UNITED
STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549




FORM 10-KSB

(Mark One)

|[X] | ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|--- | ------------------------------------------------------------------------------------

For the fiscal year ended July 31, 2006

or

|[    ] | TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|------ | ----------------------------------------------------------------------------------------

For the transition period from
             to

Commission File Number 000-49626

CORTELCO SYSTEMS PUERTO RICO, INC.

(Name of small business issuer in its charter)

|PUERTO RICO(State of incorporation) | 66-0567491(I.R.S. Employer Identification No.)
|----------------------------------- | ----------------------------------------------



Parque Industrial Caguas Oeste, Road 156 Km 58.2,
Valle Tolima, Caguas PR 00727-0137

(Address of principal executive offices)

(787) 758-0000

(Telephone number)

Securities registered under Section 12(b) of the
Exchange Act:  None

Securities registered pursuant to Section 12(g) of the
Act:

Common Stock, $0.01 par value per share

(Title of each class)

Check whether the issuer is not required to file
reports pursuant to Section 13 or 15(d) of the Exchange Act.  [    ]

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 [    ]

Check if there is no disclosure of delinquent filers
in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of
registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.  [X]

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

Revenues for the Registrants most recent fiscal
year: $7,434,000

The aggregate market value of the voting and non-voting
common equity held by non-affiliates of the registrant was approximately  $364,138 based upon the closing sale price as quoted on
the OTC Bulletin Board on 09/30/06.  The number of outstanding shares of the registrants $0.01 par value common stock was
1,571,453 shares as of that date.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the registrants Proxy
Statement for the 2006 Annual Meeting of Shareholders are incorporated by reference in Part III.

Transitional Small Business Disclosure Format (Check
one):  YES[    ]NO [X]



---







TABLE OF CONTENTS

|           |         |                                                                                                                 | Page
|---------- | ------- | --------------------------------------------------------------------------------------------------------------- | ----
|PART I     | 1      
|           | ITEM 1  | DESCRIPTION OF BUSINESS                                                                                         | 1   
|           | ITEM 2  | DESCRIPTION OF PROPERTY                                                                                         | 3   
|           | ITEM 3  | LEGAL PROCEEDINGS                                                                                               | 3   
|           | ITEM 4  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                             | 4   
|          
|PART II    | 4      
|           | ITEM 5  | MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS                                                        | 4   
|           | ITEM 6  | MANAGEMENTS DISCUSSION AND ANALYSIS                                                                            | 6   
|           | ITEM 7  | FINANCIAL STATEMENTS                                                                                            | 9   
|           | ITEM 8  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE                            | 23  
|           | ITEM 8A | CONTROLS AND PROCEDURES                                                                                         | 23  
|           | ITEM 8B | OTHER INFORMATION                                                                                               | 23  
|          
|PART III   | 24     
|           | ITEM 9  | DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT | 24  
|           | ITEM 10 | EXECUTIVE COMPENSATION                                                                                          | 25  
|           | ITEM 11 | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDERS MATTERS                 | 25  
|           | ITEM 12 | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                  | 25  
|           | ITEM 13 | EXHIBITS                                                                                                        | 25  
|           | ITEM 14 | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                          | 25  
|          
|SIGNATURES | 26     







---







PART I

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements
within the meaning of the federal securities laws.  Forward-looking statements are those that express managements views of
future events, developments, and trends.  In some cases, these statements may be identified by terminology such as "may," "will,"
"should," "expects," "plans," "intends," "anticipates," "believes," "estimates," "predicts," "potential," or "continue" or the
negative of such terms and other comparable expressions.  Forward-looking statements include statements regarding our anticipated or
projected operating performance, financial results, liquidity and capital resources.  These statements are based on
managements beliefs, assumptions, and expectations, which in turn are based on the information currently available to
management.  Information contained in these forward-looking statements is inherently uncertain, and our actual
operating performance, financial results, liquidity, and capital resources may differ materially due to a number of factors, most of
which are beyond our ability to predict or control.  We also direct your attention to the risk factors affecting our business that
are discussed elsewhere in this report.  We disclaim any obligation to update any of the forward-looking statements contained in
this report to reflect any future events or developments.  The following discussions should be read in conjunction with our
financial statements and the notes included thereto in Item 7.

