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Table of Contents
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 QUARTERLY PERIOD ENDED April 30, 2011. |
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
Commission File Number: 000-26399
eOn Communications Corporation
(Exact name of registrant as specified in its charter)
| Delaware | 62-1482176 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification Number) | |
| 1703 Sawyer Road Corinth, MS |
38834 | |
| (Address of principal executive offices) | (Zip code) | |
(408) 694-3339
(Registrant’s telephone number, including area code)
Check whether the issuer: (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 past 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. x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ¨ Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filler, a non-accelerated filer, or a small reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer ¨ | Accelerated filer ¨ | |
| Non-accelerated filer ¨ | Small reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
2,864,405 shares of common stock, $0.005 par value, were outstanding as of May 31, 2011.
Table of Contents
EON COMMUNICATIONS CORPORATION
FORM 10-Q
QUARTER ENDED APRIL 30, 2011
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EON COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share amounts)
| April 30, 2011 |
July 31, 2010 |
|||||||
| (unaudited) | ||||||||
| ASSETS |
||||||||
| Current assets: |
||||||||
| Cash and cash equivalents |
$ | 1,847 | $ | 4,108 | ||||
| Trade accounts receivable, net of allowance of $339 and $235, respectively |
4,040 | 4,168 | ||||||
| Trade accounts receivable—related party |
— | 8 | ||||||
| Inventories |
5,798 | 4,948 | ||||||
| Prepaid and other current assets |
316 | 257 | ||||||
| Total current assets |
12,001 | 13,489 | ||||||
| Property and equipment, net |
236 | 279 | ||||||
| Intangibles, net |
927 | 847 | ||||||
| Investments |
990 | 990 | ||||||
| Total assets |
$ | 14,154 | $ | 15,605 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY |
||||||||
| Current liabilities: |
||||||||
| Trade accounts payable |
$ | 2,181 | $ | 2,361 | ||||
| Notes payable—related party |
594 | 674 | ||||||
| Accrued expenses and other |
1,520 | 1,977 | ||||||
| Total current liabilities |
4,295 | 5,012 | ||||||
| Notes payable—related party, net of current portion |
3,104 | 3,647 | ||||||
| Total liabilities |
7,399 | 8,659 | ||||||
| Commitments and contingencies |
||||||||
| Stockholders’ equity: |
||||||||
| Preferred stock, $0.001 par value, (10,000,000 shares authorized, no shares issued and outstanding) |
— | — | ||||||
| Common stock, $0.005 par value (10,000,000 shares authorized, 3,003,985 and 2,989,269 shares issued, respectively) |
15 | 15 | ||||||
| Additional paid-in capital |
56,273 | 56,269 | ||||||
| Treasury stock, at cost (139,580 shares) |
(1,503 | ) | (1,503 | ) | ||||
| Accumulated deficit |
(48,710 | ) | (48,389 | ) | ||||
| Accumulated other comprehensive income |
112 | 110 | ||||||
| Total eOn Communications Corp. stockholders’ equity |
6,187 | 6,502 | ||||||
| Noncontrolling interest |
568 | 444 | ||||||
| Total stockholders’ equity |
6,755 | 6,946 | ||||||
| Total liabilities and stockholders’ equity |
$ | 14,154 | $ | 15,605 | ||||
See accompanying notes to the condensed consolidated financial statements.
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EON COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Amounts in thousands, except per share amounts)
(Unaudited)
| Three Months Ended April 30, |
Nine Months Ended April 30, |
|||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| REVENUE |
||||||||||||||||
| Net revenue |
$ | 5,561 | $ | 3,535 | $ | 17,111 | $ | 11,455 | ||||||||
| COST OF REVENUE |
||||||||||||||||
| Cost of revenue |
3,882 | 2,229 | 12,050 | 7,244 | ||||||||||||
| Gross profit |
1,679 | 1,306 | 5,061 | 4,211 | ||||||||||||
| OPERATING EXPENSE |
||||||||||||||||
| Selling, general and administrative |
1,413 | 995 | 4,405 | 3,173 | ||||||||||||
| Research and development |
121 | 141 | 391 | 395 | ||||||||||||
| Other expenses |
(1 | ) | 22 | 19 | 47 | |||||||||||
| Total operating expense |
1,533 | 1,158 | 4,815 | 3,615 | ||||||||||||
| Income from operations |
146 | 148 | 246 | 596 | ||||||||||||
| OTHER INCOME (EXPENSE) |
||||||||||||||||
| Interest income (expense), net |
56 | (149 | ) | (238 | ) | (499 | ) | |||||||||
| Equity in earnings of unconsolidated investee |
— | 2 | — | 51 | ||||||||||||
| Total other income (expense) |
56 | (147 | ) | (238 | ) | (448 | ) | |||||||||
| Income before income taxes |
202 | 1 | 8 | 148 | ||||||||||||
| Income tax expense (benefit) |
24 | 2 | 24 | (19 | ) | |||||||||||
| Net income (loss) from continuing operations |
178 | (1 | ) | (16 | ) | 167 | ||||||||||
| DISCONTINUED OPERATIONS |
||||||||||||||||
| Loss from discontinued operations |
— | (46 | ) | (232 | ) | (83 | ) | |||||||||
| Net income (loss) |
178 | (47 | ) | (248 | ) | 84 | ||||||||||
| Less: Net income attributable to noncontrolling interest |
47 | — | 73 | — | ||||||||||||
| Net income (loss) attributable to common shareholders |
$ | 131 | $ | (47 | ) | $ | (321 | ) | $ | 84 | ||||||
| COMPREHENSIVE (LOSS) INCOME |
||||||||||||||||
| Net income (loss) |
$ | 131 | $ | (47 | ) | $ | (321 | ) | $ | 84 | ||||||
| Unrealized gains on available-for-sale securities |
— | 1 | — | 5 | ||||||||||||
| Foreign currency translation adjustment |
— | — | 2 | — | ||||||||||||
| Comprehensive income (loss) |
$ | 131 | $ | (46 | ) | $ | (319 | ) | $ | 89 | ||||||
| Weighted average shares outstanding |
||||||||||||||||
| Basic |
2,862 | 2,756 | 2,859 | 2,743 | ||||||||||||
| Diluted |
2,864 | 2,756 | 2,859 | 2,745 | ||||||||||||
| Basic income (loss) per share: |
||||||||||||||||
| From continuing operations |
$ | 0.05 | $ | — | $ | (0.03 | ) | $ | 0.06 | |||||||
| From discontinued operations |
— | (0.02 | ) | (0.08 | ) | (0.03 | ) | |||||||||
| Basic income (loss) per share |
$ | 0.05 | $ | (0.02 | ) | $ | (0.11 | ) | $ | 0.03 | ||||||
| Diluted income (loss) per share: |
||||||||||||||||
| From continuing operations |
$ | 0.05 | $ | — | $ | (0.03 | ) | $ | 0.06 | |||||||
| From discontinued operations |
— | (0.02 | ) | (0.08 | ) | (0.03 | ) | |||||||||
| Diluted income (loss) per share |
$ | 0.05 | $ | (0.02 | ) | $ | (0.11 | ) | $ | 0.03 | ||||||
See accompanying notes to the condensed consolidated financial statements.
