deposited $211,000 with the Company in China to pay for Sparks expenses. As of April 30, 2005, the balance of this deposit/prepayment is $164,000. This balance is included in the Company’s balance sheet as Cash and offset in Other Payable – Related Party.

Inventories consist of the following:

eOn generally provides customers a one year product warranty from the date of purchase. Cortelco Shanghai may provide a one year warranty, but generally does not provide specific product warranties and has experienced very low returns. The Company estimates the costs of satisfying warranty claims based on analysis of past claims experience and provides for these future claims in the period that revenues are recognized. The costs of satisfying warranty claims, which approximates 2% and 0.5% of revenues for eOn and Cortelco Shanghai, respectively, have historically been comprised of materials and direct labor costs. We perform quarterly evaluations of these estimates, and any changes in estimates, which could potentially be significant, are included in earnings in the period in which the evaluations are completed.

Information regarding the changes in the Company’s aggregate product warranty accrual included in accrued expenses and other, for the nine months ended April 30, 2005 and 2004 were as follows:

8

Table of Contents

The following represents the changes in stockholders’ equity for the nine months ended April 30, 2005:

At April 30, 2005, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $1.2 million.

The Company is involved in various matters of litigation, claims, and assessments arising in the ordinary course of business. In the opinion of management, the eventual disposition of these matters will not have a material adverse effect on the financial statements.

The status of the Company’s stock option plans since August 1, 2004 is as follows:

On June 1, 2004, eOn acquired a controlling interest in Cortelco Shanghai Telecom Equipment Company (“Cortelco Shanghai”), a provider of fiber optic transmission equipment, data communications systems, and network management software in China.

Under the terms of the agreement, eOn acquired all of the stock of Cortelco China Corp, a California corporation that owns a 54.14% ownership interest in Cortelco Shanghai, from Cortelco Systems Holding Corporation (“CSHC”). CSHC received 157,167 shares of eOn common stock valued at $321,250. The agreement anticipated that up to an additional 471,501 shares may be issued over the next four fiscal quarters if Cortelco Shanghai attained specified revenue targets as set forth in the purchase agreement.

The agreement specifies revenue targets for sales of eQueue products in China during the initial 12 month period following the close of the acquisition. From June 1, 2004 through April 30, 2005, eQueue revenues in China were $810,000. The Agreement provides that if a $2,000,000 revenue target is not met by May 31, 2005, either eOn or CSHC has the option to elect to unwind the acquisition. On March 14, 2005, eOn and CSHC executed a Letter Agreement eliminating this option in

9

Table of Contents

the agreement and agreed to further amend the agreement in light of a revised business plan to be finalized by May 15, 2005, to revise and extend the stock earnout schedule. eOn and CSHC are negotiating the terms for a revised Earnout Agreement.

The company is comprised of two principal business segments: eOn US and Cortelco Shanghai. The eOn US business segment designs, develops and markets communication products for customer contact centers and other applications and offers a traditional voice-switching platform. Cortelco Shanghai provides fiber optic transmission equipment, data communications systems, and network management software. There is no overlap in operational management reporting or of decision making authority between the two segments as defined. The Company acquired Cortelco Shanghai on June 1, 2004; accordingly, there is no comparative information for the three and nine months ended April 30, 2004. Business segment information for the three and nine months ended April 30, 2005 is as follows.

Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations

This report contains forward-looking statements within the meaning of the federal securities laws. Forward-looking statements are those that express management’s views of future events, developments, and trends. In some cases, these statements may be identified by terminology such as “may,” “will,” “should,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of such terms and other comparable expressions. Forward-looking statements include statements regarding our anticipated or projected operating performance, financial results, liquidity and capital resources. These statements are based on management’s beliefs, assumptions, and expectations, which in turn are based on the information currently available to management. Information contained in these forward-looking statements is inherently uncertain, and our actual operating performance, financial results, liquidity, and capital resources may differ materially due to a number of factors, most of which are beyond our ability to predict or control. Factors that may cause or contribute to such differences include, but are not limited to, eOn’s ability to compete successfully in its industry and to continue to develop products for new and rapidly changing markets. We also direct your attention to the risk factors affecting our business that are discussed below. eOn disclaims any obligation to update any of the forward-looking statements contained in this report to reflect any future events or developments. The following discussions should be read in conjunction with our condensed financial statements and the notes included thereto.