|ITEM 1 | DESCRIPTION
OF BUSINESS
|------ | -----------------------

Introduction

Cortelco Systems Puerto Rico, Inc. (the
Company, CSPR) is a value-added reseller of third-party brands of voice and data communication systems.  The
Companys products help enterprises communicate more effectively with customers and increase their customer satisfaction and
loyalty.  The Companys revenues are comprised mostly of sales of PBX customer premise new equipment and additions, including
the newer IP based voice and data communication as well as maintenance contracts and services.  In an effort to be a one-stop-shop
to customers for all their communications needs, the Company began a new line of business in fiscal year 2006, the resale of Puerto
Rico Telephone (PRT  the local main telephone company) services offered to the local users of intra-island calls,
ISDN, T1, and other services excluding the long distance outside Puerto Rico.  At year
end, revenues for this new line of business were not significant but the Company believes there is an important opportunity in the
market to increase the revenues for the new fiscal year.  The Company also began a partnering relationship with Cisco Systems, Inc.
to sell their products in the area of data and security since many of CSPRs customers have Cisco routers and switches in their
LAN/WAN infrastructure. The Company conducts most of its business in Puerto Rico, and also sells, at times, telephone equipment in
the Caribbean and Latin America.

CSPR was incorporated in July 1998 under the laws of
the Commonwealth of Puerto Rico.  At the time of incorporation, the Companys sole stockholder was Cortelco Puerto Rico, Inc.
(CPR).  Prior to becoming a wholly-owned subsidiary of eOn Communications Corporations (eOn) in April 1999,
CPR contributed substantially all of its operations and certain assets and liabilities to the Company.  On July 31, 2002, the
Company was spun-off from eOn as a separate entity to the stockholders of eOn.

Products and Services

The Company integrates, programs, installs, and
services voice and data communications systems such as customer premise PBXs, call centers, voice over IP systems, interactive
voice switches, data switches, routers, firewall, security systems, and CTI applications, as well as reselling computers and local
area networks to enterprises and businesses of all sizes.  PBX's are private telephone switching systems, usually located on a
customers premises, which provide telephone services within the customer's premises, as well as access to the public switched
network.

Sales and Marketing

The Company utilizes a direct sales force to sell
its products and services, most of which are installed by the Companys technical staff.  CSPR advertises its products and
services primarily through trade shows and hosted marketing presentations.



1

|1
|-



---







Customer Service and Support

The Company earned approximately $3.0 million of
revenue in fiscal year 2006 and 2005 from the servicing of voice and data communications systems previously installed.  Customers
generally sign maintenance agreements, which detail the services provided and the fees charged for delivering such services.  The
equipment manufacturers provide training courses for Company personnel for the products that the Company integrates and distributes.
A key factor in assessing whether to serve additional equipment brands or acquire assets of other distributors is the size of an
installed base of customers in the market and the technical expertise required to service the equipment.

Industry Overview

Competitors that distribute many of the same
products that CSPR distributes generally characterize the Companys markets.  Therefore, price competition is often intense for
many of the products that CSPR distributes.  As other value-added resellers sometimes offer the same equipment, the quality of
customer service provided is often the differentiating factor in winning new customers.

Competition

The business communications market is highly
competitive.  Competitive factors include (1) market acceptance of the products, services and technology solutions that the Company
provides, (2) pending and future legislation affecting the communications industry, (3) name recognition and market share, (4)
ability to provide integrated communication and data solutions for customers in a dynamic industry, and (5) the introduction of new
technologies.

The dominant competitor in the Puerto Rico market is
Puerto Rico Telephone (PRT), which is significantly larger than any other competitor in the market.  The Company
believes that PRT has begun to reduce its voice equipment installation and service business in order to apply its resources to other
markets that it deems more attractive.  PRT has traditionally been the reseller, installer, and a service company in Puerto Rico for
Nortel Networks, the largest voice communications equipment provider in Puerto Rico.  As PRT exits the reseller and service business
for customer premise voice products, the Company will compete with other resellers in an attempt to acquire the maintenance
contracts from PRTs customers.  Buyers of enterprise voice communications systems are generally very sensitive to price and,
to a lesser degree, customer service; therefore, having the lowest sales price is often
the key to winning a customer initially.  Resellers will often compete aggressively on price in order to win customers for
maintenance purposes.  CSPR is one of the largest resellers in the Puerto Rico market.  The Company believes that its size offers a
competitive advantage in continuing to grow the communications systems segment as the large resellers are better able to compete on
sales price due to discounts received from equipment manufacturers for larger volume purchases and other special discounts for
obtaining certification required by some of CSPRs suppliers.

