UNITED STATESSECURITIES AND EXCHANGE
COMMISSIONWASHINGTON, D.C. 20549



FORM 10-QSB



(Mark One)



xQUARTERLY
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

| | For the
quarterly period ended January 31, 2007.
| | ------------------------------------------------



o  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(State of incorporation) |  | 66-0567491(IRS Employer Identification No.) | 
| |                                    



Parque Ind. Caguas Oeste Road 156 km 58.2, Caguas,
Puerto Rico, 00725-0137

(Address of principal executive office)



(787) 704-0000

(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. YesxNo o



Indicate by check mark whether the registrant is a
shell company (as defined in Rule 12b-2 of the Exchange Act).Yes o  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 January 31, 2007.



Transitional Small Business Disclosure Format (Check
one):  Yes o  Nox





---



CORTELCO SYSTEMS PUERTO RICO, INC. FORM 10-QSB
QUARTER ENDED JANUARY 31, 2007




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                                         |  |  |  |  | 12 | 
|                                                                       
|PART II
 OTHER INFORMATION                                             |  |  |  |  | 13 | 
|ITEM 1. LEGAL
PROCEEDINGS                                               |  |  |  |  | 13 | 
|ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS     |  |  |  |  | 13 | 
|ITEM 3.
DEFAULTS UPON SENIOR SECURITIES                                 |  |  |  |  | 13 | 
|ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS             |  |  |  |  | 13 | 
|ITEM 5. OTHER
INFORMATION                                               |  |  |  |  | 13 | 
|ITEM 6.
EXHIBITS AND REPORTS ON FORM 8-K                                |  |  |  |  | 13 | 
|                                                                       
|SIGNATURES                                                              |  |  |  |  | 14 | 

---



PART I  FINANCIAL INFORMATION




ITEM 1. FINANCIAL STATEMENTS
(UNAUDITED).




CORTELCO SYSTEMS PUERTO RICO, INC. Condensed Balance
Sheet (Unaudited) January 31, 2007(Dollars in thousands)


|ASSETS                                                                                                                                
|--------------------------------------------------------------------------------------------------------------------------------------
|Current
        assets:                                                                                                               
|Cash                                                                                                                                  
|Trade
        accounts receivable, net of allowance for uncollectible accounts of $62                                                 
|Inventories                                                                                                                           
|Prepaid
        expenses                                                                                                              
|Total
        current assets                                                                                                          
|Available
        for sale securities                                                                                                 
|Property
        and equipment, net                                                                                                   
|Purchased
        software, net of accumulated amortization of $108                                                                   
|                                                                                                                                      
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                  
|Current
        liabilities:                                                                                                          
|Trade
        accounts payable                                                                                                        
|Due
        to affiliated entities                                                                                                    
|Deposits
        on purchases                                                                                                         
|Other
        accrued liabilities                                                                                                     
|Deferred
        revenue                                                                                                              
|Total
        current liabilities                                                                                                     
|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
|Treasury
        Stock                                                                                                                
|Capital
        in excess of par value                                                                                                
|Accumulated
        deficit                                                                                                           
|Accumulated
        other comprehensive income                                                                                        
|Total
        stockholders equity                                                                                                    
|                                                                                                                                      



See notes to condensed financial statements.




1


---



CORTELCO SYSTEMS PUERTO RICO, INC. Condensed Income
(Loss) Statements and Comprehensive Income (Unaudited) For the Three Months and Six Months Ended January 31, 2007 and 2006(Dollars in
thousands, except per share data)


