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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934. For the quarter ended October 31, 2003.
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the transition period from ____ to ____.
Commission file number 000-49626
CORTELCO SYSTEMS PUERTO RICO, INC.
(Exact name of registrant as specified in its charter)
PUERTO RICO 66-0567491
(State of incorporation) (I.R.S. Employer Identification No.)
Parque Ind. Caguas Oeste Road 156 km 58.2, Caguas, Puerto Rico, 00725-0137
(Address of principal executive office)
(787) 758-0000
(Telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No | |
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 126-2 of the Exchange Act). Yes | | No |X|
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date: 1,204,557 shares of Common
---------------------------
Stock, $0.01 par value, as of October 31, 2003.
- -----------------------------------------------
CORTELCO SYSTEMS PUERTO RICO, INC.
FORM 10-Q
QUARTER ENDED OCTOBER 31, 2003
INDEX
Page
----
Part I: FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Balance Sheets as of October 31, 2003
and July 31, 2003 .......................................... 1
Condensed Statements of Operations for the Three Months
ended October 31, 2003 and 2002 ............................ 2
Condensed Statement of Changes in Stockholders' Equity
for the Three Months ended October 31, 2003 ................ 3
Condensed Statements of Cash Flows for the three Months
ended October 31, 2003 and 2002 ............................ 4
Notes to Condensed Financial Statements ....................... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................. 14
Item 3. Qualitative and Quantitative Disclosure about Market Risk ..... 25
Item 4. Controls and Procedures ....................................... 25
Part II: OTHER INFORMATION
SIGNATURES
CORTELCO SYSTEMS PUERTO RICO, INC.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED BALANCE SHEETS (Unaudited)
October 31, 2003 and July 31, 2003
(Dollars in thousands)
October 31, July 31,
2003 2003
ASSETS
Current assets:
Cash $ 72 $ 63
Trade accounts receivable, net of allowance of
$523 and $539, respectively 2,264 2,171
Due from affiliate entities 320 313
Inventories 1,281 1,247
Prepaid expenses 189 114
------ ------
Total current assets 4,126 3,908
Property and equipment, net 408 444
Goodwill 382 382
------ ------
Total $4,916 $4,734
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable 1,454 $1,265
Due to affiliated entities 118 152
Other accrued liabilities 431 394
Deferred revenue 287 271
Note payable 25 25
------ ------
Total current liabilities 2,315 2,107
------ ------
Commitments and Contingencies
Stockholders' equity:
Preferred stock, par value $0.01 per share;
authorized, 10,000,000 shares, no shares issued -- --
Common stock, par value $0.01 per share, 5,000,000
Shares authorized; 1,204,557 shares issued
and outstanding 12 12
Capital in excess of par value 6,865 6,865
Deficit (4,276) (4,250)
------ ------
Total stockholders' equity 2,601 2,627
------ ------
Total $4,916 $4,734
====== ======
See notes to condensed financial statements
1
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED STATEMENTS OF OPERATIONS (Unaudited)
For the Three Months Ended October 31, 2003 and 2002
(Dollars in thousands, except per share data)
Three Months Ended
October 31,
-----------------------
2003 2002
-------- --------
Net revenues:
Products $1,215 $1,353
Services 811 884
----- ------
Total net revenues 2,026 2,237
Cost of revenues:
Products 989 1,106
Services 469 524
----- ------
Total cost of revenues 1,458 1,630
----- ------
Gross profit 568 607
----- ------
Operating expenses:
Selling, general, & administrative 598 818
----- ------
Total operating expenses 598 818
----- ------
Loss from operations (30) (211)
Interest income, net (4) (6)
----- ------
Loss before income taxes (26) (205)
Income tax -- --
----- ------
Net loss $ (26) (205)
====== ======
Basic and diluted net loss per
common share $ (0.02) $ (0.17)
====== =======
See notes to condensed financial statements
2
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
For the Three Months Ended October 31, 2003
(Dollars in thousands, except per share data)
- --------------------------------------------------------------------------------
Capital
Contribution
Note
Common Stock Capital in Receivable
------------------ Excess of From Related
Shares Amount Par Value Party Deficit Total
--------- ------- ---------- ------------ -------- ------
Balance at
July 31, 2003 1,204,557 $ 12 $ 7,169 $ (304) $(4,250) $2,627
Net loss (26) (26)
--------- ----- -------- --------- ------ ------
Balance at
October 31, 2003 1,204,557 $ 12 $ 7,169 $ (304) $(4,276) $2,601
========= ===== ====== ========= ======== ======
See notes to condensed financial statements
3
CORTELCO SYSTEMS PUERTO RICO, INC.
CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)
For the Three Months Ended October 31, 2003 and 2002
(Dollars in thousands)
Three Months Ended
October 31,
----------------------
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (26) $ (205)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization 37 37
Changes in operating assets and liabilities:
Decrease (increase) in:
Trade accounts receivables (98) (100)
Due from affiliated entities (7) (14)
Inventories (34) 135
Prepaid expenses (75) 86
Increase (decrease) in:
Trade accounts payable 189 (67)
Due to affiliated entities (34) 14
Accrued liabilities 37 (119)
Deferred revenue 16 (10)
------- ------
Total adjustments 31 (38)
------- ------
Net cash provided by (used in) operating activities 5 (243)
------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1) (12)
Net decrease in investment in sales-type leases 5 23
------- ------
Net cash provided by investing activities 4 11
------- ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment on promissory note -- (25)
-------- ------
NET CHANGE IN CASH AND CASH EQUIVALENTS 9 (257)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 63 333
------- ------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 72 $ 76
======= ======
See notes to condensed financial statements
4
CORTELCO SYSTEMS PUERTO RICO, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited)
For the Three Months Ended October 31, 2003 and 2002
BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been
prepared by Cortelco Systems Puerto Rico, Inc. ("CSPR" or the "Company"). It is
Management's opinion that these statements include all adjustments, consisting
of only normal recurring adjustments, necessary to present fairly the financial
position, results of operations, and cash flows as of October 31, 2003 and for
all periods presented.
CSPR, a Puerto Rico corporation, was a wholly-owned subsidiary of eOn
Communications Corporation ("eOn") through July 30, 2002. Effective July 31,
2002, CSPR was spun-off from eOn to the eOn stockholders. Each holder of eOn
common stock received one share of CSPR common stock for every ten shares of eOn
common stock held as of July 22, 2002, which was the record date of the
distribution. After such spin-off, CSPR became an independent entity
headquartered in San Juan, Puerto Rico. CSPR's operations include principally
the sale of integrated communications and data equipment in Puerto Rico. The
Company's operations also include the sales of cellular telephones and cellular
airtime, but these are no longer significant.