Some competitors in the communications business are
small, owner-operated companies typically located and operated in a single geographic area.  Certain of these smaller competitors
may have lower overhead cost structures and, consequently, may be able to charge lower rates for their services.  Therefore,
CSPRs relative size may be a competitive disadvantage for small customers, but the Company is beginning to pursue the medium
to large systems for which the overhead of major competitors is higher.  Strategic alliances between CSPR, as the systems provider,
and major network providers allow presentation of a full solution to large accounts based on a monthly rate for the customer.

There are a number of large, integrated national
companies, which also manufacture and sell directly the products that the Company services and sells.  Some larger competitors may
have greater financial resources to finance acquisition and internal growth opportunities and may be willing to pay higher prices
for acquisition opportunities.  As a result, CSPR has a competitive disadvantage compared to these larger competitors.

Future competition may be encountered from other
newly formed or existing public or private service companies with aggressive acquisition and marketing programs.  Products and
services that the Company offers are manufactured or supplied by others.  This presents a competitive disadvantage since CSPR incurs
the risk of reliance upon third-party systems and services, as well as risks associated with the need to integrate services and
solutions across networks, platforms and equipment manufactured or supplied by various companies.



2



---







Principal suppliers

The Company integrates, sells, installs, and
services the voice and data communications of a number of equipment manufacturers, including Avaya, Mitel, Cisco, Cortelco, eOn,
Nortel, Lucent, Hitachi and Nec among others.  CSPR does not make any of the product parts that it sells but rather assembles,
configures, integrates and programs the communication systems.  The products that CSPR sells are not under exclusive agreements from
the main manufacturers.

Customers

CSPRs customers include large and medium sized
businesses as well as a number of small customers.   Thus, the Company does not derive a significant portion of revenues from any
single customer.

Intellectual Property

The Company does not own any patents, trademarks, or
licenses in the conduct of business.  The Company conducts most of its activities under the trade name "Cortelco" which is well
known by customers in Puerto Rico.  Under Puerto Rican law, CSPR has a proprietary interest in this trade name for as long as the
Company continues to actively use it.

Governmental Regulation

The Company is not directly regulated by any
governmental agency.  However, the Federal Communications Commission and Telecommunications Regulatory Board of Puerto Rico have
regulations, which address consumer products that connect to the public telephone network.  The Companys business could be
adversely affected if these agencies modify or adopt new regulations.  Such regulations could impact the cost of the products CSPR
sells or limit the types of products that it may sell, thus reducing revenues.

Research and Development Activities

As the Company integrates and distributes the
products of third parties and does not sell any products that the Company designs or develops, CSPR does not incur any costs for
research and development.

Employees

As of July 31, 2006, the Company had approximately
61 employees, including 17 in sales and marketing, including design and configuration, 7 in customer service, 29 technical staff
including voice and data, and 8 in finance and administration, including regular, part-time, and contract employees.



|ITEM 2 | DESCRIPTION
OF PROPERTY
|------ | -----------------------

CSPR leases one building of approximately 8,200
square feet for office space and assembly processing from the Municipality of Caguas.  The lease on this facility expires in
November 2007.  Adjacent to this building, the Company leases another building of approximately 5,800 square feet for warehouse
space from Puerto Rico Industrial Development Company (PRIDCO).  The lease on this facility expires in December 2012.  Virtually all
of CSPRs employees work at these facilities.



|ITEM 3 | LEGAL
PROCEEDINGS
|------ | -----------------

From time to time, the Company may be a party to
legal proceedings incidental to our business.  The Company does not believe that any of these proceedings will have a material
adverse effect on our business or financial condition.

In 1997, Cellu-Tel, Inc. filed a complaint in the
Court of First Instance, San Juan, Puerto Rico alleging that CSPR breached the terms of a contract by ceasing to supply services to
the plaintiff.  The plaintiff seeks damages of approximately $854,430..  Discovery proceedings are being conducted.  As a result of
the information obtained



3



---





during discovery, the Company filed a Third Party
Complaint against City Cellular, Inc. and Edgardo Correa, who is the President of Cellu-Tel, Inc. and City Cellular, Inc.  CSPR
alleged in the Third Party Complaint that City Cellular is a business conduit (an "alter ego") of plaintiff Cellu-Tel, Inc.  The
Company has also alleged that City Cellular has continued operating the business of the plaintiff.  The Company also believes that
City Cellular has received the benefits and income that plaintiff would have received, if any.  Therefore, CSPR believes that City
Cellular is directly responsible to Cellu-Tel.  City Cellular has answered the Third Party Complaint and denied the allegations and
raised several defenses.  On January 12, 2005, the Court of First Instance issued a Summary Judgment in favor of the third party
defendants, City Cellular and Edgardo Correa.  As a result, the lawsuit against the third
party defendants was dismissed.  On February 18, 2005, the Company filed an Appeal with the Puerto Rico Court of Appeals.  On August
30, 2005, the Court of Appeals held a Judgment in favor of CSPRs position.  On April 27, 2006 the Court held a Transactional
and Pre-Trial hearing in which it was discussed the possibility of a transaction.  Unfortunately, Cellu-Tel did not accept the
settlement offer.  Thus, the Company will continue with the trial procedures.  The Company 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.