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EON COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
| Nine Months Ended April 30, |
||||||||
| 2011 | 2010 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: |
||||||||
| Net (loss) income |
$ | (248 | ) | $ | 84 | |||
| Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: |
||||||||
| Stock-based compensation expense |
36 | — | ||||||
| Depreciation and amortization |
235 | 144 | ||||||
| Provision for doubtful accounts |
107 | (3 | ) | |||||
| Loss on disposal of property and equipment |
14 | — | ||||||
| Imputed interest expense on notes payable |
239 | 499 | ||||||
| Equity in earnings of unconsolidated investee |
— | (51 | ) | |||||
| Changes in net assets and liabilities: |
||||||||
| Trade accounts receivable |
21 | 951 | ||||||
| Trade accounts receivable/payable—related party |
8 | 212 | ||||||
| Inventories |
(850 | ) | 184 | |||||
| Prepaid and other assets |
(59 | ) | 64 | |||||
| Trade accounts payable |
(180 | ) | (305 | ) | ||||
| Accrued expenses and other |
(459 | ) | (447 | ) | ||||
| Net cash (used in) provided by operating activities |
(1,136 | ) | 1,332 | |||||
| CASH FLOWS FROM INVESTING ACTIVITIES: |
||||||||
| Purchases of property and equipment |
(68 | ) | (14 | ) | ||||
| Capitalized software development costs |
(218 | ) | (424 | ) | ||||
| Net cash used in investing activities |
(286 | ) | (438 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES: |
||||||||
| Repayment of note payable |
(860 | ) | (1,381 | ) | ||||
| Proceeds from employee stock purchase plan |
19 | 11 | ||||||
| Proceeds from stock warrant exercise |
— | 2 | ||||||
| Net cash used in financing activities |
(841 | ) | (1,368 | ) | ||||
| Effect of exchange rate changes on cash |
2 | — | ||||||
| Net decrease in cash and cash equivalents |
(2,261 | ) | (474 | ) | ||||
| Cash and cash equivalents, beginning of period |
4,108 | 3,010 | ||||||
| Cash and cash equivalents, end of period |
$ | 1,847 | $ | 2,536 | ||||
| Supplemental cash flow information: |
||||||||
| Interest paid |
$ | 310 | $ | 597 | ||||
See accompanying notes to the condensed consolidated financial statements.
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EON COMMUNICATIONS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
For the Three and Nine Months Ended April 30, 2011 and 2010
| 1. | Basis of Presentation |
The accompanying unaudited condensed consolidated 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, 2011, and for all periods presented.
Description of Business
eOn is a global provider of communications solutions enabling its customers to communicate more effectively. eOn’s offerings are built on reliable open architectures that enable easy adoption of emerging technologies, such as Voice over Internet Protocol (VoIP) and concepts such as Service Oriented Architecture (SOA). The Company’s Cortelco product line provides customer premise equipment (CPE) commercial grade telephone products primarily for use in businesses, government agencies, colleges and universities, telephone companies, and utilities. Cortelco Systems Puerto Rico’s operations include the sale and service of integrated communications systems, data equipment, security products, and telephony billing services.
Interim Condensed Consolidated Financial Statements
The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, and include the accounts of eOn Communications Corporation, eOn Communications (Beijing) Corporation Limited (“eOn China”), Cortelco Systems Holding Corp. (“Cortelco”) acquired on April 1, 2009 and Cortelco Systems Puerto Rico (“CSPR”), control of which was acquired on June 9, 2010. 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 consolidated financial statements be read in conjunction with the financial statements and notes thereto as of July 31, 2010 and 2009 and for each of the two years in the period ended July 31, 2010, which are included in the Annual Report on Form 10-K filed with the Securities and Exchange Commission.
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 amounts of assets and liabilities and disclosures 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.
Fair Value Measurements
Accounting standards define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact, and considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of non performance.
Accounting standards have established a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Accounting standards have established three levels of inputs that may be used to measure fair value:
| Level 1: | Quoted prices in active markets for identical assets and liabilities. |
| Level 2: | Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets with insufficient volume or infrequent transactions (less active markets), or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities. |
| Level 3: | Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity). |
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The Company’s cash equivalent instruments, primarily money market securities and U.S. Treasury Securities, are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices.
As of April 30, 2011, the carrying value of the Company’s investment in Symbio Investment Corporation (“Symbio”) was $990,000. The fair value of the Company’s investment in Symbio was not estimated as there were no events or changes in circumstances that may have a significant adverse effect on the fair value of the investment, and the Company’s management determined that it was not practicable to estimate the fair value of the investment. There are no quoted market prices for the Company’s investment in Symbio, and sufficient information is not readily available for the Company to utilize a valuation model to determine its fair value without incurring excessive costs relative to the materiality of the investment. The Company’s cost method investment is evaluated, on at least a quarterly basis for potential other-than-temporary impairment, or when an event of change in circumstances has occurred, that may have a significant adverse effect on the fair value of the investment.
Impairment indicators the Company considers in each reporting period include the following: whether there has been a significant deterioration in earnings performance, asset quality or business prospects; a significant adverse change in the regulatory, economic, or technological environment; a significant adverse change in the general market condition or geographic area in which the investment operates; industry and sector performance; current equity and credit market conditions; any bona fide offers to purchase the investment for less than the carrying value; and factors that raise significant concern, such as negative cash flow from operations or working capital deficiencies. Future changes in market conditions, the future performance of the investment, or new information provided by Symbio’s management could affect the recorded value of the investment and the amount realized upon liquidation.
The note payable to the former Cortelco shareholders (Note 6) is valued each period end using a discounted cash flow analysis of the projected future payments of Cortelco using a discount rate of 15.22%. The note is classified within Level 3 of the fair value hierarchy. Projected future payments are evaluated at each reporting period and are significantly impacted by seasonal changes in inventory and vendor and customer payments. The following represents transactions related to the note payable for the nine months ended April 30, 2011 (in thousands):
| Beginning fair value - August 1, 2010 |
$ | 4,159 | ||
| Imputed interest |
414 | |||
| Change in estimates |
(185 | ) | ||
| Interest expense |
229 | |||
| Payments |
(860 | ) | ||
| Ending fair value - April 30, 2011 |
$ | 3,528 | ||
Income Taxes
Due to uncertainties surrounding the timing of realizing the benefits of its net favorable tax attributes in future returns, to the extent that it is more likely than not that deferred tax assets may not be realized, the Company continues to record a valuation allowance against substantially all of its deferred tax assets at April 30, 2011.
Software Development Costs
The Company capitalizes costs in developing software products upon determination that technological feasibility has been established for the product, if that product is to be sold, leased or otherwise marketed. Costs incurred prior to the establishment of technological feasibility are charged to research and development expense. When the product or enhancement is available for general release to customers, capitalization is ceased, and previously capitalized costs are amortized based on current and anticipated future revenues for the product, but with an annual amortization amount at least equal to the straight-line amortization over an estimated economic life of five years. The Company’s unamortized software cost at April 30, 2011 and July 31, 2010 was $927,000 and $847,000, respectively, and is included in intangibles, net in the accompanying condensed consolidated balance sheets. On September 30, 2010, the Company announced the availability of the eConn IP-PBX. Consequently, amortization of approximately $107,000 related to the eConn IP-PBX is included in cost of revenue for the nine months ended April 30, 2011. Additional software is under development and is expected to be available for general release to customers in fiscal 2012, at which time the Company will begin amortizing it.