Certain information and footnote disclosures normally included in the
annual financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted. It is suggested that these condensed financial statements be read in
conjunction with the financial statements and notes as of July 31, 2003 and 2002
and for the periods then ended, which are included in the Annual Report on Form
10-K for the year ended July 31, 2003 filed with the Securities and Exchange
Commission.
SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates - The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Cash and cash equivalents - Cash and cash equivalents include cash in banks and
other highly liquid investments with an original maturity of three months or
less. Cash and cash equivalents are deposited in high-credit qualified financial
institutions.
Fair value of financial instruments - The carrying amounts of cash and cash
equivalents are a reasonable estimate of their fair value. The carrying amounts
of accounts receivable, accounts and notes payable, accrued expenses, and
deposit liabilities approximate fair value due to their short-term maturities.
It is impracticable to determine the fair value of the amounts due by and to
affiliated entities because they are unsecured, bear no interest, and have no
definite due date. The carrying amount of the investments in sales-type leases
approximates fair value due to the relative short-term nature of the remaining
balance.
5
Allowance for Doubtful Accounts - The allowance for doubtful accounts is an
amount that management believes will be adequate to absorb losses on existing
accounts receivable that are considered uncollectible based on evaluations of
collectibility of accounts receivable and prior credit experience. Because of
uncertainties inherent in the estimation process and the future availability of
additional information, management's estimate of credit losses inherent in the
existing accounts receivable and the related allowance may change in the near
term.
Maintenance contracts - Maintenance contract revenues are recognized over the
remaining life of each contract (usually one year) based on the straight-line
method.
The following table summarizes the activity relating to the unexpired maintenace
contracts during the first quarter of this fiscal year.
July 31, 2003 October 31, 2003
Liability Liability
Balance Additions Deductions Balance
-----------------------------------------------------------
Maintenance Contracts $ 61 $ 90 $ 82 $ 69
Product Warranties - The Company gives a one-year warranty to certain products
sold. The Company recognizes an accrued warranty liability when it sells a
product. This amount is an estimate of the cost of labor to be performed if that
warranty is exercised, based on experience. If the Company is required to
perform on its warranty, it sends the product to the manufacturer that normally
warrants the product. The Company only incurs in cost of labor of technicians
and freight. The Company recognizes warranty revenue over the term of the
warranty period. The costs related to warranties exercised are recognized
directly as cost of sales when incurred.
The following table summarizes the activity relating to the warranty reserve
during the first quarter of this fiscal year.
July 31, 2003 October 31, 2003
Liability Liability
Balance Additions Deductions Balance
-----------------------------------------------------------
Warranty Reserve $210 $ 48 $ 40 $ 218
Inventory - Inventories are stated at the lower of cost or market. Cost is
determined by the first-in, first-out ("FIFO") method. Returned equipment and
inventory, mostly related to warranty claims and replacements of outdated
communication systems, is recorded at net realizable value. Because of
uncertainties inherent in the estimation process and the future availability of
additional information, management's estimate of the obsolescence in the
existing inventory may change in the near term.
6
Going Concern and Management Plan - The accompanying condensed financial
statements have been prepared on a going concern basis, which contemplates the
realization of assets and the settlement of liabilities and commitments in the
normal course of business. The Company's significant revenue decrease and
resulting loss from operations in prior fiscal years, and its lack of financing
resources raise doubt about the Company's ability to continue as a going
concern. Management plans include continuing its reduction of operating costs
and expenses while striving for an increase in sales profits. Effective in
February 2003, the Company moved its operations to a new location, resulting in
savings of approximately $175,000 for the fiscal year 2003 and approximately
$376,000 for this fiscal year 2004. To increase sales, CSPR jointly with OEM
suppliers is developing an aggressive plan that includes visits to our current
customer base in order to offer new technologies to help them in the
productivity, security and reductions of their telecommunications expenses. Some
of these products are IP Office, Unify Messenger and Digital Video Recording
(DVR). Also, the Company is increasing its maintenance service contracts with
designated salespersons to generate maintenance contracts for new customers and
continuing the renewal of the existing customers' contracts. The Company's goal
is to improve cash flows and to ultimately generate operating profits. To
improve cash flows, management created a task force composed of representatives
of the finance and sales departments. The task force is oriented to analyze
disputed balances, visit the customers, and resolve issues in order to improve
the collection process of past due invoices. The finance department together
with the operations department will create a task force that will be working to
sell any excess or slow moving inventory to the secondary market. However, no
assurances can be given that the Company will be successful in achieving
profitability and positive cash flows. The magnitude of our future capital
requirements will depend on many factors, including, among others, investments
in working capital, and the amount of income generated by operations. If the
Company needs to raise additional capital, that capital may not be available on
acceptable terms, or at all. If the Company cannot raise necessary additional
capital on acceptable terms, it may not be able to successfully market our
products and services, take advantage of future opportunities, respond to
competitive pressures or unanticipated requirements or even continue operating
our business.
Accounting for income taxes - Deferred income taxes are accounted for using the
asset and liability method of accounting. Under this method, deferred tax assets
and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and the respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using the
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
On August 4, 2003, the Company was granted certain tax exemption benefits under
the Commonwealth of Puerto Rico Law 135 of December 2, 1997, as amended. Under
the ten-year decree, beginning on December 30, 2002, the Company's process of
assembling communication equipment will enjoy preferential tax rates, as
follows:
TAX BENEFIT
----------- --------------
Income 7% flat tax
Property 90% exemption
Municipal 60% exemption
7
Securities Authorized for Issuance Under the Company's Equity Compensation Plan
The following table summarizes the Company equity compensation plan as of
October 31, 2003:
Number of
securities to be Number of securities
issued upon Weighted-average remaining available for
exercise of exercise price of future issuance under equity
outstanding outstanding compensation plans
options, warrants options, warrants (excluding securities
Plan category and rights and rights reflected in column (a)
- ----------------------------- --------------------------- ------------------------ ---------------------------------------
(a) (b) (c)
Equity compensation plans
approved by security holders -- -- 350,000
Equity compensation plans
not approved by security
holders -- -- --
Total -- -- 350,000
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated retirement costs. The Company implemented SFAS No. 143 on August 1,
2002. Adoption of SFAS No. 143 did not have a significant effect on the
Company's results of operations or financial position.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS No. 144 supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of. However, SFAS No. 144 retains the fundamental provisions of SFAS
No. 121 for (a) recognition and measurement of the impairment of long-lived
assets to be held and used and (b) measurement of long-lived assets to be
disposed of by sale. The Company implemented SFAS No. 144 on August 1, 2002.
Adoption of SFAS No. 144 did not have a significant effect on the Company's
results of operations or financial position.