In 2001, Jorge Gonzalez-Nogueras filed a complaint
in the Court of First Instance, San Juan, Puerto Rico alleging that CSPR offered him employment in order to reduce competition from
other enterprises and with the ill intent to take advantage of his business.  After accepting employment, Mr. Gonzalez-Nogueras
resigned voluntarily alleging problems adjusting to the corporate culture of CSPR.  The plaintiff seeks $5,074,321 for alleged
damages and loss of business.  CSPR filed a Motion for Summary Judgment and such motion is under the consideration of the court.
Cortelco is strongly defending this case because the Company believes all allegations of conspiracy are false, plaintiff does not
have a profitable competing business and his resignation was voluntary.  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.

During the third quarter of this fiscal year, the
Municipal Revenue Collection Center of Puerto Rico ("CRIM") a personal property tax audit for years 1999 and 2000, as a result of
certain alleged debts arising in CRIM's system for years 2001 through 2004, in the principal amount of $313,000 ($475,000 as of July
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 4 | SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------ | ---------------------------------------------------

None.



PART II

|ITEM 5 | MARKET FOR
COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
|------ | --------------------------------------------------------

Market Information

There is currently is no established public trading
market for any class of CSPRs capital stock.  The Company is not currently offering any shares of capital stock publicly, nor
has CSPR publicly proposed to conduct such an offering.  Shares of the Companys common stock are reported on the OTC Bulletin
Board under the symbol "CPROF."

The OTC Bulletin Board is a quotation service that
displays quotes, last-sale prices and volume information regarding over-the-counter (OTC) equity securities.  An OTC equity security
generally is any equity security that is not listed or traded on a national securities exchange nor is authorized for quotation on
The NASDAQ Stock Market.



4



---







The OTC Bulletin Board is only a quotation medium,
not an issuer listing services, and should not be confused with The NASDAQ Stock Market.  Market makers for OTC Bulletin Board
securities generally are required only to match up willing buyers and sellers.  Generally, market makers are not required to
purchase securities directly from willing sellers or sell securities directly to willing buyers.  For this and other reasons, the
trading markets for OTC equity securities are generally significantly less liquid than the trading markets for securities listed on
a national securities exchange or authorized for quotation on The NASDAQ Stock Market and, therefore, there may be a substantial
delay in execution of trades.  In addition, an active trading market in the Company common stock may not develop.

The following table sets forth the quarterly high
and low bid quotations per share of common stock on the OTC Bulletin Board as reported for the periods indicated.  These prices also
represent inter-dealer quotations without retail mark-ups, markdowns, or commissions and may not necessarily represent actual
transactions.



|FISCAL YEAR
ENDED JULY 31, 2006 | HIGH   | LOW   
|------------------------------- | ------ | ------
|First
Quarter                   | $ 0.35 | $ 0.32
|Second
Quarter                  | 0.40   | 0.35  
|Third
Quarter                   | 0.60   | 0.31  
|Fourth
Quarter                  | 1.05   | 0.35  



|FISCAL YEAR
ENDED JULY 31, 2005 |        |       
|------------------------------- | ------ | ------
|First
Quarter                   | $ 0.17 | $ 0.08
|Second
Quarter                  | 0.32   | 0.10  
|Third
Quarter                   | 0.30   | 0.22  
|Fourth
Quarter                  | 0.35   | 0.25  



Holders

As of September 30, 2006, there were 222
shareholders of record of the Companys common stock and, to the best of our knowledge, approximately 2,225 beneficial owners
whose shares of common stock were held in the names of brokers, dealers, and clearing agencies.

Dividends

During fiscal year 2006, the Company did not declare
any dividends on capital stock.  The Company currently intends to retain any earnings to finance the operation and expansion of
business and, therefore, does not expect to pay cash dividends on the common stock in the foreseeable future.