Recently Issued and Adopted Accounting Standards
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In October 2009, the FASB issued authoritative guidance on revenue recognition that becomes effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued authoritative guidance on revenue arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance. Under the new guidance, when vendor-specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. The Company adopted this guidance on August 1, 2010. The adoption of guidance had no impact on its consolidated financial statements.
Reclassification
Certain amounts in the April 30, 2010 condensed consolidated financial statements have been reclassified to conform to the April 30, 2011 condensed consolidated financial statement presentation.
| 2. | Stock Based Compensation |
Equity Incentive Plans
The Company’s Equity Incentive Plans, adopted in fiscal years 1997, 1999 and 2001, authorize the granting of incentive stock options, supplemental stock options, stock bonuses, and restricted stock purchase agreements to officers, directors, and employees of the Company and to non-employee consultants. The board of directors has declared that no future grants will be made under the plan adopted in 1997. Incentive stock options are granted only to employees and are issued at prices not less than 100% of the fair market value of the stock at the date of grant. The options generally vest over a four-year period and the term of any option cannot be greater than ten years from the date of grant. Restricted stock purchase agreements are issued at prices not less than 85% of the fair market value of the stock at the date of grant. During the nine months ended April 30, 2011, there were no options to purchase shares of common stock and no restricted stock granted by the Company.
The Company’s majority-owned subsidiary, CSPR, issued previously held treasury stock to management and directors of CSPR as compensation in the quarter ended October 31, 2010. The stock, valued at $36,000, is recorded as expense in the nine months ended April 30, 2011.
Employee Stock Purchase Plan
The Employee Stock Purchase Plan permits employees to purchase up to 200,000 shares of the Company’s common stock. The purchase price under this plan is 85% of the fair market value of the common stock at the beginning of an offering period or on a purchase date, whichever is less. Offering periods generally last one year with purchase dates six and twelve months from the beginning of an offering period. During the nine months ended April 30, 2011, employees purchased 14,716 shares under the plan.
Determining Fair Value
The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model. Expected volatilities are based on historical daily closing prices adjusted for expected future volatility. The Company believes that implied volatility is more reflective of market conditions and a better indicator of expected volatility than historical volatility. The Company uses historical information to calculate the expected life of option grants. The Company believes that historical information is currently reflective of the economic life of outstanding option grants. The dividend yield is determined by dividing the expected per share dividend during the coming year by the average fair market value of the stock during the quarter. The Company has not historically declared any cash dividends on its common stock, and currently intends to retain any retained earnings to finance the operation and expansion of the business and therefore does not expect to pay cash dividends on the common stock in the foreseeable future. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. The estimated fair value of the employee stock options are amortized to expense using the straight-line method over the vesting period.
Stock-based compensation of approximately $36,000 was recognized for the nine months ended April 30, 2011. As of April 30, 2011, the Company has total unrecognized compensation cost of approximately $1,000 related to unvested stock options under the Plans.
General Stock Option Information
Activity in the Company’s stock option plans since July 31, 2010 is as follows:
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| Shares Available for Grant |
Options Outstanding |
Weighted Average Exercise Price |
||||||||||
| Options at July 31, 2010 |
245,253 | 131,024 | $ | 9.33 | ||||||||
| Granted |
— | — | — | |||||||||
| Exercised |
— | — | — | |||||||||
| Cancelled |
36,203 | (36,203 | ) | 8.63 | ||||||||
| Options at April 30, 2011 |
281,456 | 94,821 | $ | 9.60 | ||||||||
Information regarding the stock options outstanding under the Company’s stock option plans at April 30, 2011 is summarized as follows:
| Range of Exercise Prices |
Outstanding at April 30 2011 |
Weighted Average Remaining Contractual Term |
Weighted Average Exercise Price |
Exercisable at April 30 2011 |
Weighted Average Exercise Price |
|||||||||||||||
| $ 0.00 – $ 5.00 |
11,888 | 2.4 years | $ | 3.25 | 10,950 | $ | 3.48 | |||||||||||||
| $ 5.01 – $10.00 |
51,600 | 3.2 years | 7.05 | 51,600 | 7.05 | |||||||||||||||
| $10.01 – $15.00 |
1,000 | .8 years | 11.90 | 1,000 | 11.90 | |||||||||||||||
| $15.01 – $25.00 |
30,333 | 2.8 years | 16.35 | 30,333 | 16.35 | |||||||||||||||
| 94,821 | 3.0 years | $ | 9.60 | 93,883 | $ | 9.69 | ||||||||||||||
The aggregate intrinsic value of options outstanding and options exercisable as of April 30, 2011 was approximately $2,000 and $1,000, respectively. The aggregate intrinsic value of the 469 options which vested during the nine months ended April 30, 2011 was $0. During the nine months ended April 30, 2011, no options to purchase common stock were exercised.
| 3. | Revenue Recognition |
The Company’s revenues from its six product lines are the result of separate, individual deliverables:
| Type of Revenues Earned | ||||||
| Product Line |
Equipment/Software |
Professional Services | Maintenance Contracts | |||
| Millennium PBX System |
Individual sale | |||||
| eQueue Contact Center System |
Individual sale | Individual sale | Individual sale | |||
| VOIP Telephones |
Individual sale | |||||
| Cortelco Products |
Individual sale | |||||
| CSPR Products |
Individual sale | Individual sale | Individual sale | |||
| CSPR Telephony Billing |
Individual sale | |||||
Some customers contract for professional services to tailor their system to specific requirements. Professional services are invoiced separately upon completion. eQueue customers can also elect to enter into maintenance contracts to receive software updates and free technical support. Revenue is recognized quarterly for each maintenance period as provided.
The VOIP telephones can be deployed with either the Millennium or eQueue systems to provide lower call costs as well as flexible telecom management across multiple locations. These phones may be sold with a new system, but are often sold subsequent to the system sale.
Cortelco sells corded and cordless analog and digital telephones capable of operating in the multiple PBX, Key System and Centrex environments primarily through stocking distributors.
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Telephony billing revenues from the resale of Puerto Rico Telephone services are recognized monthly as services are provided to customers.
The Company records shipping and handling fees billed to customers as revenue, and shipping and handling costs incurred with the delivery of products as cost of sales.
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.
| 4. | Related Parties |
Cortelco Systems Puerto Rico
Cortelco Systems Puerto Rico (“CSPR”) was a wholly-owned subsidiary of the Company until August 28, 2001, when it was spun off to the shareholders of eOn. The Company acquired 300,100 shares (or 18.89%) of CSPR stock as the result of the acquisition of Cortelco on April 1, 2009. These shares were valued at approximately $111,000 at April 1, 2009 based on the quoted market price of CSPR’s shares at that date. Because David Lee, Chairman of the Company, was a significant shareholder of CSPR, eOn accounted for this investment using the equity method of accounting in fiscal 2010, and eOn’s proportionate share of CSPR’s earnings or losses were included in income (loss) in the consolidated financial statements.