In April 2002, the FASB issued SFAS No. 145, Rescission of SFAS No. 4, 44
and 64, Amendment of SFAS No. 13, and Technical Corrections. SFAS No. 145
rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt - an
amendment of APB Opinion No. 30, which required all gains and losses from
extinguishment of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. The Company implemented
SFAS No. 145 on August 1, 2002. Adoption of SFAS No. 145 did not have a
significant effect on the Company's financial condition or results of
operations.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
With Exist or Disposal Activities. SFAS No. 146 requires that a liability for a
cost associated with an exit or disposal activity be recognized and measured
8
initially at fair value only when the liability is incurred. SFAS No. 146 also
establishes that fair value is the objective for initial measurement of the
liability. SFAS No. 146 applies to costs associated with an exit activity but
does not involve an entity newly acquired in a business combination or with a
disposal activity covered by SFAS No. 144, SFAS No. 146 does not apply to costs
associated with a retirement of long-lived assets covered by SFAS No. 143 or
SFAS No. 144. The Company implemented SFAS No. 146 for exist or disposal
activities initiated after December 31, 2002. Adoption of SFAS No. 146 did not
have a significant effect on the Company's financial condition or results of
operations.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees and clarifies that a guarantor is required
to recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken an issuing the guarantee. The disclosure requirements
are effective for fiscal years ending after December 15, 2002. The initial
recognition and initial measurement provisions of FIN 45 are applicable on a
prospective basis to guarantees issued or modified after December 31, 2002. The
adoption of this accounting pronouncement did not have a material impact on the
Company's financial position or results of operations.
In November 2002, the EITF released Issue Abstract No. 00-21, "Accounting
for Revenue Arrangements with Multiple Deliverables." This consensus requires
that revenue arrangements with multiple deliverables be divided into separate
units of accounting if the deliverables in the arrangements meet specific
criteria. In addition, arrangement consideration must be allocated among the
separate units of accounting based on their relative fair values, with certain
limitations. The Company will be required to adopt the provision of this
consensus are applicable for revenue arrangements entered into after June 30,
2003. The adoption of this accounting pronouncement did not have a material
impact on the Company's financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. This Statement amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The Company has not implemented SFAS No. 123 because it still follows
Accounting Principle Board Opinion No. 25, Accounting for Stock Issued to
Employees, which is an acceptable alternative. Accordingly, SFAS No. 148 is not
applicable until the Company implements SFAS No. 123.
In April 2003, the FASB issued SFAS No. 149, Amendment of SFAS No. 133 on
Derivative Instruments and Hedging Activities. This SFAS amends and clarifies
financial accounting and reporting for derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities. The Company implemented SFAS No. 149 during the fourth quarter of
fiscal year 2003. Adoption of SFAS No. 149 did not have a significant effect on
the Company's financial position and results of operations.
9
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liability and Equity. This SFAS
established standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or and asset in some circumstances). Many of those instruments
were previously classified as equity. Some of the provisions of this SFAS are
consistent with the current definition of liabilities in FASB Concepts Statement
No. 6. Elements of Financial Statements. The remaining provision of this
Statement are consistent with the Board's proposal to revise that definition to
encompass certain obligations that a reporting entity can or must settle by
issuing its own equity shares, depending on the nature of the relationship
established between the holder and the issuer. The Company implemented SFAS No.
150 during the fourth quarter of fiscal year 2003. Adoption of SFAS No. 150 did
not have a significant effect on the Company's financial position and results of
operations.
REVENUE RECOGNITION
The Company recognizes revenues from the communications systems segment
upon completion of installation services and acceptance by the customer due to
the customized nature of each installation. The Company recognizes revenues upon
shipment of equipment to customers for communications systems and cellular
telephones shipped to dealers because, at that point, the Company has no further
obligations to our dealers to either deliver additional products or perform
services. Also the Company recognizes revenues upon shipment for cellular
telephones sold to retail customers and recognizes cellular sales commission
revenues when retail contracts are submitted to cellular carriers and recognizes
revenues for resold cellular airtime when the customer uses the airtime.
Revenues from communications systems service contracts are recognized over the
life of the individual contracts. Currently, the Company sells and services
communications systems purchased from various third-party communications systems
from various manufacturers, including eOn.
SPECIAL CHARGES
To reduce costs and improve productivity, the Company adopted a
restructuring plan in the second quarter of fiscal year 2001. The plan, which
included headcount reductions and office space consolidation, was effectively
amended in fiscal year 2002. The majority of the restructuring plan was
completed by July 31, 2002. The remaining expenditures for the restructuring
plan are expected to be substantially complete by July 2004.
The following table summarizes the activity relating to the special charges
during the first quarter of fiscal 2004 and the associated liabilities at
October 31, 2003 (in thousands):
July 31, 2003 October 31, 2003
Liability Liability
Balance Expenditures Balance
-----------------------------------------------------------
Termination benefits $151 $23 $128
10
The liability for restructuring charges of $128,000 as of October 31, 2003,
is included in other accrued liabilities.
INCOME (LOSS) PER COMMON SHARE
The Company reports its earnings per share ("EPS") using Financial
Accounting Standards Board ("FASB") Statement No. 128, Earnings Per Share ("SFAS
128"). SFAS 128 requires dual presentation of basic and diluted EPS. Basic EPS
is computed by dividing income (loss) attributable to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
On July 31, 2002, CSPR issued 1,194,557 shares of common stock to effect
the spin-off to eOn shareholders. The weighted average number of shares
outstanding for the period ended October 31, 2003 has been adjusted to give
effect to eOn's distribution to eOn's shareholders of all the Company's shares
held by eOn on the basis of one share of the Company's stock for every ten
shares of eOn common stock outstanding as if such distribution had occurred as
of the beginning of the earliest period presented.
The computations of basic and diluted loss per share were as follows:
Three Months Ended
October 31,
--------------------
2003 2002
-------- --------
(In thousands, except
per share data)
Basic and diluted loss per share:
Net loss $ (26) $ (205)
======== ========
Weighted average number of common
shares outstanding 1,204,557 1,204,557
Net loss per share $ (0.02) $ (0.17)
========= =========
INVENTORIES
Inventories consist of the following:
October 31, July 31,
2003 2003
---------- ---------
(In thousands)
Purchased components $ 593 $ 710
Components and materials related to
installation in process 100 85
Parts and materials for sales 588 452
--------- ---------
Total inventories $ 1,281 $ 1,247
========== ==========
11
ACCOUNTING FOR GOODWILL
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets ("SFAS 142"). SFAS No. 142 eliminates the amortization of goodwill and
indefinite-lived intangible assets and initiates an annual review for
impairment. Identifiable intangible assets with a determinable useful life will
continue to be amortized. The amortization provisions apply to goodwill and
other intangible assets acquired after June 30, 2001. Goodwill and other
intangible assets acquired prior to June 30, 2001 were affected upon adoption.