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

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





5



---





|Equity
Compensation Plan Information                    
|--------------------------------------------------------
|Plan category                                           
|Equity
compensationplans approved bysecurity holders    
|Equity
compensationplans not approvedby security holders
|Total                                                   



|ITEM 6 | MANAGEMENTS DISCUSSION AND ANALYSIS
|------ | ------------------------------------

Financial Condition

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, as the Companys cash position has improved from prior
years.  The cash at the end of the fiscal year 2006 was approximately $873,000 and for fiscal year 2005 was approximately $499,000,
mostly generated from operating activities.

Working capital increased to approximately $1.4
million in fiscal year 2006 from approximately $1.0 million in fiscal year 2005, mainly because the company had no significant
investing or financing outlays.

CSPR reduced inventory by approximately $25,000 from
approximately $276,000 in fiscal year 2005 to approximately $251,000 in fiscal year 2006.  Aggressive inventory management and
ongoing obsolescence analysis were key factors in maintaining lower balances in fiscal year 2006.

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.  At year end, revenues
for this new line of business were not significant but the Company believes there is an important opportunity in the market to
increase the revenues for the new fiscal year.  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 has established a recognized 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 in the Virgin Islands, who is a current customer.

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.  During the fiscal year 2006, CSPR
successfully continued the policy of accelerating payment terms to improve cash flows and maintain accounts receivable and
inventories at controlled levels.  In the past, customers were allowed to withhold up to 30% of the total contract until final
acceptance.  New agreements are and will be negotiated to limit the amount subject to final customer acceptance to not more than
10%.



6



---







CSPR 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 Partner 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 increased 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.

Results of Operations and Cash Flows

The following discussion provides information about
the Companys operations, for the fiscal year ended July 31, 2006 and 2005.

Net revenues consist of sales of new product and
additions (Product) and services related to revenues from maintenance contract and billable services
(Services).  Net revenues increased approximately $20,000 to $7,434,000 in fiscal year 2006 from $7,414,000 in fiscal
year 2005.  The results primarily reflected decreased revenues of approximately $43,000 from the Product segment due to certain
export sales held in fiscal year 2005 only.  In the Service segment revenues increased approximately $63,000 as a result of
increases in billable service calls partially offset by a decline in maintenance contracts due to customers decisions to
acquire new systems from the Company with a one-year of warranty.

Cost of revenues consists of the same two segments
as revenues.  The cost of revenues for the Product segment consists primarily of purchases from equipment manufacturers and other
suppliers and costs incurred for final assembly, quality assurance and installations.  The cost of revenues for the Service segment
consists primarily of costs to replace or repair equipment and labor related to the services.  The gross margins for the fiscal year
2006 and 2005 were 32% and 29%, respectively.  The gross margin improvement results basically from increased product margin,
maximized productivity, decreased subcontracted services by utilizing internal resources, and more competitive selling and
operational strategies.

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.  Selling, general and administrative expenses decreased approximately $25,000 from approximately $2,170,000 in fiscal year
2005 to approximately $2,145,000 in fiscal year 2006.

For fiscal year 2006 and 2005, there were no
additional provisions for doubtful accounts.  For the previously written-off balances, the Company plans to continue its collections
efforts by using collection agencies and legal resources.

There was no other income for the 2006 fiscal year.
Other income in the fiscal year 2005 was a nonrecurring transaction of approximately $31,000.  In addition, the Company had no
significant interest expense or interest income in either fiscal year 2006 or 2005.

The resulting income tax in fiscal years 2006 and
2005 was offset by available carryforward losses, through a change in valuation allowance.



7



---







Cash flow provided by operating activities was
approximately $405,000 and $419,000 in fiscal years 2006 and 2005, respectively.  Cash provided by operating activities in fiscal
year 2006 resulted primarily from net income and increases in accrued liabilities, customer deposits and deferred revenue, partially
offset by an increase in accounts receivable.  Cash flow used in investing activities for the fiscal year 2006 and 2005 was
approximately ($31,000) and ($46,000), respectively.  The change in cash for investing activities is related to the acquisition of
new technical equipment to improve operational performance.  For the fiscal years 2006 and 2005, there were no transactions related
to financing activities.

Other Relevant Financial Information

On September 16, 2005, the Board of Directors
authorized the Officers of the Company to accept a partial settlement related to a note receivable of $304,000 from a related party,
assigned to the Company upon the spin-off from eOn Communication Corporation, on July 31, 2002.  The partial settlement consist of
43,104 shares of CSPR stock valued at 60 days trailing average from 09/13/05, of $0.33 per share, and 175,983 shares of eOn stock
valued at 60 days trailing average from 09/13/05, of $1.29 per share.  On January 12, 2006, the Company received the 175,983 shares
of eOn stock.  At July 31, 2006 the fair value of eOns shares was $1.22 and a comprehensive loss of ($12,318) was recorded.
On May 24, 2006, the Company also received the 43,104 shares of CSPR stock and that were recorded as Treasury Stock in the Balance
Sheet.  The remaining note receivable balance of approximately $63,000 was offset
with account payable to a related party.  This note was presented in prior financial statement as a reduction of stockholders
equity.