On June 9, 2010, the Company executed a Stock Purchase Agreement to purchase 501,382 shares of common stock of Cortelco Systems Puerto Rico, Inc. (“CSPR”) from David S. Lee. The purchase of CSPR stock was completed on June 9, 2010 and combined with the shares already owned by the Company, establishes eOn Communications as the majority shareholder of Cortelco Systems Puerto Rico.
The following unaudited pro forma financial information gives effect to the acquisition as if it had been consummated at the beginning of the periods presented. This information is not necessarily indicative of the operational results that would have occurred if the acquisition had been consummated on the dates indicated nor is it necessarily indicative of the future consolidated results of operations.
| Three Months Ended April 30, |
Nine Months Ended April 30, |
|||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| Revenue |
$ | 5,561 | $ | 5,678 | $ | 17,111 | $ | 17,445 | ||||||||
| Net income (loss) |
$ | 178 | $ | (44 | ) | $ | (248 | ) | $ | 839 | ||||||
| Net income attributable to noncontrolling shareholders |
47 | 4 | 73 | 129 | ||||||||||||
| Net income (loss) attributable to eOn shareholders |
$ | 131 | $ | (48 | ) | $ | (321 | ) | $ | 710 | ||||||
| Proforma income (loss) per share: |
||||||||||||||||
| Basic |
$ | 0.05 | $ | (0.02 | ) | $ | (0.11 | ) | $ | 0.25 | ||||||
| Diluted |
$ | 0.05 | $ | (0.02 | ) | $ | (0.11 | ) | $ | 0.25 | ||||||
The allocation of the purchase price for CSPR resulted in the recognition of a gain on bargain purchase of $497,000, which was recorded in other income (expense) in the consolidated statement of operations for the year ended July 31, 2010. The gain on bargain purchase resulted from the fair value of the identifiable net assets acquired exceeding the value of the purchase consideration. The gain on bargain purchase is included in the above pro forma net income for the nine months ended April 30, 2010. The acquisition resulted in a bargain purchase as CSPR had declining annual revenues at the time of the acquisition thus impacting the fair value of CSPR as of the date of the acquisition.
Symbio Group
On August 1, 2007 and August 27, 2007, the Company made strategic investments in Symbio of $500,000 and $400,000 for 250,000 and 200,000 shares, respectively, or a total of approximately 3% of Symbio. Symbio is a China-based provider of software development, testing, and globalization outsourcing services to multinational companies. Symbio is a privately held entity and the Company accounts for its investment by the cost method.
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At the time of the second investment in Symbio, the Company received a put option from David Lee, effective beginning January 1, 2008 and expiring on January 1, 2011. In December 2010, the expiration on the put option was extended until January 1, 2013. The put option allows the Company to sell to David Lee a maximum aggregate of 200,000 shares of its investment in Symbio for a per share price of $2.00.
In consideration of the put option, in the event that the 200,000 shares are sold without exercise of the put option before January 1, 2013, the Company has agreed to pay David Lee 50% of the proceeds in excess of $1,000,000.
In conjunction with the purchase of these shares, David Lee was appointed to the board of directors of Symbio and has been elected Chairman. eOn was granted a total of 45,000 shares of Symbio stock in April 2008 and April 2009 as compensation for Mr. Lee’s services. These shares have been valued at $90,000, and have been recorded as an increase in investments and a capital contribution by David Lee.
In September 2009, Symbio announced a definitive agreement to merge with Flander Oy, a leading mobile and embedded software development company, and Ardites Ltd., a leading expert in user experience technologies. The merger was completed in the fourth calendar quarter of 2009 and the merged companies were renamed Symbio s.a.r.l.
Symbio currently shares office space and personnel with eOn in Cupertino, California. Symbio contracted to assist eOn in the United States with software development in the year ended July 31, 2010. The following represent related party transactions for the nine months ended April 30, 2011 and 2010 (in thousands):
| 2011 | 2010 | |||||||
| Receivable from Symbio |
||||||||
| Balance at beginning of period |
$ | 8 | $ | 9 | ||||
| Operating costs billed |
— | 84 | ||||||
| Payments |
(8 | ) | (85 | ) | ||||
| Balance at end of period |
$ | — | $ | 8 | ||||
| 2011 | 2010 | |||||||
| Payable to Symbio |
||||||||
| Balance at beginning of period |
$ | — | $ | 11 | ||||
| Billings and accruals for engineering services |
— | 22 | ||||||
| Payments |
— | (27 | ) | |||||
| Balance at end of period |
$ | — | $ | 6 | ||||
Symbio-ES Park Business Processing Outsourcing Joint Venture
On August 12, 2008, Hangzhou East Software Park (“Hangzhou”), Symbio and eOn formed Symbio-ESPark Business Processing Outsourcing Joint Venture (the “Joint Venture”) located in Hangzhou, China. On September 9, 2008, eOn invested RMB 900,000 (approximately $136,000) into the Joint Venture for a 9% ownership interest in the Joint Venture. On June 20, 2008, the Company received approximately $138,000 from Hangzhou Nature Opto Company, an entity related to Hangzhou and executed a promissory note due January 19, 2009. The note payable was cancelled in fiscal 2010 in exchange for the Company’s ownership in the Joint Venture.
The Company has not had significant trade activity with the joint venture in the current fiscal year. The following represents related party transactions for the nine months ended April 30, 2010 (in thousands):
| Receivable from Hangzhou |
||||
| Balance at beginning of period |
$ | 154 | ||
| Billings for product and services |
— | |||
| Payments |
(154 | ) | ||
| Balance at end of period |
$ | — | ||
Joint Venture
On October 24, 2008, eOn China invested RMB 400,000 (approximately $58,000) into a joint venture in TaiCang, China. eOn China had borrowed RMB 300,000 from an unrelated third party in TaiCang and RMB 100,000 from an employee in October 2008 to make this investment. These borrowings were unsecured and interest free. In November 2008, David Lee purchased this investment from eOn China for $58,000 and took personal ownership of the investment. The proceeds from David Lee were used to repay these borrowings in November 2008. The Company has not had significant
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trade activity with the joint venture in the current fiscal year. The following represents related party transactions for the nine months ended April 30, 2010 (in thousands):
| Receivable from TaiCang |
||||
| Balance at beginning of period |
$ | 64 | ||
| Billings for product and services |
27 | |||
| Payments |
(91 | ) | ||
| Balance at end of period |
$ | — | ||
| 5. | Inventories |
Inventories consist of the following (in thousands):
| April 30, 2011 |
July 31, 2010 |
|||||||
| Raw materials and purchased components |
$ | 1,422 | $ | 1,465 | ||||
| Finished goods |
6,011 | 5,256 | ||||||
| Total |
7,433 | 6,721 | ||||||
| Obsolescence reserve |
(1,635 | ) | (1,773 | ) | ||||
| Inventories |
$ | 5,798 | $ | 4,948 | ||||
| 6. | Notes Payable, Related Party |
On June 20, 2008, eOn China issued a note to Hangzhou Nature Opto Company in exchange for RMB 945,000, or approximately $138,000. The note payable was cancelled in fiscal year 2010 in exchange for the Company’s interest in Symbio-ES Park Business Outsourcing Joint Venture (See Note 4).