Goodwill of $382,000 had been recorded in conjunction with the assets
acquisition of Ochoa Telecom in May 14, 2001. The Company adopted SFAS No. 142
effective August 1, 2001, and performed an impairment test of its existing
goodwill based on a fair value concept. The adoption of SFAS No. 142 did not
have a significant impact on the Company's results of operations or financial
position during fiscal year 2003 or in the three months ended October 31, 2003.
As of October 31, 2003 and July 31, 2003, the Company has net unamortized
goodwill of $382,000.
CONTINGENCIES
CSPR is currently subject to one lawsuit regarding an alleged breach of
contract, three lawsuits regarding employment issues, and a fifth lawsuit in
which the Company was included as a Third Party Defendant. In the breach of
contract case, the plaintiff alleges that CSPR breached the terms of our
contract by ceasing to supply services to the plaintiff, and the plaintiff seeks
damages of approximately $854,430. In the employment lawsuits, each of the
plaintiffs are former employees of our company, and they each allege under
various theories of law that their dismissal from employment by the Company was
unjustified. Collectively, the employment law cases allege damages of
approximately $16 million. Regarding the fifth lawsuit, the Company recognized
plaintiff's seniority at the workplace and the court entered partial judgement
dismissing the cause of action at plaintiffs that work with CSPR. The Company
has analyzed each lawsuit with our legal advisors, and the Company does not
believe that any of these cases will result in an unfavorable outcome that would
have a material adverse effect upon our business. However, in the event of one
or more unfavorable determinations against us, such litigation could have a
material adverse effect on our business by harming earnings if the Company is
liable for a significant monetary judgment, by harming our reputation with our
customers through any adverse publicity generated from an unfavorable
determination, or by adversely affecting our relationship with current and
prospective employees of our company.
SEGMENT INFORMATION
CSPR's reportable segments are Communications Systems and Cellular
Services, each of which offers different products and services. Each segment
requires different technology and marketing strategies. The Communications
Systems segment offers communications solutions that address voice and data
network switching while the Cellular Services segment, which is no longer a
significant segment, resells cellular airtime and cellular telephones in Puerto
Rico.
12
Unaudited segment information for the
THREE MONTHS ENDED OCTOBER 31, 2003
-----------------------------------
Communications Cellular
Systems Services Total
-------------- ------------ ----------
(In thousands)
Revenues $ 1,940 $ 86 $ 2,026
Loss from operations (5) (25) (30)
Interest income 4 -- 4
Provision for income taxes -- -- --
Net loss (1) (25) (26)
Total Assets 4,803 113 4,916
Capital Expenditures (1) -- (1)
Depreciation and amortization 37 -- 37
THREE MONTHS ENDED OCTOBER 31, 2002
-----------------------------------
Communications Cellular
Systems Services Total
-------------- ------------ -----------
(In thousands)
Revenues $ 2,004 $ 233 $ 2,237
Loss from operations (138) (73) (211)
Interest income 6 -- 6
Provision for income taxes -- -- --
Net loss (132) (73) (205)
Total Assets 5,978 431 6,409
Capital Expenditures (12) -- (12)
Depreciation and amortization 35 2 37
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
This report contains unaudited forward-looking statements within the
meaning of the federal securities laws. Unaudited forward-looking statements are
those that express management's views of future events, developments, and
trends. In some cases, these statements may be identified by terminology such as
"may," "will," "should," "expects," "plans," "intends," "anticipates,"
"believes," "estimates," "predicts," "potential," or "continue" or the negative
of such terms and other comparable expressions. Unaudited forward-looking
statements include statements regarding our anticipated or projected operating
performance, financial results, liquidity and capital resources. These
statements are based on management's beliefs, assumptions, and expectations,
which in turn are based on the information currently available to management.
Information contained in these unaudited forward-looking statements is
inherently uncertain, and our actual operating performance, financial results,
liquidity, and capital resources may differ materially due to a number of
factors, most of which are beyond our ability to predict or control. The Company
also directs your attention to the risk factors affecting our business that are
discussed elsewhere at the end of this Item. CSPR disclaims any obligation to
update any of the unaudited forward-looking statements contained in this report
to reflect any future events or developments. The following discussions should
be read in conjunction with our unaudited financial statements and the notes
included thereto.
OVERVIEW
The Company is a value-added reseller of numerous third-party brands of
voice and data communication systems as well as cellular telephones and airtime.
Most of our business is conducted in Puerto Rico, although the Company also
sells a limited amount of communications systems in the Caribbean and Latin
America. The Company's products help enterprises communicate more effectively
with customers and increase customer satisfaction and loyalty. The Company sells
both to enterprises in our voice and data communications business and to
individual retail customers in our cellular business.
The Company's reportable segments are Communications Systems and Cellular
Services, each of which offers different products and services. Each segment
requires different technology and marketing strategies. The Communications
Systems segment offers communications solutions that address voice and data
network switching while the Cellular Services segment resells cellular airtime
and cellular telephones in Puerto Rico. The Communications Systems segment
revenues are comprised mostly of sales of PBX customer premise equipment. The
Communications Systems segment represented 90% of our revenues in fiscal year
2003 and 97% of the operating loss of the Company, while Cellular Service
represented 10% of revenues and 3% of the operating loss. Cellular Services
revenues were 4% of our total revenues for the three months ended October 31,
2003 and CSPR anticipates that these revenues will continue to represent a
smaller percentage of the total revenues than in fiscal year 2003. As
Communications Systems revenues will constitute a larger portion of our revenue
in the future than in fiscal year 2003, it is important that we continue to add
to our product and service offering and increase our installed base of
customers. In the period ended October 31, 2003, Communications Systems segment
has our highest gross margins, greater than Cellular Services segment.
While the Company's recent losses in fiscal year 2003 have primarily been
due to our Communications Systems segment, CSPR anticipates increasing the
revenues in the Communications Systems segment while trying to closely control
our selling,
14
general, and administrative expenses. The Company will continually look for ways
to increase our installed base of customers via acquisitions or by distributing
new types of voice and data communications products as our highest gross margins
are from service revenues in our Communications Systems segment. The Company's
recent losses in the Communications System segment were mainly a result of
expanding our sales and administrative infrastructure following our rapid growth
in fiscal year 1999 and the first half of fiscal year 2000. In fiscal year 2001,
CSPR restructured the business to address the downward cycle in the
telecommunications industry and began to look for ways to increase our higher
margin business by acquiring certain assets of Ochoa Telecom in Puerto Rico.