On April 26, 2006, the Board of Directors authorized
the transfer of 10,000 restricted common shares of CSPR Treasury Stock to Juan C. Ramos, President of the Company in recognition of
improvements in the Companys operational and financial performance.

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 1,011,241 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 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 the
ability to sell 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 fiscal years ended July 31, 2006 and 2005.



8



---







|ITEM 7 | FINANCIAL
STATEMENTS
|------ | --------------------



INDEX TO FINANCIAL STATEMENTS



|                                                                                         | PAGE
|---------------------------------------------------------------------------------------- | ----
|Financial Statements of Cortelco Systems Puerto Rico, Inc.:                              |     
|Independent Auditors Report  Horwath Velez & Co. PSC                                   | 10  
|Balance
Sheet as of July 31, 2006                                                        | 11  
|Statements of Operations for the Years Ended July 31, 2006 and 2005                      | 12  
|Statements of Changes in Stockholders Equity for the Years Ended July 31, 2006 and 2005 | 13  
|Statements of Cash Flows for the Years Ended July 31, 2006 and 2005                      | 14  
|Notes to
the Financial Statements                                                        | 15  



All other schedules have been omitted since the
required information is not presented or not present in an amount sufficient to require submission of the schedules, or because the
information required is included in the financial statements or notes thereto.





9



---







INDEPENDENT AUDITORS REPORT



To the Board of Directors and Stockholders of

Cortelco Systems Puerto Rico, Inc.

Caguas, Puerto Rico



We have audited the accompanying balance sheet of
Cortelco Systems Puerto Rico, Inc. as of July 31, 2006, and the related statements of operations, changes in stockholders' equity
and cash flows for each of the two years in the period ended July 31, 2006.  These financial statements are the responsibility of
the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the
standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes
consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over
financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement presentation.  We
believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to
above present fairly, in all material respects, the financial position of Cortelco Systems Puerto Rico, Inc. at July 31, 2006, and
the results of its operations and its cash flows for each of the two years in the period ended July 31, 2006 in conformity with
accounting principles generally accepted in the United States of America.



/S/  HORWATH VÉLEZ & CO, PSC

Puerto Rico



October 20, 2006

Puerto Rico Society of Certified Public Accountants

Stamp number 2184366 was

affixed to the original of this report.





10



---







CORTELCO SYSTEMS PUERTO RICO, INC BALANCE SHEET  JULY 31, 2006 (Dollars in Thousands)







|ASSETS                                                                                                                 |  |  |  |   |        |  
|---------------------------------------------------------------------------------------------------------------------- |  |  |  | - | ------ | -
|Current
assets:                                                                                                        |  |  |  |   |        |  
|Cash                                                                                                                   |  |  |  | $ | 873    |  
|Trade
accounts receivable, net of allowance of uncollectible accounts of $72                                           |  |  |  |   | 1,559  |  
|Inventories                                                                                                            |  |  |  |   | 251    |  
|Prepaid
expenses                                                                                                       |  |  |  |   | 91     |  
|Total current
assets                                                                                                   |  |  |  |   | 2,774  |  
|Available
for sale securities                                                                                          |  |  |  |   | 215    |  
|Property
and equipment, net                                                                                            |  |  |  |   | 116    |  
|Purchased
software, net of accumulated amortization of $95                                                             |  |  |  |   | 36     |  
|                                                                                                                       |  |  |  | $ | 3,141  |  
|                                                                                                                       |  |  |  |   |        |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                   |  |  |  |   |        |  
|Current
liabilities:                                                                                                   |  |  |  |   |        |  
|Trade
accounts payable                                                                                                 |  |  |  | $ | 499    |  
|Due to
affiliated entities                                                                                             |  |  |  |   | 14     |  
|Deposits on
purchases                                                                                                  |  |  |  |   | 106    |  
|Other accrued
liabilities                                                                                              |  |  |  |   | 379    |  
|Deferred
revenue                                                                                                       |  |  |  |   | 366    |  
|Total current
liabilities                                                                                              |  |  |  |   | 1,364  |  
|                                                                                                                       |  |  |  |   |        |  
|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                                                                                                    |  |  |  |   | (5,532 | )
|Accumulated
other comprehensive loss                                                                                   |  |  |  |   | (12    | )
|Total
stockholders equity                                                                                             |  |  |  |   | 1,777  |  
|                                                                                                                       |  |  |  | $ | 3,141  |  



See notes to financial statements.