On April 1, 2009, the Company executed a note payable to Cortelco’s former shareholders for $10,500,000 (the “Cortelco Note”) in connection with the acquisition of Cortelco. The Cortelco Note is non-interest bearing and is to be repaid based primarily upon the level of Cortelco earnings after closing and all Cortelco shareholders are eligible to receive quarterly payments thereunder in cash until the full consideration has been paid.
The fair value of the Cortelco Note payable obligation was approximately $3,528,000 at April 30, 2011 using a discounted cash flow analysis of the projected future payments and a discount rate of 15.22%. The Cortelco Note balance includes $229,000 of interest expense during the nine months ended April 30, 2011 imputed at the 15.22% discount rate using the effective interest method.
Actual payments under the Cortelco Note, which are to be based on future earnings of Cortelco, may differ significantly from the projected payments estimated at the Cortelco Note’s inception. These differences may result in significant fluctuations in periodic interest expense in order to properly reflect interest expense over the actual life of the Cortelco Note.
On June 9, 2010 pursuant to a Stock Purchase Agreement, the Company recorded a note payable to David S. Lee, eOn’s Chairman, for the principal amount of $185,511 payable in three annual installments beginning June 9, 2011. The present value of the note payable at April 30, 2011 is approximately $171,000.
| 7. | Product Warranties |
The Company generally provides customers a one year product warranty from the date of purchase for the Millennium and eQueue product lines. Warranty for the Cortelco product line ranges from one to five years based upon the product purchased. 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 revenue is recognized. The cost of satisfying warranty claims, which approximates 0.6%—2.3% of product revenues, has historically been comprised of materials and direct labor costs. The Company performs 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. The following table summarizes the activity related to the product warranty liability during the nine months ended April 30, 2011 and 2010 (in thousands):
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| 2011 | 2010 | |||||||
| Beginning balance |
$ | 222 | $ | 196 | ||||
| Warranty cost incurred |
(133 | ) | (81 | ) | ||||
| Accrued warranty cost |
117 | 73 | ||||||
| Ending balance |
$ | 206 | $ | 188 | ||||
| 8. | Changes in Stockholders’ Equity |
The following represents the changes in stockholders’ equity for the nine months ended April 30, 2011 (in thousands, excluding share data):
| Additional Paid-In Capital |
Accumulated Other |
Total | ||||||||||||||||||||||||||||||||||
| Common Stock | Treasury Stock | Accumulated | Comprehensive | Noncontrolling | Stockholders’ | |||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Deficit | Income | Interest | Equity | |||||||||||||||||||||||||||||
| Balance at July 31, 2010 |
2,989,269 | $ | 15 | $ | 56,269 | (139,580 | ) | $ | (1,503 | ) | $ | (48,389 | ) | $ | 110 | $ | 444 | $ | 6,946 | |||||||||||||||||
| Stock based compensation expense, stock options and ESPP |
8,277 | — | 19 | 19 | ||||||||||||||||||||||||||||||||
| Subsidiary issuance of treasury stock |
36 | 36 | ||||||||||||||||||||||||||||||||||
| Change in ownership interest in subsidiary |
(15 | ) | 15 | — | ||||||||||||||||||||||||||||||||
| Comprehensive income : |
||||||||||||||||||||||||||||||||||||
| Foreign currency translation adjustments |
2 | 2 | ||||||||||||||||||||||||||||||||||
| Net income (loss) |
— | — | — | — | — | (321 | ) | — | 73 | (248 | ) | |||||||||||||||||||||||||
| Comprehensive loss |
— | — | — | — | — | — | — | (246 | ) | |||||||||||||||||||||||||||
| Balance at April 30, 2011 |
2,997,546 | $ | 15 | $ | 56,273 | (139,580 | ) | $ | (1,503 | ) | $ | (48,710 | ) | $ | 112 | $ | 568 | $ | 6,755 | |||||||||||||||||
| 9. | Discontinued Operations |
The Company has evaluated its wholly-owned subsidiary in China and determined that the operation has not provided a strategic benefit to the Company. In conjunction with exit of operations in China, the Company recorded inventory reserve provisions of approximately $134,000 and discontinued support of the China operations in the second fiscal quarter of 2011. Consequently, current and prior period financial activity and balances are reported as discontinued operations.
Summarized financial information for discontinued operations for the referenced periods is as follows (in thousands):
| April 30, 2011 |
July 31, 2010 |
|||||||
| Cash |
$ | — | $ | 182 | ||||
| Accounts receivable |
— | 12 | ||||||
| Accounts receivable - related party |
— | 8 | ||||||
| Inventories |
— | 135 | ||||||
| Total current assets |
— | 337 | ||||||
| Property and equipment, net |
— | 16 | ||||||
| Total assets |
$ | — | $ | 353 | ||||
| Accrued expenses and other |
18 | 201 | ||||||
| Total liabilities |
$ | 18 | $ | 201 | ||||
| Net assets (liabilities) - discontinued operations |
$ | (18 | ) | $ | 152 | |||
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| Three Months Ended April 30, |
Nine Months Ended April 30, |
|||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| Revenue |
$ | — | $ | 42 | $ | 34 | $ | 163 | ||||||||
| Cost of revenue |
— | 22 | 145 | 63 | ||||||||||||
| Gross profit |
— | 20 | (111 | ) | 100 | |||||||||||
| Operating expenses |
— | 63 | 107 | 174 | ||||||||||||
| Other expense |
— | 3 | 14 | 9 | ||||||||||||
| Total expense |
— | 66 | 121 | 183 | ||||||||||||
| Net (loss) |
$ | — | $ | (46 | ) | $ | (232 | ) | $ | (83 | ) | |||||
| 10. | Concentrations, Commitments and Contingencies |
| (a) | Customer Concentrations |
At April 30, 2011, four customers accounted for approximately 35% of total accounts receivable and individually 10%, 9%, 8% and 8% of the total accounts receivable. At April 30, 2010, four customers accounted for approximately 58% of total accounts receivable and individually 20%, 14%, 12% and 12% of the total accounts receivable. For the nine months ended April 30, 2011, five customers accounted for approximately 45% of total revenue and individually 17%, 9%, 8%, 6% and 5% of total revenue. For the nine months ended April 30, 2010, four customers accounted for approximately 53% of total revenue and individually 26%, 11%, 10% and 7% of total revenue.
| (b) | Commitments |
At April 30, 2011, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $4,021,000.
Cortelco has a line of credit based on an asset formula involving accounts receivable and inventories up to a maximum of $1,000,000, none of which was drawn on in the current or prior fiscal year. The line of credit is secured by substantially all of Cortelco’s assets. The loan’s interest rate is floating based on LIBOR and expires December 15, 2011.
| (c) | Litigation |
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 Municipal Revenue Collection Center of Puerto Rico (“CRIM”) conducted a personal property tax audit for the years 1999 and 2000 which resulted in assessments of approximately $320,000 (approximately $505,000 as of March 14, 2011, including interest and penalties). The assessments arose from CRIM’s disallowances of certain credits for overpayments from 1999 and 2000, claimed in the 2001 through 2003 personal property tax returns. During the audit process, CRIM alleged that some components of the inventory reported as exempt should be taxable. The parties met several times and an informal administrative hearing was held on September 27, 2006. CSPR submitted its position in writing within the time period provided by CRIM. CSPR believes it has strong arguments to support its position that the components of inventory qualify as raw material. Management believes a settlement may be reached for an amount less than the assessment. Accordingly, the Company has recorded a liability of $80,000 as of the CSPR stock acquisition date of June 9, 2010 and April 30, 2011.
| 11. | Segments |
The Company’s reportable segments are Communications Systems and Services, Telephony Products and Puerto Rico, each of which offers different products and services or services a different geographic area. The Communications Systems and Services segment develops and markets products that help businesses communicate more effectively and efficiently with their customers. The Telephony Products segment provides telephone products, service and support to businesses and organizations. The Puerto Rico segment provides the sale and service of integrated communications systems, data equipment, security products and telephony billing services to Puerto Rico and the Virgin Islands. Performance of each
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segment is assessed independently. Prior to the acquisition of Cortelco Systems Puerto Rico on June 9, 2010, the Company reported all of its operations as two segments.