10

Table of Contents

Overview

We design, develop and market next-generation communications servers which integrate and manage voice, email and Internet communications for customer contact centers and other applications. We also offer a traditional voice-switching platform for small and medium-sized installations. We also offer fiber optic transmission equipment, data communications systems, and network management software through our subsidiary Cortelco Shanghai Telecom Equipment Company.

Critical Accounting Policies and Estimates

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties and that could potentially result in materially different results under different assumptions and conditions. We believe that our critical accounting policies are limited to those described below. For a detailed description of our accounting policies, see Note 2, “Summary of Significant Accounting Policies,” in Part II, Item 8, “Consolidated Financial Statements and Supplementary Data,” of our Annual Report on Form 10-K for the year ended July 31, 2004.

Revenue Recognition

Revenues from our products are recognized only when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price to the customer is fixed or determinable, and collectibility is reasonably assured. Generally, revenue is recognized (1) upon shipment for equipment and software, (2) as work is performed for professional services, and (3) in equal periodic amounts over the term of the contract for software and hardware maintenance. The Company believes that its revenue recognition policies are compliant with Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” and Statement of Position No. 97-2, “Software Revenue Recognition.”

Product Warranties

eOn generally provides customers a one year product warranty from the date of purchase. Cortelco Shanghai may provide a one year warranty, but generally does not provide specific product warranties and has experienced very low returns. We estimate the costs of satisfying warranty claims based on analysis of past claims experience and provide for these future claims in the period that revenue is recognized. The cost of satisfying warranty claims, which approximates 2% and 0.5% of revenues for eOn and Cortelco Shanghai, respectively, have historically been comprised of materials and direct labor costs. We perform quarterly evaluations of these estimates, and any changes in estimate, which could potentially be significant, are included in earnings in the period in which the evaluations are completed.

Inventory Obsolescence

We carry inventories at the lower of cost or market. This policy depends on the timely identification of those items included in inventory whose market price may have declined below carrying value, such as slow-moving or obsolete items, and we record any necessary valuation reserves. We perform an analysis of slow-moving or obsolete inventory on a quarterly basis, and any necessary valuation reserves, which could potentially be significant, are included in earnings in the period in which the evaluations are completed.

Allowance for Doubtful Accounts

We typically grant standard credit terms to customers in good credit standing. As a result, we must estimate the portion of our accounts receivable that are uncollectible and record any necessary valuation reserves. We generally reserve for estimated uncollectible accounts on a customer-by-customer basis, which requires us to make judgments about each individual customer’s ability and intention to fully pay balances payable to us. We make these judgments based on our knowledge of and relationship with our customers, and we update our estimates on a monthly basis. Any changes in estimate, which can be significant, are included in earnings in the period in which the change in estimate occurs.

Deferred Taxes

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Because of losses during the years 2000 through 2004, the Company has available net operating loss (“NOL”) carry forwards of $18.8 million.

Accounting principles generally accepted in the United States require the recording of a valuation allowance against the net deferred tax asset associated with this NOL and other timing differences if it is “more likely than not” that the Company will not be able to utilize the NOL to offset future taxes. Due to the size of the NOL carry forward in relation to the Company’s taxable income in recent years and to the continuing uncertainties surrounding future earnings, management has not recognized any of its net deferred tax asset. Because this asset has been offset by a valuation allowance, the Company currently provides for income taxes only to the extent of expected cash payments of taxes, primarily state income taxes, for current income.