|                                                                     |  |  |  | Three
      Months Ended
      January 31, |       | Six
      Months Ended
      January 31, | 
|-------------------------------------------------------------------- |  |  |  | ------------------------------------------ | ----- | ---------------------------------------- | 
|
|Net
        revenues:                                                |  |  |  |                                            |       |                                          | 
|Products                                                             |  |  |  | $                                          | 689   |                                          | 
|Services                                                             |  |  |  |                                            | 784   |                                          | 
|Other                                                                |  |  |  |                                            | 226   |                                          | 
|Total
        net revenues                                           |  |  |  |                                            | 1,699 |                                          | 
|Cost
        of revenues:                                            |  |  |  |                                            |       |                                          | 
|Products                                                             |  |  |  |                                            | 518   |                                          | 
|Services                                                             |  |  |  |                                            | 442   |                                          | 
|Other                                                                |  |  |  |                                            | 190   |                                          | 
|Total
        cost of revenues                                       |  |  |  |                                            | 1,150 |                                          | 
|Gross
        profit                                                 |  |  |  |                                            | 549   |                                          | 
|Operating
        expenses:                                          |  |  |  |                                            |       |                                          | 
|Selling,
        general, & administrative                           |  |  |  |                                            | 515   |                                          | 
|Income
        (loss) from operations                                |  |  |  |                                            | 34    |                                          | 
|Other
        income, net:                                           |  |  |  |                                            | 9     |                                          | 
|Income
        (loss) before income taxes                            |  |  |  |                                            | 43    |                                          | 
|Provision
        for income taxes:                                  |  |  |  |                                            |       |                                          | 
|Current,
        assuming no carryforward benefit                    |  |  |  |                                            | 20    |                                          | 
|Deferred
        credit from losses                                  |  |  |  |                                            |      |                                          | 
|Change
        in valuation Allowance                                |  |  |  |                                            | (20   | )                                        | 
|Total
        income tax expense                                     |  |  |  |                                            |      |                                          | 
|Net
        income (loss)                                            |  |  |  | $                                          | 43    |                                          | 
|Other
        comprehensive income:                                  |  |  |  |                                            |       |                                          | 
|Net
        unrealized gain (loss) on available for sales securities |  |  |  |                                            | (66   | )                                        | 
|Comprehensive income (loss)                                          |  |  |  | $                                          | (23   | )                                        | 
|Basic
        and diluted net income (loss) per common share         |  |  |  | $                                          | 0.03  |                                          | 



See notes to condensed financial statements.




2


---



CORTELCO SYSTEMS PUERTO RICO, INC. Condensed Statements of Changes in Stockholders Equity (Unaudited) For the Six Months
Ended January 31, 2007(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,
        January 31, 2007  |  |  |  | $                  | 16 |                      |  | $                                                | (11 | )         |  | $                                                               | 7,316 |      



See notes to condensed financial statements




3


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CORTELCO SYSTEMS PUERTO RICO, INC. Condensed
Statements of Cash Flows (Unaudited) For the Three Months and Six Months ended January 31, 2007 and 2006(Dollars in
thousands)







|                                                                                             |  |  |  | Three
      Months Ended,
      January 31, |      | Six
      Months Ended,
      January 31,
|-------------------------------------------------------------------------------------------- |  |  |  | ------------------------------------------- | ---- | -----------------------------------------
|
|Cash
        flows from operating activities:                                                |  |  |  |                                             |      |                                          
|Net
        income (loss)                                                                    |  |  |  | $                                           | 43   |                                          
|Adjustments
        to reconcile net income (loss) to net cash used in operating activities: |  |  |  |                                             |      |                                          
|Depreciation
        and amortization                                                        |  |  |  |                                             | 28   |                                          
|Changes
        in operating assets and liabilities:                                         |  |  |  |                                             |      |                                          
|Decrease
        (increase) in:                                                              |  |  |  |                                             |      |                                          
|Trade
        accounts receivable                                                            |  |  |  |                                             | (187 | )                                        
|Inventories                                                                                  |  |  |  |                                             | 7    |                                          
|Prepaid
        expenses                                                                     |  |  |  |                                             | (44  | )                                        
|Increase
        (decrease) in:                                                              |  |  |  |                                             |      |                                          
|Trade
        accounts payable                                                               |  |  |  |                                             | 125  |                                          
|Due
        to affiliated entities                                                           |  |  |  |                                             | (2   | )                                        
|Deposits
        on purchases                                                                |  |  |  |                                             | (19  | )                                        
|Other
        accrued liabilities                                                            |  |  |  |                                             | (2   | )                                        
|Deferred
        revenue                                                                     |  |  |  |                                             | (59  | )                                        
|Total
        adjustments                                                                    |  |  |  |                                             | (153 | )                                        
|Net
        cash used in operating activities                                                |  |  |  |                                             | (110 | )                                        
|Cash
        flows from investing activities:                                                |  |  |  |                                             |      |                                          
|Capital
        expenditures                                                                 |  |  |  |                                             | (12  | )                                        
|Net
        cash used in investing activities                                                |  |  |  |                                             | (12  | )                                        
|Net
        change in cash                                                                   |  |  |  |                                             | (122 | )                                        
|Cash,
        beginning                                                                      |  |  |  |                                             | 734  |                                          
|Cash,
        ending                                                                         |  |  |  | $                                           | 612  |                                          



