UNITED STATESSECURITIES AND EXCHANGE
COMMISSIONWASHINGTON, D.C. 20549




FORM 10-QSB




(Mark One)


|[X]                                               |  | Quarterly
report under Section 13 or 15(d) of the Securities  Exchange Act of 1934
|------------------------------------------------- |  | ----------------------------------------------------------------------------------
|For the quarterly period ended October 31,  2006.






|[  ]                                                        |  | Transition
report under Section 13 or 15(d) of the Exchange  Act
|----------------------------------------------------------- |  | ----------------------------------------------------------------
|For the transition period from ____________ to ____________



Commission file number 000-49626




CORTELCO SYSTEMS PUERTO RICO, INC.(Exact name of
small business issuer as specified in its charter)


|PUERTO
RICO              |  |  |  | 66-0567491                       
|------------------------ |  |  |  | ---------------------------------
|(State of
incorporation) |  |  |  | (IRS 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(Issuers telephone number,
including area code)




Check whether the issuer (1) filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]




Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]




State the number of shares outstanding of each of the
issuers classes of common equity, as of the latest practicable date:




1,571,453 shares of Common Stock, $0.01 par value, as of
October 31, 2006.




Transitional Small Business Disclosure Format (Check one): Yes
[  ] No [X]


---



CORTELCO SYSTEMS PUERTO RICO, INC. FORM 10-QSB
QUARTER ENDED OCTOBER 31, 2006




INDEX


|PART I
 FINANCIAL INFORMATION                                          |  |  |  |  | 1  | 
|----------------------------------------------------------------------- |  |  |  |  | -- | 
|                                                                        |  |  |  |  |    | 
|ITEM 1.
FINANCIAL STATEMENTS (UNAUDITED).                               |  |  |  |  | 1  | 
|Condensed
Balance Sheet (Unaudited)                                     |  |  |  |  | 1  | 
|Condensed
Income (Loss) Statements and Comprehensive Income (Unaudited) |  |  |  |  | 2  | 
|Condensed
Statements of Changes in Stockholders Equity (Unaudited)     |  |  |  |  | 3  | 
|Condensed
Statements of Cash Flows (Unaudited)                          |  |  |  |  | 4  | 
|Notes to
Condensed Financial Statements (Unaudited)                     |  |  |  |  | 5  | 
|ITEM 2.
MANAGEMENTS DISCUSSION AND ANALYSIS.                           |  |  |  |  | 8  | 
|ITEM 3.
CONTROLS AND PROCEDURES.                                        |  |  |  |  | 11 | 
|                                                                        |  |  |  |  |    | 
|PART II
 OTHER INFORMATION                                             |  |  |  |  | 12 | 
|                                                                        |  |  |  |  |    | 
|ITEM 1.
LEGAL PROCEEDINGS.                                              |  |  |  |  | 12 | 
|ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.    |  |  |  |  | 12 | 
|ITEM 3.
DEFAULTS UPON SENIOR SECURITIES.                                |  |  |  |  | 12 | 
|ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.            |  |  |  |  | 12 | 
|ITEM 5.
OTHER INFORMATION.                                              |  |  |  |  | 12 | 
|ITEM 6.
EXHIBITS AND REPORTS ON FORM 8-K.                               |  |  |  |  | 12 | 
|                                                                        |  |  |  |  |    | 
|SIGNATURES                                                              |  |  |  |  | 13 | 

---





PART I  FINANCIAL INFORMATION




ITEM 1. FINANCIAL STATEMENTS (UNAUDITED).