11

Table of Contents

Should the Company’s earnings trend cause management to conclude that it is more likely than not the Company will realize all or a material portion of the NOL carry forward, management would record the estimated net realizable value of its deferred tax asset at that time. The Company would then provide for income taxes at a rate equal to its combined federal and state effective rates, which would approximate 39% under current tax rates. Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause the provision for income taxes to vary significantly from period to period, although the Company’s cash tax payments would remain unaffected until the benefit of the NOL is utilized.

Results of Operations

For the Three Months Ended April 30, 2005 compared to the Three Months Ended April 30, 2004

Net Revenue

Net revenue increased approximately 71% to $4.7 million for the three months ended April 30, 2005 compared to $2.8 million for the same period of the previous year. The increase resulted from the inclusion of Cortelco Shanghai revenue of $1.8 million and an increase in eQueue revenue of $0.4 million, partially offset by a $0.3 million decline in Millennium revenue. Revenue to related parties included in Cortelco Shanghai for the three months ended April 30, 2005 was $0.7 million compared to $0.0 for the same period of the previous year.

Cost of Revenue and Gross Profit

Cost of revenue is primarily comprised of purchases from our contract manufacturers and other suppliers and costs incurred for final assembly of our systems. Gross profit increased approximately 42% to $2.1 million for the three months ended April 30, 2005 from $1.5 million for the same period of the previous year, resulting from the inclusion of Cortelco Shanghai gross profit of $0.2 million and higher gross profit of $0.4 million from eQueue. Millennium gross profit was flat period over period. Gross margin decreased to approximately 46% for the three months ended April 30, 2005 compared with gross margin of approximately 55% for the same period of the previous year. This decrease was primarily due to the inclusion of Cortelco Shanghai operations which have lower margins. Related party cost of revenues was $0.6 million for the three months ended April 30, 2005 compared to $0.0 for the same period of the previous year.

Selling, General and Administrative

Selling, general and administrative expense consists primarily of salaries and benefit costs, advertising and trade show related costs, and facilities and other overhead expenses incurred to support our business. Selling, general and administrative expenses increased approximately 39% to $2.2 million for the three months ended April 30, 2005, from $1.6 million for the same period of the previous year. The increase was due to the inclusion of Cortelco Shanghai expenses of $0.5 million and an increase in domestic expenses of $0.1 million resulting from higher bad debt expense, partially offset by lower marketing and travel and entertainment expense.

Research and Development

Research and development expense consists primarily of personnel and related facility costs for our engineering staff. Research and development expenses decreased approximately 10% to $0.8 million for the three months ended April 30, 2005 from $0.9 million for the same period of the previous year. The decrease was the result of reduced international travel expenses.

Interest and other income and expense

Interest income was $33 thousand for the three months ended April 30, 2005 compared to $15 thousand for the same period of the previous year. Other income was $29 thousand for the quarter ended April 30, 2005 compared to other expense of $8 thousand for the same period of the previous year.

For the Nine Months Ended April 30, 2005 Compared to the Nine Months Ended April 30, 2004

Net Revenue

Net revenue increased approximately 41% to $16.6 million for the nine months ended April 30, 2005 from $11.8 million for the same period of the previous year. The increase resulted primarily from the inclusion of Cortelco Shanghai revenue of $6.5 million, partially offset by a combined decrease in Millennium and eQueue revenue of $1.7 million. Revenue to related parties included in Cortelco Shanghai was $1.8 million during the nine months ended April 30, 2005 compared to $0.0 for the same period of the previous year.

Cost of Revenue and Gross Profit

Cost of revenue is primarily comprised of purchases from our contract manufacturers and other suppliers and costs incurred for final assembly of our systems. Gross profit increased approximately 7% to $7.3 million for the nine months ended

12

Table of Contents

April 30, 2005 from $6.8 million for the same period of the previous year, primarily due to the inclusion of Cortelco Shanghai operations and a lower level of combined eQueue and Millennium revenues. Gross margin decreased to approximately 44% for the nine months ended April 30, 2005 from approximately 58% for the same period of the previous year, due to the inclusion of lower margin Cortelco Shanghai operations. Related party cost of revenue was $1.4 million in the nine months ended April 30, 2005 compared to $0.0 for the same period of the previous year.