Segment reporting for activity as of and for the three and nine months ended April 30, 2011 follows (in thousands):
| Communications Systems and Services |
Telephony Products | Puerto Rico | Total | |||||||||||||||||||||||||||||
| 3 Months | 9 Months | 3 Months | 9 Months | 3 Months | 9 Months | 3 Months | 9 Months | |||||||||||||||||||||||||
| Revenue |
$ | 513 | $ | 1,831 | $ | 2,728 | $ | 8,684 | $ | 2,320 | $ | 6,596 | $ | 5,561 | $ | 17,111 | ||||||||||||||||
| Net (loss) income from operations |
(219 | ) | (824 | ) | 262 | 909 | 103 | 161 | 146 | 246 | ||||||||||||||||||||||
| Total assets |
4,345 | 6,628 | 3,181 | 14,154 | ||||||||||||||||||||||||||||
| Capital expenditures |
— | 4 | — | 6 | 24 | 58 | 24 | 68 | ||||||||||||||||||||||||
| Capitalized software development |
11 | 218 | — | — | — | — | 11 | 218 | ||||||||||||||||||||||||
| Allowance for doubtful accounts |
298 | 16 | 25 | 339 | ||||||||||||||||||||||||||||
| Depreciation and amortization |
58 | 148 | 14 | 43 | 13 | 44 | 85 | 235 | ||||||||||||||||||||||||
Segment reporting for activity as of and for the three and nine months ended April 30, 2010 follows (in thousands):
| Communications Systems and Services |
Telephony Products | Total | ||||||||||||||||||||||
| 3 Months | 9 Months | 3 Months | 9 Months | 3 Months | 9 Months | |||||||||||||||||||
| Revenue |
$ | 901 | $ | 2,691 | $ | 2,634 | $ | 8,764 | $ | 3,535 | $ | 11,455 | ||||||||||||
| Net (loss) income from operations |
(82 | ) | (244 | ) | 230 | 840 | 148 | 596 | ||||||||||||||||
| Total assets |
6,067 | 6,015 | 12,082 | |||||||||||||||||||||
| Capital expenditures |
3 | 13 | — | 1 | 3 | 14 | ||||||||||||||||||
| Capitalized software development |
136 | 424 | — | 136 | 424 | |||||||||||||||||||
| Allowance for doubtful accounts |
282 | 16 | 298 | |||||||||||||||||||||
| Depreciation and amortization |
30 | 92 | 17 | 52 | 47 | 144 | ||||||||||||||||||
Substantially all of the Company’s revenues are earned in the United States and the Commonwealth of Puerto Rico. Revenue from discontinued operations earned in the People’s Republic of China for the nine months ended April 30, 2011 and 2010 was approximately $34,000 and $162,000, respectively. Substantially all of the Company’s assets are located in the United States.
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 in the Company’s most recently filed 10-K. 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.
Overview
eOn Communications Corporation (“eOn” or the “Company”) is a global provider of communications solutions. Backed with over 20 years of telecommunications engineering expertise, the Company’s solutions enable its customers to communicate more effectively. eOn’s offerings are built on reliable open architectures that enable easy adoption of emerging technologies, such as Voice over Internet Protocol (VoIP) and concepts such as Service Oriented Architecture (SOA). Whether businesses are looking to leverage the advantages of enterprise IP telephony or advanced contact center technologies, eOn delivers proven, IP-ready products that improve business performance. Cortelco is committed to fulfilling the communication needs of business and organizations worldwide. Cortelco’s mission is to provide our valued customers with telephone products together with service and support. Cortelco has formed partnerships with distributors and provides
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the support needed to supply customers with sales, marketing, customer service, technical support and training. The Company’s Cortelco product line provides customer premise equipment (CPE) commercial grade telephone products primarily for use in businesses, government agencies, colleges and universities, telephone companies, and utilities. Cortelco Systems Puerto Rico’s operations include the sale and service of integrated communications systems, data equipment, security products, and telephony billing services.
On April 1, 2009, the Company acquired Cortelco for up to $11,000,000 in cash. Cortelco merged with a newly formed wholly-owned subsidiary of eOn and is now a wholly-owned subsidiary of eOn. In exchange for all of the outstanding shares of Cortelco stock, Cortelco shareholders received an initial aggregate payment of $500,000 and a note payable for $10,500,000 (the “Cortelco Note”). The Cortelco Note is non-interest bearing and is to be repaid based primarily upon the level of Cortelco earnings after closing and all Cortelco shareholders are eligible to receive quarterly payments thereunder in cash until the full consideration has been paid. The fair value of the Cortelco Note payable obligation assumed on the April 1, 2009 acquisition date was estimated using a discounted cash flow method, and together with approximately $124,000 in acquisition costs, resulted in a total purchase price of $5,054,000. As of April 30, 2011, the Company has made payments of approximately $2,786,000 to former Cortelco shareholders for the acquisition, including the initial aggregate payment of $500,000. David Lee, Chairman of eOn, was the Chairman and the controlling shareholder of Cortelco at the date of acquisition.
On June 9, 2010, the Company executed a Stock Purchase Agreement to purchase 501,382 shares of common stock of Cortelco Systems Puerto Rico, Inc. (“CSPR”) from David S. Lee, eOn’s Chairman. The acquisition of CSPR stock was completed on June 9, 2010. The consideration for the CSPR shares consists of (i) 90,959 Company shares of stock, issued to Mr. Lee effective June 9, 2010, (ii) a cash payment of $185,511.34, payable in three annual installments, with the initial installment due on June 9, 2011, (iii) and the right to share in sales proceeds received by the Company if the Company sells the CSPR shares on or before June 9, 2013 for a price that is more than the Company paid for the shares. The number of eOn shares issued to Mr. Lee was calculated based on the average closing price of eOn Shares for thirty (30) trading days ending on June 8, 2010. The Company has the right to require Mr. Lee to repurchase the CSPR shares at the price paid by the Company on or after June 9, 2013, but before June 9, 2014. The purchase, combined with shares already owned by the Company, establishes eOn Communications as the majority shareholder of Cortelco Systems Puerto Rico.
Critical Accounting Policies and Estimates
There were no material changes during the three months ended April 30, 2011 to the critical accounting policies reported in our Annual Report on Form 10-K for the fiscal year ended July 31, 2010.