CORTELCO SYSTEMS PUERTO RICO, INC. Condensed Balance
Sheet (Unaudited)




October 31, 2006(Dollars in
thousands)


|ASSETS                                                                                                                 |  |  |  |   |        |  
|---------------------------------------------------------------------------------------------------------------------- |  |  |  | - | ------ | -
|Current
assets:                                                                                                        |  |  |  |   |        |  
|Cash                                                                                                                   |  |  |  | $ | 734    |  
|Trade accounts
receivable, net of allowance for uncollectible accounts of $72                                          |  |  |  |   | 1,296  |  
|Inventories                                                                                                            |  |  |  |   | 370    |  
|Prepaid
expenses                                                                                                       |  |  |  |   | 119    |  
|Total current
assets                                                                                                   |  |  |  |   | 2,519  |  
|Available
for sale securities                                                                                          |  |  |  |   | 304    |  
|Property
and equipment, net                                                                                            |  |  |  |   | 99     |  
|Purchased
software, net of accumulated amortization of $101                                                            |  |  |  |   | 29     |  
|                                                                                                                       |  |  |  | $ | 2,951  |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                   |  |  |  |   |        |  
|Current
liabilities:                                                                                                   |  |  |  |   |        |  
|Trade accounts
payable                                                                                                 |  |  |  | $ | 486    |  
|Due to
affiliated entities                                                                                             |  |  |  |   | 6      |  
|Deposits on
purchases                                                                                                  |  |  |  |   | 47     |  
|Other accrued
liabilities                                                                                              |  |  |  |   | 316    |  
|Deferred
revenue                                                                                                       |  |  |  |   | 290    |  
|Total current
liabilities                                                                                              |  |  |  |   | 1,145  |  
|                                                                                                                       |  |  |  |   |        |  
|Commitments
and contingencies                                                                                          |  |  |  |   |        |  
|                                                                                                                       |  |  |  |   |        |  
|Stockholders equity:                                                                                                  |  |  |  |   |        |  
|Preferred
stock, par value $.01 per share; authorized 10,000,000 shares, no shares issued                              |  |  |  |   |       |  
|Common stock,
par value $.01 per share; 5,000,000 shares authorized, 1,604,557 shares issued and 1,571,453 outstanding |  |  |  |   | 16     |  
|Treasury
Stock                                                                                                         |  |  |  |   | (11    | )
|Capital in
excess of par value                                                                                         |  |  |  |   | 7,316  |  
|Accumulated
deficit                                                                                                    |  |  |  |   | (5,592 | )
|Accumulated
other comprehensive income                                                                                 |  |  |  |   | 77     |  
|Total
stockholders equity                                                                                             |  |  |  |   | 1,806  |  
|                                                                                                                       |  |  |  | $ | 2,951  |  



See notes to condensed financial statements.




1


---



Cortelco Systems Puerto Rico, Inc.




Condensed Income (Loss) Statements and Comprehensive
Income (Unaudited)




For the Three Months Ended October 31, 2006 and
2005




(Dollars in thousands, except per share
data)


|                                                      |  |  |  | Three Months Ended, October 31, |      
|----------------------------------------------------- |  |  |  | ------------------------------- | -----
|
|Net
revenues:                                         |  |  |  |                                 |      
|Products                                              |  |  |  | $                               | 483  
|Services                                              |  |  |  |                                 | 857  
|Other                                                 |  |  |  |                                 | 107  
|Total net
revenues                                    |  |  |  |                                 | 1,447
|                                                      |  |  |  |                                 |      
|Cost of
revenues:                                     |  |  |  |                                 |      
|Products                                              |  |  |  |                                 | 376  
|Services                                              |  |  |  |                                 | 558  
|Other                                                 |  |  |  |                                 | 96   
|Total cost of
revenues                                |  |  |  |                                 | 1,030
|                                                      |  |  |  |                                 |      
|Gross
profit                                          |  |  |  |                                 | 417  
|                                                      |  |  |  |                                 |      
|Operating
expenses:                                   |  |  |  |                                 |      
|Selling,
general, & administrative                    |  |  |  |                                 | 479  
|                                                      |  |  |  |                                 |      
|Income (loss)
from operations                         |  |  |  |                                 | (62  
|                                                      |  |  |  |                                 |      
|Other income,
net:                                    |  |  |  |                                 | 2    
|                                                      |  |  |  |                                 |      
|Income (loss)
before income taxes                     |  |  |  |                                 | (60  
|                                                      |  |  |  |                                 |      
|Provision for
income taxes:                           |  |  |  |                                 |      
|Current,
assuming no carryforward benefit             |  |  |  |                                 |     
|Deferred
credit from losses                           |  |  |  |                                 | 20   
|Change in
Valuation Allowance                         |  |  |  |                                 | (20  
|                                                      |  |  |  |                                 |      
|Total income
tax expense                              |  |  |  |                                 |     
|                                                      |  |  |  |                                 |      
|Net income
(loss)                                     |  |  |  | $                               | (60  
|                                                      |  |  |  |                                 |      
|Other
comprehensive income:                           |  |  |  |                                 |      
|Net
unrealized gain on available for sales securities |  |  |  |                                 | 89   
|                                                      |  |  |  |                                 |      
|Comprehensive income                                  |  |  |  |                                 | 29   
|                                                      |  |  |  |                                 |      
|Basic and
diluted net income (loss) per common share  |  |  |  | $                               | (0.04