Selling, General and Administrative

Selling, general and administrative expense consists primarily of salaries and benefit costs, advertising and trade show related costs, and facilities and other overhead expenses incurred to support our business. Selling, general and administrative expense increased approximately 19% to $6.0 million for the nine months ended April 30, 2005, from $5.1 million for the same period of the previous year. The increase was primarily due the inclusion of Cortelco Shanghai expenses of $1.3 million partially offset by a reduction in domestic spending associated with the Company’s cost-cutting initiatives.

Research and Development

Research and development expense consist primarily of personnel and related facility costs for our engineering staff. Research and development expense increased 8% to $2.4 million for the nine months ended April 30, 2005 from $2.2 million for the same period of the previous year. The increase was the result of increased engineering headcount during the first fiscal quarter of 2005 to focus on product development for future generation products and expenses related to product certification in China.

Interest and other income and expense

Interest income was $104 thousand for the nine months ended April 30, 2005 compared to $47 thousand for the same period of the previous year. The increase was primarily due to higher interest rates earned on investments in the current period compared to the prior year period. During the nine months ended April 30, 2004, the Company incurred interest expense of $26 thousand. The interest expense was related to the expiration of the company’s obligations associated with the termination of the lease on the Memphis facility during fiscal year 2004. Other income was $59 thousand for the current nine months compared to expense of $59 thousand for the same period of the previous year.

Liquidity and Capital Resources

As of April 30, 2005, we had cash and cash equivalents of $4.3 million, $3.6 million in short term investments, and working capital of $8.9 million. Our short term investments are primarily invested in taxable auction rate securities with frequent rate resets.

Our operating activities resulted in a net cash outflow of $0.7 million for the nine months ended April 30, 2005 compared to a net cash out flow of $1.3 million for the same period of the previous year. The net operating cash outflow for the current period was primarily the result of a net loss for the period, a reduction in accounts payable partially offset by a reduction in accounts receivable. The net operating cash outflow for the prior year period was primarily the result of a reduction in accrued expenses, an increase in accounts receivable and inventory and a decline in accrued expenses, partially offset by our net loss (adjusted for non-cash items).

Our investing activities resulted in a net cash inflow of $0.3 million for the nine months ended April 30, 2005 compared to a net cash outflow of $0.1 million for the same period of the previous year. Cash provided by investing activities in the current period consisted primarily of $0.6 million from the sale of short term marketable securities, offset by $0.3 million in net capital expenditures. Cash used in investing activities in the prior period consisted of $0.2 million in net capital expenditures partially offset by $0.1 million in disposals of property and equipment.

Our financing activities resulted in a cash inflow of $0.1 million for the nine months ended April 30, 2005 compared to a cash inflow of $0.1 million for the same period of the previous year. Cash provided by financing activities in the current period was due to proceeds from stock option exercises and purchases under the Employee Stock Purchase Plan. Cash provided by financing activities in the prior period consisted of $0.6 million in proceeds from stock option exercises and purchases under the Employee Stock Purchase Plan, offset by payments against our outstanding note payable of $0.5 million.

Liquidity

Since inception, the Company has financed its operations through debt financing and proceeds generated from public offerings of its common stock. The proceeds from these transactions have been used primarily to fund research and development costs, and selling, general and administrative expenses. Additionally, since inception, the Company has invested $4.5 million in capital expenditures.

13

Table of Contents

The Company has incurred substantial net operating losses since inception and negative cash flows from operating activities through July 31, 2004; resulting in an accumulated deficit of $43.4 million. During the second fiscal quarter of 2001, the Company adopted a restructuring plan, which included headcount reductions and office space consolidation to reduce costs and improve productivity. During fiscal year 2004, cash and cash equivalents and short term investments increased from $7.4 million to $8.7 million, primarily reflecting $3.1 million of cash acquired from Cortelco Shanghai, partially offset by an operating loss of $0.9 million.

