EON COMMUNICATIONS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) 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 provider of communications solutions. Backed with over 20 years of telecommunications engineering expertise, the Company's solutions enable its customers to use technologies to communicate more effectively. eOn's offerings are built on reliable open architectures that enable easy adoption of 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 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.

12 -------------------------------------------------------------------------------- Table of Contents CSPR's core business includes the design, implementation and maintenance of solutions in the area of voice, data center and security. CSPR's other lines of business include the reselling of telephone lines, internet access, disaster recovery, business continuity and private cloud computing solutions. CSPR has partnered with strategic suppliers and utilizes a direct sales force to sell its services and products, most of which are installed by CSPR technicians.

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 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 January 31, 2013, the Company has made payments of approximately $3,128,000 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.

Critical Accounting Policies and Estimates There were no material changes during the six months ended January 31, 2013 to the critical accounting policies reported in our Annual Report on Form 10-K for the fiscal year ended July 31, 2012.

Results of Operations For the Three Months Ended January 31, 2013 compared to the Three Months Ended January 31, 2012 Net Revenue Net revenue decreased by approximately 8% to $5,241,000 for the three months ended January 31, 2013 compared to $5,673,000 for the same period of the previous year. The decrease was primarily attributable to decreased revenues of approximately $700,000 in the Company's systems and telephony product lines. The decrease is partially offset by revenue increases of approximately $268,000 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 decreased approximately 20% to $1,287,000 for the three months ended January 31, 2013 from $1,611,000 for the same period of the previous year. The decrease was primarily attributable to declines in eQueue and Cortelco gross profits when compared to the same period of the previous year.

Gross profit percent decreased to approximately 25% for the three months ended January 31, 2013 compared with gross profit percent of approximately 28% for the same period of the previous year, primarily the result of product mix.

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 decreased approximately 2% to $1,312,000 for the three months ended January 31, 2013, from $1,337,000 for the same period of the previous year. The decrease is primarily due to declines in subcontract, professional fees and facility expenses when compared to the same period of the previous year.

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 8% to $96,000 for the three months ended January 31, 2013 from $104,000 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.

Other Operating Expense (Income), net Other operating expense is primarily comprised of bank service charges, stock compensation expense, franchise taxes, currency differences, proceeds from scrap sales, and gains or losses from disposal of fixed assets. Other operating expense was $24,000 for the three months ended January 31, 2013 compared to income of $8,000 for the same period of the previous year.

13-------------------------------------------------------------------------------- Table of Contents Interest Expense (Income), net Interest income was $239,000 for the three months ended January 31, 2013 compared to interest expense of $94,000 for the same period of the previous year. Interest income in the current period includes $240,000 of imputed interest benefit on the Cortelco Note, of which approximately $366,000 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 January 31, 2013 and 2012 totaled $0 and $10,000, respectively. Income tax expense in the current period consists 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 January 31, 2013.

For the Six Months Ended January 31, 2013 compared to the Six Months Ended January 31, 2012 Net Revenue Net revenue decreased by approximately 8% to $10,975,000 for the six months ended January 31, 2013 compared to $11,903,000 for the same period of the previous year. The decrease was attributable to decreased revenues of approximately $1,597,000 in the Company'systems and telephony product lines compared to the same period of the previous year. The decrease is partially offset by revenue increases of $669,000 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 decreased approximately 16% to $2,802,000 for the six months ended January 31, 2013 from $3,339,000 for the same period of the previous year. Decreases in Cortelco, eQueue and Millennium gross profit was partially offset by an increase in CSPR gross profit for the six months ended January 31, 2013 when compared to the same period of the previous year. Gross profit percent decreased to approximately 26% for the six months ended January 31, 2013 compared with gross profit percent of approximately 28% for the same period of the previous year, primarily the result of product mix.

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 decreased approximately 0% to $2,604,000 for the six months ended January 31, 2013, from $2,612,000 for the same period of the previous year.

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 3% to $205,000 for the six months ended January 31, 2013 from $212,000 for the same period of the previous year. Research and development expense for the current period reflects reductions in compensation and related expenses and overhead expenses when compared to the same period of the previous year.