While the telecommunications market has continued to be depressed in Puerto Rico
due to macroeconomic factors in the country, CSPR will continue to seek
acquisition opportunities that allow us to increase our maintenance revenues in
the Communications Systems segment.
THREE MONTHS ENDED OCTOBER 31, 2003 AND 2002
The following discussion provides information about the Company's
operations, for the three months ended October 31, 2003 and for the three months
ended October 31, 2002.
NET REVENUES
Net revenues decreased 9% to $2.0 million in the three months ended October
31, 2003 from $2.2 million in the three months ended October 30, 2002. The
results primarily reflects decreased revenue of approximately $64,000 in
Communications Systems segment and a decrease of approximately $147,000 in
Cellular Services segment due to a general decline in demand.
COST OF REVENUES AND GROSS PROFIT (LOSS)
Cost of revenues consists primarily of purchases from equipment
manufacturers and other suppliers and costs incurred for final assembly, quality
assurance and installation of our systems. For cellular contracts submitted to
the carriers from our authorized dealers, any commissions paid to the dealer are
also included as a component of cost of revenues. Gross profit decreased 6.4% to
$568,000 in the three months ended October 31, 2003 from $607,000 in the three
months ended October 31, 2002. CSPR's gross margins were 28.0% in the three
months ended October 31, 2003 and 27.1% in the three months ended October 31,
2002. The increase in gross margin was primarily due to the net effect of
reductions of costs and productivity improvements resulting from the
restructuring plan adopted by the Company.
SELLING, GENERAL AND ADMINISTRATIVE
The operating expenses consist mainly of salaries of our sales, marketing,
service, and administrative personnel and associated overhead. CSPR recognizes
these expenses as incurred. As the Company distributes the products of third
parties and does not sell any products that the Company designs or develops, the
Company does not incur any costs for research and development. While prior to
the spin-off the Company essentially operated as a stand-alone entity from our
parent due to our location in Puerto Rico, with separate audits, legal counsel,
corporate officers, and accounting and administrative functions, the Company has
not previously operated as a stand-alone public company. Therefore, CSPR
anticipates
15
that it will incur additional general and administrative expenses due to the
public company reporting requirements that were previously performed by our
parent. However, selling, general and administrative expenses decreased 27% to
$0.6 million in the quarter ended October 31, 2003 from $.8 million in the
quarter ended October 31, 2002. The decrease was primarily due to reductions in
personnel, facilities, and associated overhead resulting from the implementation
of the Company's restructuring plan.
INTEREST AND OTHER INCOME AND EXPENSES
No material amount was recorded in the three months ended October 31, 2003
or the three months ended October 31, 2002.
INCOME TAX BENEFIT (EXPENSE)
No income tax benefit was recognized in the three months ended October 31,
2003 or the three months ended October 31, 2002 because CSPR cannot conclude
that it is more likely than not that its deferred tax assets will be realized in
the future.
LIQUIDITY AND CAPITAL RESOURCES
Prior to the initial public offering of eOn, the Company funded its
operations primarily through cash generated from operations and periodic
borrowings under our former revolving credit facility. Subsequent to the initial
public offering, eOn periodically provided funds through parent-subsidiary loans
as our credit facility was retired with funds from the initial public offering.
The last funds received from eOn were in November 2000 and we have funded all
cash requirements and loan repayments to eOn of $2.25 million since that date
from operating revenues. However, if our business begins to grow, CSPR may need
additional capital. Such capital may not be available on favorable terms and
conditions.
The Company's significant revenue decrease and resulting loss from
operations through fiscal year 2003, and its lack of financing resources raise
doubt about the Company's ability to continue as a going concern. Management
plans include continuing its reduction of operating costs and expenses while
striving for an increase in sales profits. Effective in February 2003, the
Company moved its operations to a new location, resulting in savings of
approximately $175,000 for the fiscal year 2003 and approximately $376,000 for
this fiscal year 2004. To increase sales, CSPR jointly with OEM suppliers is
developing an aggressive plan that includes visits to our current customer base
in order to offer new technologies to help them in the productivity, security
and reductions of their telecommunications expenses. Some of these products are
IP Office, Unify Messenger and Digital Video Recording (DVR). Also, the Company
is increasing its maintenance service contracts with designated salespersons to
generate maintenance contracts for new customers and continuing the renewal of
the existing customers' contracts. The Company's goal is to improve cash flows
and to ultimately generate operating profits. To improve cash flows, management
created a task force composed of representatives of the finance and sales
departments. The task force is oriented to analyze disputed balances, visit the
customers, and resolve issues in order to improve the collection process of past
due invoices. The finance department together with the operations department
will create a task force that will be working to sell any excess or slow moving
inventory to the secondary
16
market. However, no assurances can be given that the Company will be successful
in achieving profitability and positive cash flows. The magnitude of our future
capital requirements will depend on many factors, including, among others,
investments in working capital, and the amount of income generated by
operations. If the Company needs to raise additional capital, that capital may
not be available on acceptable terms, or at all. If the Company cannot raise
necessary additional capital on acceptable terms, it may not be able to
successfully market our products and services, take advantage of future
opportunities, respond to competitive pressures or unanticipated requirements or
even continue operating our business.
Net cash provided by operating activities was approximately $5,000 for the
three months ended October 31, 2003 and net cash used in operating activities
was approximately $243,000 for the three months ended October 31, 2002. Cash
provided by operating activities in the three months of this fiscal year
resulted primarily from the increase in accounts payable, partially offset by
the increase in accounts receivable and prepaid expense.
Net cash provided by investing activities was approximately $4,000 for the
three months ended October 31, 2003 and was approximately $11,000 for the same
period fiscal year 2002. Cash provided by investing activities in this three
months of the current fiscal year consisted primarily of cash used for capital
expenditures offset by a decrease in the investment in sales-type leases.
Net cash used in financing activities was approximately $25,000 in the
three months ended October 31, 2002. There were no financing activities in the
three months ended October 31, 2003.
ADDITIONAL RISK FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
You should carefully consider the risks set forth in this Form 10-Q,
particularly the risk that we may not be able to continue operations as
described in "Liquidity and Capital Resources" and the risk factors described
below when evaluating CSPR. If any of the following risks occur, CSPR's
business, operating results and financial condition could be seriously harmed.
Additional risks and uncertainties that CSPR is presently not aware of could
also impair its business, operating results and financial condition.
IF THE COMPANY IS NOT ABLE TO SUSTAIN OUR TRADITIONAL PRIVATE BRANCH EXCHANGE
(PBX) MARKET, OUR BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION WILL BE
HARMED.