Results of Operations
For the Three Months Ended April 30, 2011 compared to the Three Months Ended April 30, 2010
Net Revenue
Net revenue increased by approximately 57% to $5,561,000 for the three months ended April 30, 2011 compared to $3,535,000 for the same period of the previous year. The increase was attributable to the inclusion of CSPR’s net revenue of $2,320,000 and an increase of $94,000 in Cortelco revenue for the three months in the current quarter compared to the same period of the previous year. The increase is partially offset by revenue declines in the Company’s other product lines.
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 29% to $1,679,000 for the three months ended April 30, 2011 from $1,306,000 for the same period of the previous year. Declines in eQueue and Milennium product and maintenance gross profit was partially offset by the inclusion of CSPR gross profit of $545,000 and an increase of $62,000 in Cortelco gross profit for the three months ended April 30, 2011 when compared to the same period of the previous year. The increase in cost of revenue included approximately $46,000 in amortization of eConn IP-PBX software costs. Gross margin % decreased to approximately 30% for the three months ended April 30, 2011 compared with gross margin of approximately 37% for the same period of the previous year, primarily the result of product mix. The margin percentage on Cortelco and CSPR revenue is significantly less than the historical margins for both the Millennium and eQueue products.
Selling, General and Administrative
Selling, general and administrative expense consists primarily of salaries and benefit costs, marketing costs, and facilities and other overhead expenses incurred to support our business. Selling, general and administrative expenses increased approximately 42% to $1,413,000 for the three months ended April 30, 2011, from $995,000 for the same period of the previous year. The increase is primarily due to the inclusion of CSPR’s expenses of approximately $445,000, partially
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offset by declines in subcontract, salaries and related expenses in the Company’s other product lines when compared to the same period of the previous year. Current period and prior period expenses include approximately $11,000 and $21,000, respectively, of amortization related to technology that the Company plans to amortize through fiscal 2011. The Company expects to continue to sell products utilizing this technology through 2011 and beyond.
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 14% to $121,000 for the three months ended April 30, 2011 from $141,000 for the same period of the previous year. Research and development expense for the current quarter reflect reductions in compensation and related expenses and overhead expenses when compared to the same period of the previous year. In the three months ended April 30, 2011, the Company capitalized approximately $11,000 of software development, compared to approximately $136,000 for the same period of the previous year. Amortization of the eConn IP-PBX capitalized costs began in October 2010 when the product was announced for general release to customers. Additional software is under development with projected completion in fiscal 2012.
Other Expense
Other expense is primarily comprised of bank service charges, franchise taxes, currency differences, and gains or losses from disposal of fixed assets. Other income was $1,000 for the three months ended April 30, 2011 compared to expense of $22,000 for the same period of the previous year. The decline in expense in primarily attributable to a decline in franchise taxes in the three months ended April 30, 2011 when compared to the same period of the previous year.
Interest Expense, net
Interest benefit was $56,000 for the three months ended April 30, 2011 compared to interest expense of $149,000 for the same period of the previous year. Interest benefit in the current period includes $59,000 of imputed interest on the Cortelco Note, of which approximately $185,000 in interest benefit is a result of changes in the estimated timing of future principal payments.
Income Tax Expense
Income tax expense for the three months ended April 30, 2011 and 2010 totaled $24,000 and $2,000, respectively, and consisted of current state income tax expense in states in which net operating loss carry forwards were not available to offset taxable income. Due to uncertainties surrounding the timing of realizing the benefits of its net favorable tax attributes in future returns, to the extent that it is more likely than not that deferred tax assets may not be realized, the Company continues to record a valuation allowance against substantially all of its deferred tax assets at April 30, 2011.
For the Nine Months Ended April 30, 2011 compared to the Nine Months Ended April 30, 2010
Net Revenue
Net revenue increased by approximately 49% to $17,111,000 for the nine months ended April 30, 2011 compared to $11,455,000 for the same period of the previous year. The increase was attributable to the inclusion of CSPR’s net revenue of $6,596,000 for the nine months in the current period. The increase is partially offset by revenue declines in the Company’s other product lines.
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 20% to $5,061,000 for the nine months ended April 30, 2011 from $4,211,000 for the same period of the previous year. The inclusion of CSPR gross profit of $1,511 for the nine months ended April 30, 2011 was partially offset by declines in eQueue, Milennium, and Cortelco product and maintenance gross profit. The increase in cost of revenue included approximately $107,000 in amortization of eConn IP-PBX software costs. Gross margin % decreased to approximately 30% for the nine months ended April 30, 2011 compared with gross margin of approximately 37% for the same period of the previous year, primarily the result of product mix. The margin percentage on Cortelco and CSPR revenue is significantly less than the historical margins for both the Millennium and eQueue products.
Selling, General and Administrative
Selling, general and administrative expense consists primarily of salaries and benefit costs, marketing costs, and facilities and other overhead expenses incurred to support our business. Selling, general and administrative expenses increased approximately 39% to $4,405,000 for the nine months ended April 30, 2011, from $3,173,000 for the same period
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of the previous year. The increase is primarily due to the inclusion of CSPR’s expenses of approximately $1,350,000 and $106,000 in bad debt expenses in the current period, partially offset by declines in sales and marketing expenses when compared to the same period of the previous year. Current period and prior period expenses include approximately $31,000 and $63,000, respectively, of amortization related to technology that the Company plans to amortize through fiscal 2011. The Company expects to continue to sell products utilizing this technology through 2011 and beyond.
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 1% to $391,000 for the nine months ended April 30, 2011 from $395,000 for the same period of the previous year. Research and development expense for the current period reflect reductions in compensation-related and overhead expenses when compared to the same period of the previous year. In the nine months ended April 30, 2011, the Company capitalized approximately $218,000 of software development, compared to approximately $424,000 for the same period of the previous year. Amortization of the eConn IP-PBX capitalized costs began in October 2010 when the product was announced for general release to customers. Additional software is under development with projected completion in fiscal 2012.
Other Expense
Other expense is primarily comprised of bank service charges, franchise taxes, currency differences, and gains or losses from disposal of fixed assets. Other expense was $19,000 for the nine months ended April 30, 2011 compared to $47,000 for the same period of the previous year. Current year other expense is net of $25,000 in recovery of old cellular claims by CSPR and a reduction in the Company’s franchise tax expenses compared to the same period of the previous year.
Interest Expense, net
Interest expense was $238,000 for the nine months ended April 30, 2011 compared to interest expense of $499,000 for the same period of the previous year. Interest expense in the current period includes $229,000 of imputed interest on the Cortelco Note, of which approximately $185,000 in interest benefit is a result of changes in the estimated timing of future principal payments.
Income Tax Expense (Benefit)
Income tax expense (benefit) for the nine months ended April 30, 2011 and 2010 totaled $24,000 and ($19,000), respectively. The 2011 income tax expenses consisted of current state income tax expense in states in which net operating loss carry forwards were not available to offset taxable income. The 2010 income tax benefit consisted of refunds of state income taxes recorded in the 2010 period that were previously expensed. Due to uncertainties surrounding the timing of realizing the benefits of its net favorable tax attributes in future returns, to the extent that it is more likely than not that deferred tax assets may not be realized, the Company continues to record a valuation allowance against substantially all of its deferred tax assets at April 30, 2011.
Liquidity and Capital Resources
As of April 30, 2011, the Company had cash and cash equivalents of $1,847,000 and working capital of $7,706,000.