Other Operating Expense (Income), net Other operating expense is primarily comprised of bank service charges, stock compensation expense, franchise taxes, currency differences, proceeds from scrap sales, and gains or losses from disposal of fixed assets. Other operating expense was $38,000 for the six months ended January 31, 2013 compared to income of $17,000 for the same period of the previous year.

Interest Expense(Income), net Interest income was $281,000 for the six months ended January 31, 2013 compared to interest expense of $82,000 for the same period of the previous year.

Interest income in the current period includes $283,000 of imputed interest benefit on the Cortelco Note, of which approximately $537,000 in interest benefit is a result of changes in the estimated timing of future principal payments.

14 -------------------------------------------------------------------------------- Table of Contents Income Tax Expense Income tax expense for the six months ended January 31, 2013 and 2012 totaled $7,000 and $18,000, respectively. Income tax expense in the current period consists 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 January 31, 2013.

Net Income Net income was $83,000 and $171,000 for the three and six months ended January 31, 2013 compared to net income of $5,000 and $351,000 for the three and six month periods in the previous year due to fluctuations in gross margins and expenses explained above.

Liquidity and Capital Resources As of January 31, 2013, the Company had cash and cash equivalents of $1,567,000 and working capital of $7,794,000.

Operating activities resulted in a net cash outflow of $244,000 for the six months ended January 31, 2013 compared to a net cash inflow of $510,000 for the same period of the previous year. The net operating cash outflow for the current period primarily reflects higher inventories and lower accrued expenses partially offset by lower trade accounts receivable and higher trade accounts payable. The net operating cash inflow for the prior year period primarily reflects net income (adjusted for non-cash items), lower accounts receivable and inventories partially offset by lower trade accounts payable and accrued expenses.

Investing activities resulted in a net cash outflow of $160,000 for the six months ended January 31, 2013 compared to a net cash outflow of $73,000 for the same period of the previous year. Cash used in investing activities for the six months ended January 31, 2013 was a result of net cash used for 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 purchases of property and equipment.

Financing activities resulted in a cash outflow of $191,000 for the six months ended January 31, 2013 compared to a cash inflow of $9,000 for the same period of the previous year. Cash used in financing activities in the current period reflects payments on notes payable. Cash provided by financing activities in the prior period reflects purchases under the Employee Stock Purchase Plan.

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.

The Company has incurred substantial net operating losses since inception and has had negative cash flows from operating activities resulting in an accumulated deficit of $49,134,000. As of January 31, 2013 the Company had $1,567,000 in cash and cash equivalents to fund operations.

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 with available borrowings 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 and expires December 15, 2013. The loan's interest rate, with a floor of 4%, is floating based on LIBOR. CSPR has a $500,000 revolving line of credit, none of which was drawn on as of January 31, 2013, secured by trade accounts receivable and bears interest at 2% over Citibank's base rate. The agreement has certain covenant requirements and expires November 30, 2013. On January 28, 2013 CSPR signed a commitment letter to increase the revolving line of credit to $800,000 with similar terms. 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.

15 -------------------------------------------------------------------------------- Table of Contents Concentrations, Commitments and Contingencies (a) Customer Concentrations At January 31, 2013, four customers accounted for approximately 38% of total accounts receivable and individually 18%, 7%, 7% and 6% of the total accounts receivable. At January 31, 2012, five customers accounted for approximately 39% of total accounts receivable and individually 10%, 9%, 8%, 6%, and 6% of the total accounts receivable. For the six months ended January 31, 2013, four customers accounted for approximately 40% of total revenue and individually 17%, 12%, 17%, and 4% of total revenue. For the six months ended January 31, 2012, four customers accounted for approximately 45% of total revenue and individually 16%, 13%, 11, and 5% of total revenue.

(b) Commitments At January 31, 2013, the Company had outstanding commitments for inventory purchases under open purchase orders of approximately $2,580,000.

(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 ($530,000 as of July 31, 2012, 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 July 31, 2012 and January 31, 2013.

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