See notes to condensed financial statements.




2


---



CORTELCO SYSTEMS PUERTO RICO, INC.




Condensed Statements of Changes in Stockholders
Equity (Unaudited)




For the Three Months Ended October 31,
2006




(Dollars in thousands)


|                           |  |  |  | Common stock |    | Treasury Stock |  | Capital in excess of par value |     | (Deficit) |  | Accumulated other comprehensive income
(loss) |       | Total
|-------------------------- |  |  |  | ------------ | -- | -------------- |  | ------------------------------ | --- | --------- |  | --------------------------------------------- | ----- | -----
|Balance,
July 31, 2006     |  |  |  | $            | 16 |                |  | $                              | (11 | )         |  | $                                             | 7,316 |      
|Net
loss                   |  |  |  |              |    |                |  |                                |     |           |  |                                               |       |      
|Other
comprehensive income |  |  |  |              |   |                |  |                                |    |           |  |                                               |      |      
|Balance,
October 31, 2006  |  |  |  | $            | 16 |                |  | $                              | (11 | )         |  | $                                             | 7,316 |      



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, 2006 and 2005




(Dollars in thousands)


|                                                                                            |  |  |  | Three Months Ended, October 31 |     
|------------------------------------------------------------------------------------------- |  |  |  | ------------------------------ | ----
|
|Cash flows
from operating activities:                                                       |  |  |  |                                |     
|Net income
(loss)                                                                           |  |  |  | $                              | (60 
|                                                                                            |  |  |  |                                |     
|Adjustments
to reconcile net income to net cash provided by (used in) operating activities: |  |  |  |                                |     
|Depreciation
and amortization                                                               |  |  |  |                                | 28  
|Changes in
operating assets and liabilities:                                                |  |  |  |                                |     
|Decrease
(increase) in:                                                                     |  |  |  |                                |     
|Trade
accounts receivable                                                                   |  |  |  |                                | 263 
|Inventories                                                                                 |  |  |  |                                | (119
|Prepaid
expenses                                                                            |  |  |  |                                | (28 
|Increase
(decrease) in:                                                                     |  |  |  |                                |     
|Trade accounts
payable                                                                      |  |  |  |                                | (13 
|Due to
affiliated entities                                                                  |  |  |  |                                | (8  
|Deposits on
purchases                                                                       |  |  |  |                                | (59 
|Other accrued
liabilities                                                                   |  |  |  |                                | (63 
|Deferred
revenue                                                                            |  |  |  |                                | (76 
|Total
adjustments                                                                           |  |  |  |                                | (75 
|Net cash
provided by (used in) operating activities                                         |  |  |  |                                | (135
|                                                                                            |  |  |  |                                |     
|Cash flows
from investing activities:                                                       |  |  |  |                                |     
|Capital
expenditures                                                                        |  |  |  |                                | (4  
|Net cash used
in investing activities                                                       |  |  |  |                                | (4  
|                                                                                            |  |  |  |                                |     
|Net change in
cash                                                                          |  |  |  |                                | (139
|                                                                                            |  |  |  |                                |     
|Cash,
beginning                                                                             |  |  |  |                                | 873 
|                                                                                            |  |  |  |                                |     
|Cash,
ending                                                                                |  |  |  | $                              | 734 



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, 2006 and
2005




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 necessary to present fairly the financial position, results of operations, changes in stockholders equity, and
cash flows as of October 31, 2006 and for all periods presented, and the same were of normal recurring nature.