The Company incurred a loss from continuing operations of $1.1 million for the nine months ended April 30, 2005 versus loss from operations of $0.5 million for the same period in the prior year. As of April 30, 2005, the Company had $4.8 million in cash and cash equivalents and short term investments in the United States available to fund operations, and Cortelco Shanghai had $3.1 million in cash and cash equivalents to fund its operations.

The Company is dependent on available cash, short-term investments and operating cash flow to finance operations and meet its other capital needs. If such sources are not sufficient, alternative funding sources may not be available. The Company believes that cash on hand and short-term marketable securities plus the additional liquidity that it expects to generate from operations will be sufficient to cover its working capital and fund expected capital expenditures over at least the next twelve months.

Capital Resources

We have principally relied on the proceeds from equity and cash provided from operations as our primary sources of capital. While we do not currently anticipate the need to raise additional capital to meet our operating and capital expenditure requirements in the foreseeable future, our funding status is dependent on a number of factors influencing projections of operating cash flows, including those related to profit margins, controlling selling, general and administrative costs and research and development costs. Further, we believe that the cash and short-term investment securities on hand plus the additional liquidity that we expect to generate from operations will be sufficient to meet the cash requirements of the business including capital expenditures, cash interest payments and working capital needs for at least the next twelve months. Should actual results differ significantly from our current assumptions, our liquidity position could be adversely affected and we could be in a position that would require us to raise additional capital, which may not be available to us or may not be available on acceptable terms.

Commitments and Contingencies

At April 30, 2005, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $1.2 million.

The Company is involved in various matters of litigation, claims, and assessments arising in the ordinary course of business. In the opinion of management, the eventual disposition of these matters will not have a material adverse effect on the financial statements.

Additional Risk Factors That May Affect Future Results of Operations

The following risk factors and other information contained in this report should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that are not currently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occurs, our business, financial condition, and operating results could be materially adversely affected.

In addition to the other information included in this report, the following factors should be considered in evaluating our business and future prospects.

Fluctuations in our quarterly operating results could cause our stock price to decline.

Future operating results are likely to fluctuate significantly from quarter to quarter. Factors that could affect our quarterly operating results include:

14

Table of Contents

Our quarterly operating results are also likely to fluctuate due to seasonal factors. Some of our vertical markets, such as the U.S. government, educational and retail buyers, follow seasonal buying patterns and do not make substantial purchases during the quarters ending January 31. Thus, revenues in the quarters ending January 31 are often lower than in the previous quarters. Because of these and other factors, our operating results may not meet expectations in some future quarters, which could cause our stock price to decline.

Our communications servers face intense competition from many companies that have targeted our markets.

The competitive arena for our products is changing very rapidly and we face intense competition in our markets. Well-established companies and many emerging companies are scrambling to develop products to improve customer service in e-commerce. While the industry remains fragmented, it is rapidly moving toward consolidation, driven by both emerging companies’ desires to expand product offerings and resources and established companies’ attempts to acquire new technology and reach new market segments. A number of emerging companies have completed initial public offerings, while many more remain private. More established competitors, as well as those emerging companies that have completed initial public offerings, currently have greater resources and market presence than we do. Additionally, a number of our current and potential competitors have recently been acquired by larger companies who seek to enter our markets.

We expect competition to intensify as competitors develop new products, new competitors enter the market, and companies with complementary products enter into strategic alliances.

Our current and potential competitors can be grouped into the following categories:

Many of our current and potential competitors have significantly greater financial, technical, marketing, customer service and other resources, greater name and brand recognition and a larger installed customer base than we do. Therefore, our competitors may be able to respond to new or emerging technologies and changes faster than we can. They may also be able to devote greater resources to the development, promotion and sale of their products.

Actions by our competitors could result in price reductions, reduced margins and loss of market share, any of which would damage our business. We cannot assure you that we will be able to compete successfully against these competitors.