See notes to condensed financial statements.




4


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Cortelco Systems Puerto Rico, Inc. Notes to Condensed Financial Statements (Unaudited) For the Six Months Ended January 31, 2007
and 2006




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 January 31, 2007 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
revenue 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
arrangements 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 Bulletin 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 January 31, 2007:


|(Dollars
      in thousands)  |  |  |  | October
      31, 2006
      Liability Balance |   | Additions |  | Deductions |  | January
      31, 2007
      Liability Balance
|----------------------------- |  |  |  | ---------------------------------------------- | - | --------- |  | ---------- |  | ----------------------------------------------
|Maintenance
        Contracts |  |  |  |                                                | $ | 225       |  |            |  | $                                             



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 January 31, 2007:


|(Dollars
      in thousands) |  |  |  | October
      31, 2006
      Liability Balance |   | Additions |  | Deductions |  | January
      31, 2007
      Liability Balance
|---------------------------- |  |  |  | ---------------------------------------------- | - | --------- |  | ---------- |  | ----------------------------------------------
|Warranty
        Reserve     |  |  |  |                                                | $ | 61        |  |            |  | $                                             



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. They were restricted until January 12, 2007. 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 January 31, 2007:




6


---






|Plan category                                              |  |  |  | Number of securities to be issued upon exercise
of outstanding options, warrants and rights |   | Weighted-average exercise price of outstanding
options, warrants and rights |  | Number of securities remaining available for future
issuance under equity compensation plans (excluding securities reflected in column (a)
|---------------------------------------------------------- |  |  |  | ------------------------------------------------------------------------------------------- | - | --------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|                                                           |  |  |  | (a)                                                                                         |   | (b)                                                                         |  | (c)                                                                                                                                       
|Equity
compensation plans approved by security holders     |  |  |  |                                                                                             |  |                                                                             |  |                                                                                                                                           
|Equity
compensation plans not approved by security holders |  |  |  |                                                                                             |  |                                                                             |  |                                                                                                                                           
|Total                                                      |  |  |  |                                                                                             |  |                                                                             |  |                                                                                                                                           



Inventories




Inventories consist of the following:


|                                                            |  |  |  | January 31, 2007
|----------------------------------------------------------- |  |  |  | ----------------
|
|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 January 31, |           | Six Months Ended January 31, | 
|---------------------------------------------------- |  |  |  | ------------------------------ | --------- | ---------------------------- | 
|
|
|Basic and
diluted income (loss) per share:           |  |  |  |                                |           |                              | 
|Net income
(loss)                                    |  |  |  | $                              | 43        |                              | 
|Weighted
average number of common shares outstanding |  |  |  |                                | 1,571,453 |                              | 
|Income (loss)
from operations per share              |  |  |  | $                              | 0.03      |                              | 