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. These condensed financial statements should be read in conjunction with the financial statements and notes as of July 31, 2006
and for the periods then ended, which are included in the Annual Report on Form 10-KSB for the year ended July 31, 2006 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.




Fair value of financial instruments The carrying
amounts of cash is a reasonable estimate of its fair value. The carrying amounts of accounts receivable, accounts payable (including to related
parties), accrued expenses, and deposit liabilities approximate fair value due to their short-term maturities. Marketable securities are classified as
available for sale and are reported at fair value.




Revenue Recognition  The Company recognizes revenues
for equipment shipped to customers only after completion of installation services and acceptance by the customer due to the customized nature of each
installation. 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 vendors. The Company allocates fees from multiple-element arrangement to
the elements based on the relative fair value of each element.




The Company believes that its revenue recognition policies are
compliant with Staff Accounting Bulleting No. 104, Revenue Recognition in Financial Statements.




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 maintenance contracts during the quarter ended October 31, 2006.


|(Dollars in thousands) |  |  |  | July 31, 2006Liability Balance |     | Additions |  | Deductions |    | October 31, 2006 Liability Balance
|---------------------- |  |  |  | ------------------------------ | --- | --------- |  | ---------- | -- | ----------------------------------
|Maintenance
Contracts  |  |  |  | $                              | 288 |           |  | $          | 39 |                                   



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 the cost of labor of technicians and return




5


---



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 quarter ended October 31, 2006.


|(Dollars in thousands) |  |  |  | July 31, 2006Liability Balance |    | Additions |  | Deductions |   | October 31, 2006 Liability Balance
|---------------------- |  |  |  | ------------------------------ | -- | --------- |  | ---------- | - | ----------------------------------
|Warranty
Reserve       |  |  |  | $                              | 78 |           |  | $          | 7 |                                   



Cash  Cash includes cash deposited in high-credit
qualified financial institutions.




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.




Inventories  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 accounted at no cost, unless repaired, at which time, it is valued at the lower of the
repair cost or its net realizable value.




Available for sale securities  Securities held in
eOn Communications, a related party, are accounted as available for sale securities although they represent restricted shares as defined in Rule 144
under the Act. They are reported at fair value, and unrealized gains and losses reported as a net amount in other comprehensive
income.




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



Recent Accounting Pronouncements




Recently issued FASB Statements or Interpretations, SEC Staff
Accounting Bulletins, and AICPA Emerging Issue Task Force Consensuses have either been implemented in prior periods or are not applicable to the
Company.




Securities Authorized for Issuance Under the Companys
Equity Compensation Plan




The following table summarizes the Company equity compensation
plan as of October 31, 2006:




6


---






|Plan category                                              |  |  |  | Number of securities to beissued upon exercise
ofoutstanding options,warrants and rights |  | Weighted-averageexercise price ofoutstanding
options,warrants and rights |  | Number of securitiesremaining availablefor
future issuance under equity compensation plans(excluding securitiesreflected in column (a)
|---------------------------------------------------------- |  |  |  | ---------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------ |  | --------------------------------------------------------------------------------------------------------------------------------------
|                                                           |  |  |  | (a)                                                                                      |  | (b)                                                                      |  | (c)                                                                                                                                   
|Equity
compensation plans approved by security holders     |  |  |  |                                                                                         |  |                                                                         |  | 375,000                                                                                                                               
|Equity
compensation plans not approved by security holders |  |  |  |                                                                                         |  |                                                                         |  |                                                                                                                                      
|Total                                                      |  |  |  |                                                                                         |  |                                                                         |  | 375,000                                                                                                                               



Inventories




Inventories consist of the following:


|                                                            |  |  |  | October 31, 2006
|----------------------------------------------------------- |  |  |  | ----------------
|
|Purchased
components, net                                   |  |  |  | $               
|Components
and materials related to installation in process |  |  |  |                 
|Parts and
materials for maintenance, net                    |  |  |  |                 
|Total
inventories                                           |  |  |  | $               



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.