Approximately 56.3% and 58.1% of CSPR revenues for fiscal year 2003 and
2002, respectively, were from sales of PBX customer premise equipment. The
Company's PBX revenues declined 65.2% from fiscal year 2001 to fiscal year 2003
due mainly to a decline in the overall PBX markets and significant Year 2000
upgrade revenues. These revenues comprise approximately 56.3% of the Company
Communications Systems segment revenues, as virtually all enterprise voice
communications systems sold worldwide today are PBX's. The remainder of the
segment revenues is service revenue.
The Company may not be able to sustain our PBX market revenues because the
traditional PBX market is declining. One reason for the decline of the
traditional PBX market is the emergence of voice switching platforms based on
standard PCs and the continued introduction of IP based voice and data
communications devices by many of the large equipment manufacturers such as
Mitel,
17
Nortel Networks, Avaya, Nec, Toshiba, Panasonic, and Siemens. If CSPR is not
able to grow or sustain our traditional PBX revenues or properly train our
personnel to sell and service the newer products developed by these companies,
our business, operating results and financial condition could be harmed.
IF THE COMPANY FAILS TO OBTAIN AND MARKET NEW TELECOMMUNICATION AND DATA
PRODUCTS OR TO ADD FEATURES TO OUR EXISTING TELECOMMUNICATION AND DATA PRODUCTS,
THE COMPANY MAY NOT BE ABLE TO GENERATE SUFFICIENT REVENUES TO SUSTAIN OUR
BUSINESS.
Our success is highly dependent upon the continued successful timely
introduction of new telecommunication and data products and new models of our
existing telecommunications and data products containing additional features.
The markets for our products are characterized by rapid technological change,
frequent new product introductions, uncertain product life cycles and changing
customer requirements. The rapid change in customers' requirements and the
constant introduction of new products by our suppliers could cause technological
obsolescence of some of our inventory, which could harm our business, operating
results and financial condition.
The success of new products and new models with additional features depends
on a number of factors, including strategic allocation of limited financial and
technical resources, accurate forecasting of consumer demand, and market and
industry acceptance of our products and services. If CSPR is unable to
successfully train our sales and technical personnel to sell and service the new
telecommunications and data products developed by our equipment manufacturers,
our business, operating results, and financial condition could be harmed.
CSPR FACES INTENSE COMPETITION FROM PARTICIPANTS IN THE TELECOMMUNICATIONS AND
DATA VALUE-ADDED RESELLER MARKETS, WHICH MAY IMPAIR OUR REVENUES AND ABILITY TO
OBTAIN NEW CUSTOMERS AND MAINTAIN EXISTING CUSTOMERS.
The telecommunications and data value-added reseller markets are intensely
competitive and rapidly evolving. In addition, there are few barriers to entry
into the telecommunications and data value-added reseller markets, and new
entrants to these markets may develop and offer products that will compete
directly with our products and services. Rapid technological innovation and
intense price competition characterize the markets, and the competition for new
customers and for retention of existing customers is intense.
Some of the products and services provided by the Company are available
through competitors with long operating histories in our markets and many of
these products are already familiar to and accepted by consumers. Many of the
manufacturers and distributors of these competing telecommunication and data
products and services have substantially greater brand recognition, market
presence, distribution channels, advertising and marketing budgets and
promotional and other strategic partners than us.
Actions by our competitors could result in price reductions, reduced
margins and loss of market share, any of which would damage our business. CSPR
cannot assure you that the Company will be able to compete successfully against
these competitors.
18
THE LENGTHY SALES CYCLES OF SOME OF OUR PRODUCTS AND THE DIFFICULTY IN
PREDICTING THE TIMING OF OUR SALES MAY CAUSE FLUCTUATIONS IN OUR QUARTERLY
OPERATING RESULTS.
The uncertainty of our sales cycle makes the timing of sales difficult to
predict and may cause fluctuations in our quarterly operating results. Our sales
cycles generally vary from one to twelve months based on the size of the system
to be installed and the various requirements of our potential customers. The
purchase of our products may involve a significant commitment of our customers'
time, personnel, financial, and other resources. The Company generally
recognizes revenues on the date of shipment for communications systems and
cellular telephones shipped to dealers and upon completion of installation for
communications systems sold directly to end users. For cellular sales commission
revenues the Company recognizes revenues when retail contracts are submitted to
cellular carriers. Resold cellular airtime is recognized as revenues as the
airtime is actually used. Also, it is difficult to predict the timing of
indirect sales because we have little control over the selling activities of our
dealers and value-added resellers.
The Company incurs substantial sales and marketing expenses and spends
significant management time before customers place orders with us, if at all.
Revenues from a specific customer may not be recognized in the quarter in which
CSPR incurs related sales and marketing expense, which may cause CSPR to miss
our revenue or earnings expectations.
SEASONAL TRENDS MAY CAUSE OUR QUARTERLY OPERATING RESULTS TO FLUCTUATE, WHICH
MAY ADVERSELY AFFECT THE MARKET PRICE OF OUR STOCK.
Telecommunications product sales have traditionally been much lower in
Puerto Rico, our main market, during the winter holiday season than during other
times of the year due to the potential business disruption caused by installing
new communications systems, and the extended winter holiday season present in
Puerto Rico due to local custom. Although predicting consumer demand for our
products will be very difficult, the Company believes that sales of
telecommunications systems will be disproportionately low during this period
when compared to other times of the year due to the factors above and the
seasonal buying patterns of many of our customers. Any fluctuation in our
quarterly operating results may cause the market price of our stock to decline,
and that decline may be substantial if the fluctuation is caused by factors
other than anticipated seasonal buying patterns of customers. Finally, if CSPR
is unable to accurately forecast and respond to consumer demand for our
telecommunications systems, our reputation and brand may suffer, and the market
price of our stock would likely fall.
ANY FUTURE BUSINESS ACQUISITIONS MAY DISRUPT OUR BUSINESS, DILUTE STOCKHOLDER
VALUE OR DISTRACT MANAGEMENT ATTENTION.
As part of our ongoing business strategy, the Company may consider
additional acquisitions of, or significant investments in, businesses that offer
products, services and technologies complementary to our own. In particular,
CSPR may pursue acquisitions and strategic alliances as a means of acquiring
additional brands of communications systems to sell and service. Such
acquisitions could materially adversely affect our operating results and the
price of our stock. Acquisitions also entail numerous risks, including:
- - difficulty of assimilating the operations, products and personnel of the
acquired businesses;
19
- - potential disruption of our ongoing business;
- - unanticipated costs associated with the acquisition;
- - inability of management to manage the financial and strategic position of
acquired or developed products, services and technologies;
- - inability to maintain uniform standards, controls, policies and procedures;
and
- - impairment of relationships with employees and customers that may occur as a
result of integration of the acquired business.
To the extent that shares of our stock or other rights to purchase stock
are issued in connection with any future acquisitions, dilution to our existing
stockholders will result and our earnings per share may suffer. Any future
acquisitions or strategic investments may not generate additional revenue or
provide any benefit to our business, and we may not achieve a satisfactory
return on our investment in any acquired businesses.