7


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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 Court considered a partial motion for summary judgment in CSPRs favor. 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 2007, in the principal amount of $320,000 ($497,000 as of January 31, 2007, 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 within the
time period provided by CRIM. 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 fiscal year, the revenue from the resale of these
services was presented separate in the Income Statement as Other. For this quarter, the revenues from the reselling services exceeded the
budget and the Company believes there is an important opportunity in the market to increase its revenues for this fiscal year 2007. The Companys
management is also looking for long distance suppliers to increase the services offered to reselling customers. CSPR also began a partnering
relationship with Cisco Systems, Inc. to sell their products in the area of data and security. The Company has submitted proposals for various projects
that CSPR believes it can sell in the next quarter. CSPR also began a partnering relationship with strategic suppliers like 1) McAfee, a security
software provider for networks; 2) Juniper, a router and LAN security provider; and 3) Extreme Network, a network switch provider.
With




8


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proposals including these product lines, CSPR is trying to
be a one-stop-shop to its 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. At
present, the Company has been awarded a major project in one of the largest companies on the Virgin Island. CSPR expects to complete this installation
during the next quarter of this fiscal year.




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 is a Platinum Mitel Business Partner, Advance Nortel Business Partner and recently obtained a McAfee
Premium Business Partner. To continue the service performance, CSPR began a partnering relationship with Cisco, and created a new department
specialized in Data with experts certified in Cisco Certified Network Associate (CCNA) and Cisco Sell Expert (CSE) among other certifications. To
develop this new Data Department, CSPR has incorporated other trademarks like McAfee, Juniper and Extreme. 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 there 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 continues with its strong collection efforts to improve cash flows and continue to maintain accounts receivable and inventories at
controlled levels during the current fiscal year. CSPRs shortfall to budgeted sales in the first quarter ended October 31, 2006 was due to a
postponement of some installations. Historically, the second quarter of each fiscal year is a low point for sales revenue. CSPR achieved the current
budget for the quarter ended January 31, 2007. For the third quarter, the Company has received customer orders and commitments for new systems
installations that are expected to allow CSPR to achieve the current budget also.




Results of Operations and Cash Flows for the Three
Months Ended January 31, 2007 and 2006




The following discussion provides information about the
Companys operations, for the three months ended January 31, 2007 and for the three months ended January 31, 2006.




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 increased 3% in the three months ended January
31, 2007 compared to the same quarter last fiscal year. The results primarily reflect decreased revenue of approximately $213,000 in Products, due to a
logistic problem of one of the Companys major suppliers of telecommunication equipment and postponement of some medium and small new equipment
installations, an increase of approximately $38,000 in Services due to normal fluctuations in the maintenance business, and for this quarter the
revenue from a new line of business of reselling services was approximately $226,000.




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 Product, Services and Other for the three months ended January 31, 2007 and 2006 was 32.31% and
35.74%, respectively. The gross margin decreased principally because the reselling division shown as Other produces less
margin




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than Products and Services. The gross margin for Products
and Services has 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 the Companys business
activities. This expense decreased 4.45% to approximately $515,000 in the three months ended January 31, 2007 from approximately $539,000 in the same
period last fiscal year. This is principally the result of the decrease in business during the period.




Interest, Other Income and Expense and Other
Comprehensive Income




The Company had no significant other income and interest
expense in the three months ended January 31, 2007 or 2006.




For the three months ended January 31, 2007 and 2006, the
deferred tax credit resulting from the reported losses was fully allowed. For the quarter ended January 31, 2007 and 2006, other comprehensive loss
consists of unrealized potential losses, if sold at that point in time, of securities owned by the Company.




Cash Flows




Cash flow used in operating activities was approximately
($110,000) and ($561,000) in the three months ended January 31, 2007 and 2006 respectively. Cash used in operating activities in the three months ended
January 31, 2007 resulted primarily from an increase in trade accounts receivable, partially offset by an increase in trade accounts payable. Cash
flows used in investing activities for the three months ended January 31, 2007 were approximately ($12,000). Cash used for investing activities in this
quarter was related mainly in the acquisition of new hardware and minor improvements in the warehouse facilities to improve employee
performance.




Results of Operations and Cash Flows for the Six Months
Ended January 31, 2007 and 2006




The following discussion provides information about the
Companys operations, for the six months ended January 31, 2007 and for the six months ended January 31, 2006.




