More Red Flags On eOn Communications Corp. (EONC)
Posted by Timothy Sykes on Tue 10th of Nov, 2009 07:30:08 AM
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Did you read my article from last night detailing all the red flags over at EONC which is why I’m short 13,000 shares overnight?
Well, one of my top students, Michael Goode, with whom I am creating a “Learn To Read SEC Filings” instructional DVD package, has a slightly different take…he’s short the stock too, but he dug up even more red flags:
This trade is a great example of how traders can benefit from understanding fundamentals … the company’s earnings press release was not actually news because the information in it had already been released in the 10-k (annual report) the company filed back on October 29th. Normally companies release earnings in press releases as soon as the data are available, maybe a week or so before the quarter’s results are sent to the SEC in a 10-Q or 10-K. Considering that the company’s results were available for over a week, why did the stock spike over 100% today when the earnings report hit the newswires?
The likely reason for the stock spiking today is that most traders do not read the SEC filings before deciding what to trade. They take a brief look at Yahoo! Finance and look at the news there. Earnings releases are usually new information (because they usually precede the SEC filings) so stock traders and individual investors all bought EONC today in response to the ‘good’ news. As they pushed the price up it showed up on the screens of momentum day-traders who then bought en masse, sending EONC up even more. Even though the press release today caused the stock rise, it was not new information, so the stock will likely dive in the coming days.
How is eOn doing?
eOn’s business involves VoIP and telephone routing products. After a quick glance at the company’s recently filed 10-K, I am glad I am short and not long.
eOn, while it was profitable in its most recent two quarters, has never been consistently profitable.
For the year ended July 31, 2009, eOn had a net loss of $339,000. eOn has incurred substantial losses since inception through July 31, 2009 resulting in an accumulated deficit of $48,856,000. eOn may not be able to achieve profitability from operations in the future.
eOn was also only profitable in the most recent quarters because of its acquisition of Cortelco. While it earned $111,000 in the most recent quarter, it would have lost money were it not for the Cortelco acquisition (Cortelco has earned $430,000 since being bought by eOn and it has only been 4 months since the deal closed).
Financial results for the current fiscal year include net income of $430,000 of Cortelco Systems Holding Corp., which was acquired on April 1, 2009.
While the earnings press release from today noted that:
Total year revenue increased 52% to $10,645,000 from $6,994,000 in fiscal year 2008.
This is due entirely to the Cortelco acquisition. Here the company describes revenues in the 10-K:
Net revenue increased approximately 52% to $10,645,000 for the year ended July 31, 2009 from $6,994,000 for the previous fiscal year. The increase reflects $4,231,000 in Cortelco revenue subsequent to the acquisition on April 1, 2009, partially offset by lower eQueue revenue from products, maintenance and professional services, and lower Millennium revenue compared to the prior year.
In actuality, were it not for the acquisition of Cortelco, eOn’s revenues would have decreased by 8%! But an 8% decrease does not sound as good as a 52% increase, so the company chose not to put the 8% figure in the press release.
Related party transactions
One thing an investor never wants to see is related-party transactions. These are always red flags, indicative of a company’s executives enriching themselves at shareholder expense. Related-party transactions also sometimes accompany fraud. Here are some of eOn’s related party transactions. All quotes are from the most recent 10-K unless otherwise noted.
Let’s start with the chairman of the board, who was also CEO and president until June 2008. Here is an interesting transaction between eOn and Symbio:
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 approximately 3% of Symbio. Symbio is a China-based provider of software development, testing, and globalization outsourcing services to multinational companies. The investment is expected to establish eOn as a preferred provider of telephony and contact center solutions for Symbio’s outsourcing engagements requiring customer interaction management. eOn also gains the ability to provide Symbio outsourcing services to its customer base. Symbio is a privately held entity and the Company accounts for its 3% investment by the cost method.
At the time of the second investment in Symbio for $400,000, the Company received a put option from David Lee, effective beginning January 1, 2008 and expiring January 1, 2011. 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, 2011, the Company has agreed to pay David Lee 50% of the proceeds in excess of $1,000,000.
So Lee entered into a derivative contract with eOn hedging the value of Symbio’s shares. Here is a question for management: if Symbio is worth investing in, is it not worthwhile for the company to retain all the upside of the investment?
Lee was also the controlling shareholder in Cortelco, which was acquired by eOn back on April 1, 2009. Here are some details on that transaction, from the press release announcing it:
In exchange for all the outstanding shares of Cortelco stock, Cortelco shareholders will receive an initial aggregate payment of $500,000. All subsequent payments will be made to Cortelco stockholders quarterly in an amount based upon Cortelco’s quarterly earnings after closing, less $25,000 quarterly distributions made to eOn until eOn has received $500,000. Contingent primarily upon the level of Cortelco earnings after closing, all Cortelco stockholders are eligible to receive quarterly payments in cash until the full $11,000,000 consideration has been paid. David Lee, Chairman and CEO of eOn, is the Chairman and the controlling shareholder of Cortelco.
Whenever an executive of a public company sells a private company to the public company, shareholders in the public company need to ask who benefits from the deal. Such transactions are rife with conflicts of interest.
Read the whole blog post HERE, it’s really solid and it’s funny that Goode didn’t realize that it’s not just Lee who is involved with Cortelco, it’s the entire EONC management team…basically they used their public company to buy their private one and get paid a nice chunk over time…most importantly, to make it appear that EONC was growing when it really is not, EONC simply is paying for a profitable company and what they pay basically equals the profits they receive aka it’s just one big fancy accounting trick IMHO.
I am short 13,000 shares overnight, sitting on unrealized gains of $6,000+, but only TIMalert subscribers will know what I’m gonna do with them today and where I see the stock headed…
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