IF THE COMPANY LOSES KEY MANAGEMENT PERSONNEL, WE MAY NOT BE ABLE TO
SUCCESSFULLY OPERATE THE BUSINESS.
CSPR's future performance will be substantially dependent on the continued
services of our senior management, especially our President and Chief Executive
Officer, Sergio R. Moren, and other key personnel. The loss of any members of
our executive management team and our inability to hire additional executive
management could harm our business and results of operations. The Company
employs our key personnel on an at-will basis. CSPR does not maintain key person
insurance policies on any of the members of our executive management team.
THE COMPANY MAY BE UNABLE TO HIRE AND RETAIN SALES, MARKETING, AND SERVICE
PERSONNEL TO EXECUTE OUR BUSINESS STRATEGY.
Competition for highly qualified personnel is intense due to the limited
number of people available with the necessary technical skills, and CSPR may not
be able to attract, assimilate or retain such personnel. If the Company cannot
attract, hire and retain sufficient qualified personnel, the Company may not be
able to successfully market, sell, or service new products.
SINCE THE COMPANY DOES NOT HAVE EXCLUSIVE AGREEMENTS WITH THE MANUFACTURERS,
MANUFACTURERS MAY ENTER INTO DEALER AGREEMENTS WITH OUR COMPETITORS, WHICH MAY
ADVERSELY AFFECT OUR BUSINESS.
CSPR distributes and services products designed and manufactured by eOn,
Avaya, Nortel, Hitachi, Mitel, Toshiba, NEC, Cortelco, Nokia, Ericsson,
Motorola, and others. However, the Company does not have exclusive distribution
agreements with these companies and have competitors in our major markets that
sell the same products. Our customers often have the option of purchasing
similar communications systems from other distributors in our markets. A
decision by the manufacturer to sell to other dealers in our market increases
competitive pressures on the Company, and may adversely affect our business.
20
IF THE COMPANY IS UNABLE TO ESTABLISH AND MAINTAIN SATISFACTORY RELATIONSHIPS
WITH THE MANUFACTURERS OF OUR PRODUCTS THAT THE COMPANY EXPECTS TO SELL AND
SERVICE, OUR BUSINESS WILL SUFFER.
The Company acquires all of our products that sell from manufacturers
pursuant to the terms of distribution agreements. The loss of our distribution
agreements with our product manufacturers would reduce our revenues, increase
obsolescence risk to our existing inventory, and materially harm our business.
CSPR DEPENDS ON A LIMITED NUMBER OF THIRD PARTIES TO MANUFACTURE AND SUPPLY OUR
PRODUCTS, AND MAY BE UNABLE TO OPERATE THE BUSINESS IF THOSE PARTIES DO NOT
PERFORM THEIR OBLIGATIONS.
The Company expects to rely on third-party suppliers for many of the
products that it distribute and service, including telecommunications and data
systems as well as cellular phones and accessories. CSPR does not have long-term
agreements in place with our suppliers and does not control the time and
resources that these third parties devote to our business. CSPR cannot be sure
that these parties will perform their obligations as expected or that any
revenue, cost savings or other benefits will be derived from the efforts of
these parties. If any of our third party suppliers breaches or terminates its
agreement with us or otherwise fails to perform its obligations in a timely
manner, CSPR may be delayed or prevented from delivering some of our products
and services. Because our relationships with these parties are non-exclusive,
they may also support products or services that compete directly with ours or
offer similar or greater support to our competitors. Any of these events could
require us to undertake unforeseen additional responsibilities or devote
additional resources to deliver our products and services. This outcome would
harm our ability to compete effectively and perform our services.
THE COMPANY FACES MANY RISKS IN EXPANDING ITS INTERNATIONAL OPERATIONS INTO THE
CARIBBEAN.
Sales outside of Puerto Rico accounted for approximately less than 1% of
our total revenues during fiscal year 2003. The Company expects to increase
sales to customers outside Puerto Rico and establish additional distribution
channels in the Caribbean. However, foreign markets for our products may develop
more slowly than currently anticipated. CSPR may not be able to successfully
establish international distribution channels, or may not be able to hire the
additional personnel necessary to support such distribution channels.
CSPR FUTURE RESULTS COULD BE HARMED BY ECONOMIC, POLITICAL, REGULATORY AND OTHER
RISKS ASSOCIATED WITH THE RELIANCE ON INTERNATIONAL SALES AND OPERATIONS.
As stated above, sales outside of Puerto Rico accounted for approximately
less that 1% of our total revenues during fiscal year 2003. Because of the
operations and relationships in other parts of the Caribbean, and our reliance
on foreign third-party manufacturing, assembly and testing operations, we are
subject to the risks of conducting business outside of Puerto Rico, including:
- - changes in a specific country's or region's political or economic conditions;
- - trade protection measures and import or export licensing requirements;
- - potentially negative consequences from changes in tax laws;
- - difficulty in managing widespread sales and customer service operations; and
21
- - less effective protection of intellectual property.
CSPR IS CURRENTLY INVOLVED IN LITIGATION, WHICH, IF RESOLVED UNFAVORABLY, COULD
HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
CSPR is currently subject to one lawsuit regarding an alleged breach of
contract, three lawsuits regarding employment issues, and a fifth lawsuit in
which the Company was included as a Third Party Defendant. In the breach of
contract case, the plaintiff alleges that CSPR breached the terms of our
contract by ceasing to supply services to the plaintiff, and the plaintiff seeks
damages of approximately $854,430. In the employment lawsuits, each of the
plaintiffs are former employees of our company, and they each allege under
various theories of law that their dismissal from employment by the Company was
unjustified. Collectively, the employment law cases allege damages of
approximately $16 million. Regarding the fifth lawsuit, the Company recognized
plaintiff's seniority at the workplace and the court entered partial judgement
dismissing the cause of action of plaintiffs that work with CSPR. The Company
has analyzed each lawsuit with our legal advisors, and the Company does not
believe that any of these cases will result in an unfavorable outcome that would
have a material adverse effect upon our business. However, in the event of one
or more unfavorable determinations against us, such litigation could have a
material adverse effect on our business by harming earnings if the Company is
liable for a significant monetary judgment, by harming our reputation with our
customers through any adverse publicity generated from an unfavorable
determination, or by adversely affecting our relationship with current and
prospective employees of our company.
LAWS OR REGULATIONS THAT GOVERN THE TELECOMMUNICATIONS INDUSTRY AND COPYRIGHTED
WORKS COULD EXPOSE US TO LEGAL ACTION IF THE COMPANY FAIL TO COMPLY OR COULD
REQUIRE US TO CHANGE OUR BUSINESS.