11


---



CORTELCO SYSTEMS PUERTO RICO, INC. STATEMENTS OF OPERATIONS YEARS ENDED JULY 31, 2006 AND 2005 (Dollars and Share Data in
Thousands Except Per Share Data)







|                                                      |  |  |  | 2006 |       | 2005
|----------------------------------------------------- |  |  |  | ---- | ----- | ----
|Net
revenues:                                         |  |  |  |      |       |     
|Product                                               |  |  |  | $    | 4,349 |     
|Services                                              |  |  |  |      | 3,085 |     
|Total net
revenues                                    |  |  |  |      | 7,434 |     
|                                                      |  |  |  |      |       |     
|Cost of
revenues:                                     |  |  |  |      |       |     
|Product                                               |  |  |  |      | 3,131 |     
|Services                                              |  |  |  |      | 1,957 |     
|Total cost of
revenues                                |  |  |  |      | 5,088 |     
|Gross
profit                                          |  |  |  |      | 2,346 |     
|                                                      |  |  |  |      |       |     
|Operating
expenses:                                   |  |  |  |      |       |     
|Selling,
general and administrative                   |  |  |  |      | 2,145 |     
|Income (loss)
from operations                         |  |  |  |      | 201   |     
|Other income,
net                                     |  |  |  |      |      |     
|Income before
provision for income taxes              |  |  |  |      | 201   |     
|Provision for
income taxes                            |  |  |  |      |      |     
|Net
income                                            |  |  |  | $    | 201   |     
|                                                      |  |  |  |      |       |     
|Other
comprehensive loss:                             |  |  |  |      |       |     
|Net
unrealized loss on available for sales securities |  |  |  |      | (12   | )   
|Comprehensive
income                                  |  |  |  | $    | 189   |     
|Basic and
diluted net income per share                |  |  |  | $    | 0.13  |     
|Weighted-average number of shares outstanding         |  |  |  |      | 1,597 |     



See notes to financial statements.




12


---



CORTELCO SYSTEMS PUERTO RICO, INC. STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY YEARS ENDED JULY 31, 2006 AND 2005
(Dollars in Thousands)







|                                                           |  |  |  | Common stock |    | Treasury Stock |  | Capital in excess of par value |     | Capital contribution note receivable
from related party |  | (Deficit) |       | Accumulated other comprehensive loss |  | Total
|---------------------------------------------------------- |  |  |  | ------------ | -- | -------------- |  | ------------------------------ | --- | ------------------------------------------------------- |  | --------- | ----- | ------------------------------------ |  | -----
|Balance,
        August 1, 2004                            |  |  |  | $            | 16 |                |  | $                              |    |                                                         |  | $         | 7,273 |                                      |  | $    
|Net
income                                                 |  |  |  |              |   |                |  |                                |    |                                                         |  |           |      |                                      |  |      
|Balance,
July 31, 2005                                     |  |  |  |              | 16 |                |  |                                |    |                                                         |  |           | 7,273 |                                      |  |      
|Collection of
capital contribution note from related party |  |  |  |              |   |                |  |                                |    |                                                         |  |           |      |                                      |  |      
|Cancellation of
debt assumed in 2002 spin-off              |  |  |  |              |   |                |  |                                |    |                                                         |  |           | 43    |                                      |  |      
|Treasury
stock                                             |  |  |  |              |   |                |  |                                | (11 | )                                                       |  |           |      |                                      |  |      
|Net
income                                                 |  |  |  |              |   |                |  |                                |    |                                                         |  |           |      |                                      |  |      
|Other
comprehensive loss                                   |  |  |  |              |   |                |  |                                |    |                                                         |  |           |      |                                      |  |      
|Balance,
July 31, 2006                                     |  |  |  | $            | 16 |                |  | $                              | (11 | )                                                       |  | $         | 7,316 |                                      |  | $    



See notes to financial statements.