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 10.14% in the six months ended January
31, 2007 compared to the same quarter last fiscal year. The results primarily reflect decreased revenue of approximately $787,000 in Products, due to a
logistic problem of one of the Companys major suppliers of telecommunication equipment and postponement of some medium and small new equipment
installations, an increase of approximately $99,000 in Services due to normal fluctuations in the maintenance business. For this period, the revenue
from reselling services (a new line of business) was approximately $333,000.




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 Product, Services and Other for the six months ended January 31, 2007 and 2006 was 30.71%, and
32.48%, respectively. The gross margin decreased principally because the new reselling division shown as Other produce less margin than
Products and Services. The gross margin for Products and Services has 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 the Companys business
activities. This expense decreased 6.49% to approximately




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$994,000 in the six months ended January 31, 2007 from
approximately $1,063,000 in the same period last fiscal year. This is principally the result of the decrease in business during the
period.




Interest, Other Income and Expense and Other
Comprehensive Income




The Company had no significant other income and interest
expense in the six months ended January 31, 2007 or 2006.




For the six months ended January 31, 2007, the deferred tax
credit resulting from the reported losses was fully allowed. For the six months ended January 31, 2006, the resulting income tax was offset by the
available carryforward losses, through a change in valuation allowance.




Other comprehensive income (loss) consists of unrealized
potential gain (losses), if sold at that point in time, of securities owned by the Company.




Cash Flows




Cash flow used in operating activities was approximately
($245,000) and ($62,000) in the six months ended January 31, 2007 and 2006 respectively. Cash used in operating activities in the six months of this
fiscal year resulted primarily from a decrease in deferred revenues and deposits and an increase in inventories partially offset by an increase in
accounts payable. Cash flows used in investing activities for the six months ended January 31, 2007 and 2006 were approximately ($16,000) and
($12,000), respectively. Cash used for investing activities in the six months of this period was related mainly in the acquisition of new hardware to
improve employee performance.




Liquidity and Capital Resources




The Company has principally relied on cash provided from
operations as its 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. 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 remains stable, it will continue to obtain beneficial credit terms from its primary
suppliers.




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 the Companys certificate of incorporation and bylaws may make it more difficult for a third party to acquire
control of CSPR without the consent of the Companys 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 1,001,177 shares, which in the aggregate represent approximately 63%
voting interest in the outstanding shares of the Companys common stock. These stockholders have the ability to control all matters submitted to
the Companys stockholders for approval, including the election and removal of directors and the approval of any business
combinations.




Off-Balance Sheet Arrangements




CSPR was not involved in any significant off-balance sheet
arrangement during the six months ended January 31, 2007 and 2006.




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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 six months ended January 31, 2007 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.




On January 9, 2007, the Company held the annual meeting of
its stockholders to vote upon the election of directors. The common stockholders voted to elect two directors to serve on the Corporations Board
of Directors for a term expiring at the 2009 annual meeting of shareholders or until their successors are duly elected and qualified. The
Companys common stockholders elected Walter D. Duffey to the Board of Directors by a vote of 1,305,972 for, and 3,363 withheld. Also, the
Companys common stockholders elected Robert A. Gordon to the Board of Directors by a vote of 1,306,179 for, and 3,156 withheld.




In addition, the common stockholders ratified the
appointment of Horwath Vélez & Co PSC as the Companys independent accountants for the fiscal year ending July 31, 2007 by a vote of
1,307,586 for, 593 against, and 1,156 abstentions.




ITEM 5. OTHER INFORMATION.




None.




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


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

|Exhibit Number |  |  |  | Description of Document                                                                               
|-------------- |  |  |  | ------------------------------------------------------------------------------------------------------
|10.10          |  |  |  | Interconnection Agreement dated as of August 18, 2005, between CSPR and Puerto Rico Telephone Company.
|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.


|Date: March 16,
2007 |  |  |  | /s/
Francisco Sanchez Francisco Sanchez, Vice President Chief Financial Officer, Treasurer Duly Authorized Officer (Principal
Financial and Accounting Officer)
|-------------------- |  |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



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