The computations of basic and diluted income per share were as
follows:


|                                                     |  |  |  | Three Months Ended October 31, |          
|---------------------------------------------------- |  |  |  | ------------------------------ | ---------
|
|
|Basic and
diluted income (loss) per share:           |  |  |  |                                |          
|Net income
(loss)                                    |  |  |  | $                              | (60      
|Weighted
average number of common shares outstanding |  |  |  |                                | 1,571,453
|                                                    
|Income
(loss)from operations per share               |  |  |  | $                              | (0.04    



7


---



Contingencies




The Company is currently subject to claims regarding an alleged
breach of contract, employment issues, and property taxes as follows:




In the breach of contract case, the plaintiff alleges that the
Company breached the terms of contract by ceasing to supply services to the plaintiff, and the plaintiff seeks damages of approximately $855,000.
Although management is strongly contesting the claim, management believes, based on the opinion of counsel, that if the Court does not accept the
Companys defense, a negative outcome is reasonably possible, although for a lower sum than the one claimed by plaintiff. Because the loss, if
any, cannot be classified as probable nor the amount determinable, an accrual for losses has not been recorded in the Companys financial
statements.




The Company is also defendant in one claim by former employee,
totaling approximately $5 million. The Company has filed motion for summary judgment and such motion is under the consideration of the court. The
Companys management believes based on the opinion of counsel that the Company has strong defenses to allow CSPR to prevail. However, at the
present time, an outcome of the case cannot be determined. Accordingly, no provision for losses, if any, has been recorded in the financial
statements.




The Municipal Revenue Collection Center of Puerto Rico
(CRIM) conducted a personal property tax audit for the years 1999 and 2000 as a result of certain alleged debts arising in CRIMs
system for the years 2001 through 2004, in the principal amount of $313,000 ($480,000 as of October 31, 2006, including interest and penalties). The
alleged debts arose from CRIMs disallowance of certain credits for overpayments from 1999 and 2000, claimed in the 2001 through 2004 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. The Company will submit its position in writing. The Company
believes it has strong arguments to support the position that the components of inventory qualify as raw material. However, at this point, the Company
cannot predict the outcome of this matter. Accordingly, no provision for losses, if any, has been recorded in the financial
statements.




ITEM 2. MANAGEMENTS DISCUSSION AND
ANALYSIS.




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 the Companys 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 the
Companys actual operating performance, financial results, liquidity, and capital resources may differ materially due to a number of factors, most
of which are beyond Managements ability to predict or control. The Company also directs your attention to the risk factors affecting its business that
are discussed in our 10-KSB filed for the period ended July 31, 2006. 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 the
Companys unaudited financial statements and the notes included thereto.




Plan of Operation




During the fiscal year 2006, the Company began a new line of
business, the resale of PRT services offered to the local users of intra-island calls, ISDN, T1, and other services excluding the long distance outside
Puerto Rico to customers that are willing to change the billing company. Beginning this quarter, the revenue from the resale of these services was
presented separate in the Income Statement as Other. The Company believes there is an important opportunity in the market to increase its
revenues for this fiscal year 2007. CSPR also began a partnering relationship with Cisco Systems, Inc. to sell their products in the area of data and
security. Many of CSPRs customers have Cisco routers and switches in their LAN/WAN infrastructure. With this approach, CSPR is trying to be a
one-stop-shop to our customers for all of their telecommunications needs, including voice, data, security, applications, transmission services and
telephony invoicing. CSPR is establishing a presence in the Virgin Islands as part of its ongoing efforts to increase sales in the Caribbean. The
Company submitted a proposal for one of the largest companies on the Virgin Islands, which is a current customer.




8


---



The Company is dependent on cash and operating cash flows to
finance operations and meet capital needs. If such resources are not sufficient, alternative sources may not be available or on terms acceptable to the
Company. Management believes that cash on hand and cash generated from operations will be sufficient to meet the Companys needs for at least the
next twelve months.