If we cannot expand our indirect sales channel to sell our eQueue products, our ability to generate revenue would be harmed.

We sell our eQueue communications servers both directly and indirectly through dealers and value added resellers that have experience in data as well as voice communications. We may not be able to expand this indirect sales channel. In addition, new distribution partners may devote fewer resources to marketing and supporting our products than to our competitors’ products and could discontinue selling our products at any time in favor of our competitors’ products or for any other reason.

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 four to twelve months for our eQueue products and from one to six months for our Millennium voice switching platform. The purchase of our products may involve a significant commitment of our customers’ time, personnel, and financial and other resources. Also, it is difficult to predict the timing of indirect sales because we have little control over the selling activities of our dealers and value added resellers.

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

Unanticipated difficulties in integrating our recent acquisition of Cortelco Shanghai could harm our business.

On June 1, 2004 eOn purchased a controlling interest in Cortelco Shanghai. Cortelco Shanghai provides telecommunications products in China, including fiber optic transmission equipment, data communications systems, and network management software. eOn’s future operating results may be adversely affected if we are not able to realize operating efficiencies and sales opportunities as a result of this acquisition.

15

Table of Contents

We face many risks from expanding into foreign markets.

The Company expects to increase sales to customers outside of the United States and establish additional distribution channels in Asia. However, foreign markets for our products may develop more slowly than currently anticipated. eOn may not be able to successfully establish international distribution channels, or may not be able to hire the additional personnel necessary to support such distribution channels.

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

Because our growth initiatives include expansion into foreign markets, we are subject to the risks of conducting business outside of the United States, including:

Our products must respond to rapidly changing market needs and integrate with changing protocols to remain competitive.

The markets for our products are characterized by rapid technological change, frequent new product introductions, uncertain product life cycles and changing customer requirements. If we are not able to rapidly and efficiently develop new products and improve existing products to meet the changing needs of our customers and to adopt changing communications standards, our business, operating results and financial condition would be harmed.

Key features of our products include integration with standard protocols, computer telephony integration and automatic call distribution applications and protocols, operating systems and databases. If our products cannot be integrated with third-party technologies or if they do not respond to changing market needs, we could be required to redesign our products. Redesigning any of our products may require significant resources and could harm our business, operating results and financial condition.

If we are not able to sustain our Millennium voice switching platform revenues, our business, operating results and financial condition could be harmed.

We may not be able to sustain our Millennium revenues because the traditional private branch exchange (PBX) market, which accounts for a substantial portion of our Millennium revenues, is declining. One reason for the decline of the traditional PBX market is the emergence of voice switching platforms based on standard PCs. If we are not able to grow or sustain our Millennium voice switching platform revenues, our business, operating results and financial condition could be harmed.

In addition, a significant portion of Millennium revenues are derived from dealers and value added resellers who have no obligation to sell our products. Therefore, dealers and value added resellers could discontinue selling our products at any time in favor of our competitors’ products or for any other reason. A reduction or loss of orders from our dealers and value added resellers could harm our business, operating results and financial condition.

Delayed deliveries of components from our single source suppliers or third-party manufacturers could reduce our revenues or increase our costs.

We depend on sole source suppliers for certain components, digital signal processors and chip sets, and voice processor boards. Interruptions in the availability of components from our key suppliers could result in delays or reductions in product shipments, which could damage our customer relationships and harm our operating results. Finding alternate suppliers or modifying product designs to use alternative components may cause delays and expenses. Further, a significant increase in the price of one or more third-party components or subassemblies could reduce our gross profit.

We depend upon our primary contract manufacturers ACT Electronics, Innovative Circuits, and Clover Electronics. We may not be able to deliver our products on a timely basis if any of these manufacturers fail to manufacture our products and deliver them to us on time. In addition, it could be difficult to engage other manufacturers to build our products. Our business, results of operations and financial condition could be harmed by any delivery delays.

16

Table of Contents

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

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

Our business could be harmed if we lose principal members of our management team.