Our operating activities resulted in a net cash outflow of $1,136,000 for the nine months ended April 30, 2011 compared to a net cash inflow of $1,332,000 for the same period of the previous year. The net operating cash outflow for the current period primarily reflects net loss (adjusted for non-cash items) and higher inventories and lower accrued expenses and accounts payable. The net operating cash inflow for the prior year period primarily reflects net income (adjusted for non-cash items) and lower accounts receivable partially offset by lower accrued expenses and accounts payable.
Our investing activities resulted in a net cash outflow of $286,000 for the nine months ended April 30, 2011 compared to a net cash outflow of $438,000 for the same period of the previous year. Cash used in investing activities for the nine months ended April 30, 2011 was a result of net cash used for capitalized software costs of approximately $218,000 and purchases of property and equipment. Cash used in investing activities for the same period of the previous year was a result of net cash used for capitalized software costs of approximately $424,000, and purchases of property and equipment.
Our financing activities resulted in a cash outflow of $841,000 for the nine months ended April 30, 2011 compared to a cash outflow of $1,368,000 for the same period of the previous year. Cash used in financing activities in both the current period and prior period reflect payments on notes payable partially offset by purchases under the Employee Stock Purchase Plan.
Liquidity
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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.
The Company has incurred substantial net operating losses since inception and has had negative cash flows from operating activities through July 31, 2010; resulting in an accumulated deficit of $48,389,000 at that date. During the nine months ended April 30, 2011, cash and cash equivalents decreased to $1,847,000 from $4,108,000 at July 31, 2010, primarily as a result of payments made against the Cortelco Note and funding operations and software development.
The Company had income from continuing operations of $246,000 for the nine months ended April 30, 2011 versus income from operations of $596,000 for the same period in the prior year. As of April 30, 2011, the Company had $1,847,000 in cash and cash equivalents available to fund operations, of which $13,000 was held in international bank accounts.
The Company is largely dependent on available cash, cash equivalents, and operating cash flow to finance operations and meet its other capital needs. Cortelco has a line of credit based on an asset formula involving accounts receivable and inventories up to a maximum of $1,000,000, none of which was drawn on in the current or prior fiscal years. The line of credit is secured by substantially all of Cortelco’s assets. The loan’s interest rate is floating based on LIBOR and expires December 15, 2011. If such sources are not sufficient, alternative funding sources may not be available. The Company believes that cash on hand 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 believe that cash and cash equivalents 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 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. .
Discontinued Operations
The Company has evaluated its wholly-owned subsidiary in China and determined that the operation has not provided a strategic benefit to the Company. In conjunction with exit of operations in China, the Company recorded inventory reserve provisions of approximately $134,000 in the current fiscal year. The Company discontinued support of the China operations in the second fiscal quarter of 2011. Consequently, current and prior period financial activity and balances are reported as discontinued operations.
Net Income (Loss)
Net income was $131,000 and net loss was $321,000 for the three months and nine months ended April 30, 2011 compared to net loss of $47,000 for the three months ended April 30, 2010 and net income of $84,000 for the nine month period in the previous year due to fluctuations in gross margins and expenses explained above.
Reported net loss has been materially impacted by the imputed interest expense due to the amortization of the difference between the face value of the contingent obligation to the former Cortelco shareholders and the discounted present value of the note payable recorded on the balance sheet. The table below presents a non-GAAP financial disclosure to provide a quantitative analysis of the impact of the imputed interest expense on reported net loss and loss per share. Management does not include this expense in its analysis of financial results or how resources are allocated. Because of this, we deemed it meaningful to provide this non-GAAP disclosure of the impact of this significant item on our financial results.
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Non-GAAP Financial Disclosure
(In thousands, except per share amounts)
| Three Months Ended April 30, 2011 |
Nine Months Ended April 30, 2011 |
|||||||
| Net income (loss) reported |
$ | 131 | $ | (321 | ) | |||
| Imputed interest (benefit) expense on notes payable |
(59 | ) | 229 | |||||
| Net income (loss) less imputed interest |
$ | 72 | $ | (92 | ) | |||
| Net income (loss) per common share as reported |
$ | 0.05 | $ | (0.11 | ) | |||
| Interest imputed |
(0.02 | ) | 0.08 | |||||
| Net income (loss) per common share less imputed interest |
$ | 0.03 | $ | (0.03 | ) | |||
| Weighted average shares outstanding - basic |
2,862 | 2,859 | ||||||
Concentrations, Commitments and Contingencies
| (a) | Customer Concentrations |
At April 30, 2011, four customers accounted for approximately 35% of total accounts receivable and individually 10%, 9%, 8% and 8% of the total accounts receivable. At April 30, 2010, Four customers accounted for approximately 58% of total accounts receivable and individually 20%, 14%, 12% and 12% of the total accounts receivable. For the nine months ended April 30, 2011, five customers accounted for approximately 45% of total revenue and individually 17%, 9%, 8%, 6% and 5% of total revenue. For the nine months ended April 30, 2010, four customers accounted for approximately 53% of total revenue and individually 26%, 11%, 10% and 7% of total revenue.
| (b) | Commitments |
At April 30, 2011, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $4,021,000.
Cortelco has a line of credit based on an asset formula involving accounts receivable and inventories up to a maximum of $1,000,000, none of which was drawn on in the current or prior fiscal year. The line of credit is secured by substantially all of Cortelco’s assets. The loan’s interest rate is floating based on LIBOR and expires on December 15, 2011.
| (c) | Litigation |
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 Municipal Revenue Collection Center of Puerto Rico (“CRIM”) conducted a personal property tax audit for the years 1999 and 2000 which resulted in assessments of approximately $320,000 (approximately $505,000 as of March 14, 2011, including interest and penalties). The assessments arose from CRIM’s disallowances of certain credits for overpayments from 1999 and 2000, claimed in the 2001 through 2003 personal property tax returns. During the audit process, CRIM alleged that some components of the inventory reported as exempt should be taxable. The parties met several times and an informal administrative hearing was held on September 27, 2006. CSPR submitted its position in writing within the time period provided by CRIM. CSPR believes it has strong arguments to support its position that the components of inventory qualify as raw material. However, management believes a settlement may be reached for an amount less than the assessment. Accordingly, the Company has recorded a liability of $80,000 as of the CSPR stock acquisition date of June 9, 2010 and April 30, 2011.
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Item 3.—Quantitative and Qualitative Disclosures About Market Risk.
The Company is subject to market rate risk from exposure to changes in interest rates based on its financing, investing and cash management activities, but the Company does not believe such exposure is material.
Item 4.—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 no changes in the Company’s internal control over financial reporting that occurred during the three-month period ended April 30, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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None.
There have been no material changes in the Company’s risk factors from those reported on the Company’s most recently filed 10-K.
Item 2.—Unregistered Sales of Securities and Use of Proceeds.
None.
Item 3.—Defaults Upon Senior Securities.
None.
None.
(A) Exhibits.
| Exhibit No. |
Description | |
| 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 |
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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.
EON COMMUNICATIONS CORPORATION
| Dated: June 10, 2011 | /s/ Lee M. Bowling | |||
| Lee M. Bowling Chief Financial Officer (Duly Authorized Officer, Principal Financial and Accounting Officer) | ||||
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