CSPR will continue to seek a credit line from a Puerto Rican
financial institution to provide cash flow financing. The Company believes that, if its financial condition continues to improve, it will continue to
obtain beneficial credit terms from its primary suppliers.




The Company plans to continue to closely monitor its operating
costs and expenses. The Company will also look for ways to increase its installed base of customers by improving equipment sales and customer service
performance, along with the increase in maintenance service sales efforts. The service sales increased this fiscal year as per CSPR managements
plans, which will be continued for the next fiscal year. To improve service performance, the Company will continue its training program to develop more
highly qualified technicians and salespersons. CSPR has achieved Platinum level with Avaya, the highest qualification that Avaya gives to its Business
Partner. CSPRs technical staff includes two Avaya Certified Experts (ACE), the highest level given to a technical person and the first ACE
awarded to an Avaya Business Partner in the Caribbean. Also, all members of the Avaya sales team obtained the Avaya Certified Associate (ACA) during
this year. The Company retained the Platinum Mitel Business Partner level and obtained the Advance Nortel Business Partner Level. To continue the
service performance, CSPR began a partnering relationship with Cisco and created a new department specialized in Data with two experts certified in
Cisco Certified Network Associate (CCNA) and other certifications. These levels of Business Partners entitle the Company to additional discounts and
special technical trainings. Also, the Company believes it will improve its competitive position with customers and suppliers. To improve new
installation and maintenance sales results, the Company has three of its sales staff dedicated to support and increase its maintenance customer base.
The Company is pursuing an increase in productivity with continuing improvements in customer service and support through Web ticketing and Project
Management programs.




While the Company believes that here are a number of positive
trends in its business, no assurance can be given that CSPR will be successful in achieving its near term goals, at a time when the local economy is
going through a slow down period.




Managements Discussion and Analysis of Financial
Condition and Results of Operations




The Companys cash position has improved from prior years.
The Company will continue with the policy of accelerated payment terms to improve cash flows and continue to maintain accounts receivable and
inventories at controlled levels during the current fiscal year. CSPRs slight shortfall to budgeted sales in this first quarter ended October 31,
2006 was due to a postponement of some installations to the second quarter. Historically, the second quarter of each fiscal year is a low point for
sales revenue, but CSPR believes it will achieve the current budget for the second quarter.




Results of Operations and Cash Flow for the Three Months Ended
October 31, 2006 and 2005




The following discussion provides information about the
Companys operations, for the three months ended October 31, 2006 and for the three months ended October 31, 2005.




Net Revenues




Net revenues consist of sales of new system installations and
additions (Products), services related to revenues from maintenance contract, warranties and other billable services (Services)
and revenues from the resale of PRT services (Other). Net revenues decreased 21.91% in the three months ended October 31, 2006 compared to
the same quarter last fiscal year. The results primarily reflect decreased revenue of approximately $574,000 in Products, due to postponement of some
medium and small new equipment installations, an increase of approximately $61,000 in Services due to normal fluctuations in the maintenance business,
and for this quarter the revenue from PRT services was approximately $107,000, when it was not significant in prior quarters.




Cost of Revenues and Gross Profit




Cost of revenues consists primarily of purchases from equipment
manufacturers and other suppliers and costs incurred for final assembly, quality assurance, system installation, maintenance labor cost and cost of the
reselling revenues. The gross margin for the three months ended October 31, 2006 and 2005 was 28.82% and 29.57%, respectively. The gross
margin




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basically has been stabilized for both periods due to better
markups in the price of products, maximizing productivity, a decrease in some subcontracting services by fulfilling them with internal resources, and
more competitive selling and operational strategies.




Selling, General and Administrative




Selling, general and administrative expenses consist primarily of
salaries and benefit costs, advertising, facilities and other overhead expenses incurred to support our business. This expense decreased 8.59% to
approximately $479,000 in the three months ended October 31, 2006 from approximately $524,000 in the same quarter last fiscal year. This is principally
the result of the decrease in business during the quarter.