Because our products and services provide our customers with access to the
public telephone system and other methods of electronic communication, the
products CSPR sells are subject to the regulations of the Federal Communications
Commission and Junta Reglamentadora de Telecomunicaciones de Puerto Rico,
relating to consumer products that connect to the public telephone network and
electronic emissions of consumer products.
Changes in the regulatory climate or the enforcement or interpretation of
existing laws could expose us to legal action if the Company fails to comply. In
addition, any of these regulatory bodies could promulgate new regulations or
interpret existing regulations in a manner that would cause us to incur
significant compliance costs or force us to alter the features or functionality
of our products and services.
PRODUCT DEFECTS, SYSTEM FAILURES OR INTERRUPTIONS MAY HAVE A NEGATIVE IMPACT ON
OUR REVENUES, DAMAGE OUR REPUTATION AND DECREASE OUR ABILITY TO ATTRACT NEW
CUSTOMERS.
Errors and product defects can result in significant warranty and repair
problems, which could cause customer relations problems. Correcting product
defects requires significant time and resources, which could delay product
releases and affect market acceptance of our products. Any delivery by us of
products with undetected material product defects could harm our credibility and
market acceptance of our products.
22
THE PRODUCTS THE COMPANY SELLS AND SERVICES MAY HAVE UNDETECTED FAULTS LEADING
TO LIABILITY CLAIMS, WHICH COULD HARM OUR BUSINESS.
The products the Company sells and services may contain undetected faults
or failures. Any failures of these products could result in significant losses
to our customers, particularly in mission-critical applications. A failure could
also result in product returns and the loss of, or delay in, market acceptance
of our products. In addition, any failure of the product CSPR sells could result
in claims against us. Our purchase agreements with our customers typically
contain provisions designed to limit our exposure to potential product liability
claims. Although CSPR is unaware of any specific laws or cases that would
invalidate our purchase agreement limitation of liability provisions, there is a
risk that such provisions may not be effective as a result of federal, state or
local laws or ordinances or unfavorable judicial decisions in Puerto Rico or
other countries. CSPR maintain insurance to protect against certain claims
associated with the use of our products, but our insurance coverage may not
adequately cover all possible claims asserted against us. In addition, even
claims that ultimately are unsuccessful could be expensive to defend and consume
management time and resources.
OUR CHARTER CONTAINS CERTAIN ANTI-TAKEOVER PROVISIONS THAT MAY DISCOURAGE
TAKE-OVER ATTEMPTS AND MAY REDUCE OUR STOCK PRICE.
Our board of directors has the authority to issue up to 10,000,000 shares
of preferred stock and to determine the preferences, rights and privileges of
those shares without any further vote or action by the stockholders. The rights
of the holders of any preferred stock that may be issued in the future may harm
the rights of the holders of common stock. Certain provisions of our certificate
of incorporation and bylaws may make it more difficult for a third party to
acquire control of us without the consent of our board of directors, even if
such changes were favored by a majority of the stockholders. These include
provisions that provide for a staggered board of directors, prohibit
stockholders from taking action by written consent and restrict the ability of
stockholders to call special meetings.
OUR STOCK IS SUBJECT TO THE REQUIREMENTS FOR PENNY STOCKS, WHICH COULD ADVERSELY
AFFECT YOUR ABILITY TO SELL AND THE MARKET PRICE OF YOUR SHARES.
The Company believes our stock fits the definition of a penny stock. The
Securities Exchange Act of 1934 defines a penny stock as any equity security
that is not traded on a national securities exchange or authorized for quotation
on The Nasdaq Stock Market and that has a market price of less than $5.00 per
share, with certain exceptions. Penny stocks are subject to Rule 15g under the
Securities Exchange Act of 1934, which imposes additional sales practice
requirements on broker-dealers who sell such securities. In general, a
broker-dealer, prior to a transaction in a penny stock, must deliver a
standardized risk disclosure document that provides information about penny
stocks and the risks in the penny stock market. The broker-dealer must provide
the customer with current bid and offer quotations for the penny stock,
information about the commission payable to the broker-dealer and its
salesperson in the transaction and monthly statements that disclose recent price
information for each penny stock in the customer's account. Finally, prior to
any transaction in a penny stock, the broker-dealer must make a special written
suitability determination for the purchaser and receive the purchaser's written
consent to the transaction prior to sale. All of these requirements may restrict
your ability to sell our stock and could limit the trading volume of our stock
and adversely affect the price investors are willing to pay for our stock.
23
INSIDERS HAVE SUBSTANTIAL VOTING CONTROL OVER US, WHICH COULD DELAY OR PREVENT
US FROM ENGAGING IN A CHANGE OF CONTROL TRANSACTION AND YOU FROM SELLING OUR
SHARES AT A PREMIUM TO THE SHARES' THEN CURRENT MARKET VALUE.
Our officers, directors and five percent or greater stockholders
beneficially own or control, directly or indirectly, approximately 490,029
shares, which in the aggregate represents approximately 41% voting interest in
the outstanding shares of our common stock. These stockholders have the ability
to control all matters submitted to our stockholders for approval, including the
election and removal of directors and the approval of any business combinations.
24
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The vast majority of the Company's sales are made in U.S. dollars, and
consequently, the Company believes that our foreign exchange rate risk is
immaterial. The Company does not have any derivative instruments and do not
engage in hedging transactions.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period preceding the filing of this Quarterly Report on
Form 10-Q, an evaluation was performed under the supervision of and with the
participation of the Company's management, including the Chief Executive Officer
(CEO) and Chief Financial Officer (CFO), of the effectiveness of the design and
operation of the Company's disclosure controls and procedures. Based on that
evaluation, the Company's management, including the CEO and CFO, concluded that
the design and operation of the Company's disclosure controls and procedures
were effective to ensure that material information relating to CSPR is made
known to such officers by others within CSPR, particularly during the period
this quarterly report and prepared, in order to allow timely decisions regarding
required disclosure. There have been no significant changes in the Company's
internal control or in other factors that could significantly affect internal
controls subsequent to the date of their evaluation.
25
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
..
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) Exhibits.
Exhibit
Number Description of Document
- ----------------------------------------------------------------------------------------------------------
31.1 Officers' Certification of Periodic Report pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
32.2 Officers' Certification of Periodic Report pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
(B) Reports On Form 8-K.
None.
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SIGNATURES
Pursuant to the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto authorized.
Cortelco Systems Puerto Rico, Inc.
Date: December 11, 2003 /s/ Francisco Sanchez
----------------- -----------------------------------------
Francisco Sanchez, Vice President
Chief Financial Officer, Secretary
Duly Authorized Officer
(Principal Financial and Accounting Officer)
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