We are highly dependent on the continued service of our management team. The loss of any key member of our management team may substantially disrupt our business and could harm our business, results of operations and financial condition. In addition, replacing management personnel could be costly and time consuming.

We are effectively controlled by our principal stockholders and management, which may limit your ability to influence stockholder matters.

As of April 30, 2005, our executive officers, directors and principal stockholders and their affiliates beneficially owned 3,676,296 shares, or 28.6% of the outstanding shares of common stock. Thus, they effectively control us and direct our affairs, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying, deferring or preventing a change in control of our company and some transactions may be more difficult or impossible without the support of these stockholders. The interests of these stockholders may conflict with those of other stockholders. We also conduct transactions with businesses in which our principal stockholders maintain interests. We believe that these transactions have been conducted on an arm’s length basis, but we cannot assure you that these transactions would have the same terms if conducted with unrelated third parties.

We may not be able to protect our intellectual property, and any intellectual property litigation could be expensive and time consuming.

Our business and competitive position could be harmed if we fail to adequately protect our intellectual property. Although we have filed patent applications, we are not certain that our patent applications will result in the issuance of patents, or that any patents issued will provide commercially significant protection to our technology. In addition, as we grow and gain brand recognition, our products are more likely to be subjected to infringement litigation. We could incur substantial costs and may have to divert management and technical resources in order to respond to, defend against, or bring claims related to our intellectual property rights. In addition, we rely on a combination of patent, trademark, copyright and trade secret laws and contractual restrictions to establish and protect our proprietary rights. These statutory and contractual arrangements may not provide sufficient protection to prevent misappropriation of our technology or to deter independent third-party development of similar technologies. Any litigation could result in our expenditure of funds, management time and resources.

Our products may have undetected faults leading to liability claims, which could harm our business.

Our products may contain undetected faults or failures. Any failures of our 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 our products 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. However, the limitation of liability provisions contained in our purchase agreements may not be effective as a result of federal, state or local laws or ordinances or unfavorable judicial decisions in the United States or other countries. We maintain insurance to protect against certain claims associated with the use of our products, but our insurance coverage may not adequately cover all possible claims asserted against us. In addition, even claims that ultimately are unsuccessful could be expensive to defend and consume management time and resources.

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

Our board of directors has the authority to issue up to 10,000,000 shares of preferred stock and to determine the preferences, rights and privileges of those shares without any further vote or action by the stockholders. The rights of the holders of common stock may be harmed by the rights of the holders of any preferred stock that may be issued in the future. 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.

Future sales of shares may decrease our stock price.

Sales of substantial amounts of our common stock in the public market, including shares issued upon the exercise of outstanding options, or the perception that such sales could occur, could reduce the market price of our common stock. These sales also might make it more difficult for us to raise funds through future offerings of common stock.

17

Table of Contents

Item 3. – Qualitative and Quantitative Disclosure About Market Risk.

The majority of our cash equivalents and marketable securities are invested in variable rate instruments with frequent rate resets. Because these securities have short effective maturities, we believe the market risk for such holdings is insignificant.

Item 4. – Disclosure Controls and Procedures

Evaluation of disclosure controls and procedures. Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in internal control over financial reporting. There were changes in internal control over financial reporting that occurred during the three month period ending April 30, 2005 to remediate the ineffective disclosure controls and procedures described in the January 31, 2005 10-Q that materially affected the Company’s internal control over financial reporting as follows:

In addition, as part of our ongoing plan to improve internal controls at Cortelco Shanghai we implemented the following internal controls during the first and second quarter:

PART II - OTHER INFORMATION

Item 1. – Legal Proceedings

None.

Item 2. – Changes in Securities and Use of Proceeds

None.

Item 3. – Defaults Upon Senior Securities

None.

Item 4. – Submission of Matters to a Vote of Security Holders

None.

Item 5. – Other Information

None.

18

Table of Contents

Item 6. – Exhibits.

19

Table of Contents

SIGNATURE

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.

20