Interest, Other Income and Expense and Other Comprehensive
Income




The Company had no significant other income and interest expense
in the three months ended October 31, 2006 or 2005.




For the quarter ended October 31, 2006, the deferred tax credit
resulting from the reported losses was fully allowed. For the quarter ended October 31, 2005, the resulting income tax was offset by the available
carryforward losses, through a change in valuation allowance.




Other comprehensive income consists of unrealized potential gain,
if sold, of securities owned by the Company.




Cash Flow




Cash flow used in operating activities was approximately
($135,000) in the three months ended October 31, 2006 and cash flow provided by operating activities was approximately $501,000 in the three months
ended October 31, 2005. Cash used in operating activities in the three months of this fiscal year resulted primarily from an increase in inventories
and other current liabilities, partially offset by a decrease in trade accounts receivable. Cash flows used in investing activities for the three
months ended October 31, 2006 was approximately ($4,000). The change in cash for investing activities in this quarter was related to the acquisition of
new hardware to improve employee performance.




Liquidity and Capital Resources




The Company has principally relied on cash provided from
operations as our primary sources of capital. CSPR does not anticipate the need to raise additional capital to meet its operational and capital
expenditure requirements in the foreseeable future. The Companys funding status is dependent on a number of factors in the cash flow, including
those related to profit margins, inventories, and the control of selling, general and administrative expenses. CSPR expects the cash generated from
operations will be sufficient to meet the cash requirements for the business, including capital expenditures and working capital needs for the near
future. Should actual results differ significantly from current assumptions, the Companys liquidity position could be adversely affected and
could be in a position that would require the Company to raise additional capital, which may not be available to CSPR or may not be available on
acceptable terms.




Other Relevant Financial Information




The Companys 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 CSPR
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.




CSPRs officers, directors and five percent or greater
stockholders beneficially own or control, directly or indirectly, approximately 1,011,677 shares, which in the aggregate represent approximately 64%
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.




The Company believes its 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




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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 CSPR stock
and could limit the trading volume and adversely affect the price investors are willing to pay for CSPR stock.




Off-Balance Sheet Arrangements




CSPR was not involved in any significant off-balance sheet
arrangement during the three months ended October 31, 2006 and for the three months ended October 31, 2005.




ITEM 3. CONTROLS AND PROCEDURES.




Under the supervision and with the participation of the Company
management, including the Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation
of its disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e) as of the end of the period covered by this report. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedure are effective. There
were no changes in CSPR internal controls over financial reporting during the three months ended October 31, 2006 that have materially affected, or are
reasonably likely to materially affect, the Companys internal controls over financial reporting.




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PART II  OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS.




No new legal proceedings.




ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS.




None.




ITEM 3. DEFAULTS UPON SENIOR SECURITIES.




None.




ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS.




None.




ITEM 5. OTHER INFORMATION.




None.




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.


|(A) |  | Exhibits.
|--- |  | ---------

|Exhibit Number |  | Description of Document                                                                    
|-------------- |  | -------------------------------------------------------------------------------------------
|31.1           |  | Officers Certification pursuant to Rules 13a-14(a) of the Securities Exchange Act of 1934.
|31.2           |  | Officers Certification pursuant to Rules 13a-14(a) of the Securities Exchange Act of 1934.
|32.1           |  | Officers Certification pursuant to 18 U.S.C ss1350.                                       

|(B) |  | Reports On Form 8-K.
|--- |  | --------------------



None.




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SIGNATURES




In accordance with the requirements of the Exchange Act, the
Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.







|                  |  |  |  | Cortelco Systems Puerto Rico, Inc.                                                                                                     |  |  |  | 
|----------------- |  |  |  | -------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | 
|                  |  |  |  |                                                                                                                                        |  |  |  | 
|December 15,
2006 |  |  |  | /s/ Francisco Sanchez                                                                                                                  |  |  |  | 
|                  |  |  |  | Francisco Sanchez, Vice PresidentChief Financial Officer, TreasurerDuly Authorized Officer(Principal Financial and Accounting
Officer) |  |  |  | 



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