13


---



CORTELCO SYSTEMS PUERTO RICO, INC. STATEMENTS OF CASH FLOWS YEARS ENDED JULY 31, 2006 AND 2005 (Dollars in
Thousands)







|                                                                                  |  |  |  | 2006 |      | 2005
|--------------------------------------------------------------------------------- |  |  |  | ---- | ---- | ----
|Cash flows
from operating activities:                                             |  |  |  |      |      |     
|Net
income                                                                        |  |  |  | $    | 201  |     
|Adjustments
to reconcile net income to net cash provided by operating activities: |  |  |  |      |      |     
|Depreciation
and amortization                                                     |  |  |  |      | 112  |     
|Changes in
operating assets and liabilities:                                      |  |  |  |      |      |     
|Decrease
(increase) in:                                                           |  |  |  |      |      |     
|Trade
accounts receivable                                                         |  |  |  |      | (177 | )   
|Inventories                                                                       |  |  |  |      | 24   |     
|Prepaid
expenses                                                                  |  |  |  |      | 5    |     
|Increase
(decrease) in:                                                           |  |  |  |      |      |     
|Trade
accounts payable                                                            |  |  |  |      |     |     
|Due to
affiliated entities                                                        |  |  |  |      | (46  | )   
|Deposits on
purchases                                                             |  |  |  |      | 89   |     
|Other
accrued liabilities                                                         |  |  |  |      | 120  |     
|Deferred
revenue                                                                  |  |  |  |      | 77   |     
|Total
adjustments                                                                 |  |  |  |      | 203  |     
|Net cash
provided by operating activities                                         |  |  |  |      | 405  |     
|                                                                                  |  |  |  |      |      |     
|Cash flows
from investing activities:                                             |  |  |  |      |      |     
|Capital
expenditures                                                              |  |  |  |      | (31  | )   
|Net cash
used in investing activities                                             |  |  |  |      | (31  | )   
|                                                                                  |  |  |  |      |      |     
|Net change
in cash                                                                |  |  |  |      | 374  |     
|                                                                                  |  |  |  |      |      |     
|Cash,
beginning of year                                                           |  |  |  |      | 499  |     
|                                                                                  |  |  |  |      |      |     
|Cash,
end of year                                                                 |  |  |  | $    | 873  |     
|                                                                                  |  |  |  |      |      |     
|Supplemental Disclosure of Non cash Investing and Financing Activities           
|                                                                                  |  |  |  |      |      |     
|Common stock
received in partial settlement of related party receivable           |  |  |  | $    | 227  |     
|Treasury stock
received in partial settlement of related party receivable         |  |  |  | $    | 11   |     
|Cancellation of
debt assumed in 2002 spin-off                                     |  |  |  | $    | 43   |     



See notes to financial statements.




14


---





CORTELCO SYSTEMS PUERTO RICO, INC. NOTES TO FINANCIAL
STATEMENTS YEARS ENDED JULY 31, 2006 AND 2005 (Dollars in Tables in Thousands)


|1. |  | ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES:
|-- |  | ------------------------------------------------------------



Organization 
Cortelco Systems Puerto Rico, Inc. (the Company), a Puerto Rico corporation, was a wholly-owned subsidiary of eOn Communications
Corporation (eOn) through July 30, 2002. Effective July 31, 2002, the Company was spun-off from eOn to the eOn stockholders. After such
spin-off, the Company became an independent entity originally headquartered in San Juan, Puerto Rico that subsequently moved to Caguas, Puerto Rico.
The Companys operations include the sale and service of integrated communications and data equipment in Puerto Rico.




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 amounts of assets and liabilities and 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.




Credit risk concentration
 The Companys business activities primarily are with customers located in Puerto Rico and its trade accounts receivable reflects a
broad customer base in the local market. The Company routinely assesses the financial strength of its customers. As a consequence, concentration of
credit risk on an individual customer basis is limited.




Recent accounting
pronouncement  The following are recent accounting pronouncements:




In June 2006, the Financial
Accounting Standards Board (FASB) issued an Interpretation No. 48, Accounting for Uncertainty in Income Taxes  an interpretation of FASB
Statement No. 109. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial
statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This
Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and
transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. Earlier application of the provisions of this
Interpretation is encouraged if the enterprise has not yet issued financial statements, including interim financial statements, in the period this
Interpretation is adopted.




In September 2006, the FASB
issued a Statement Accounting Financial Standard (SFAS) No. 157, Fair Value Measurements. This Statement defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This
Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those
accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value
measurements. However, for some entities, the application of this Statement will change current practice. The future implementation of this Statement
will have no significant effect on the Companys financial statements.




Other recently issued FASB
Statements or Interpretations, SEC Staff Accounting Bulletins, and AICPA Emerging Issue Task Force Consensuses have either being implemented or are not
applicable to the Company.




Fair value of financial
instruments  The carrying amount of cash is a reasonable estimate of their fair value. The carrying amounts of accounts receivable, accounts
payable trade (including related party), accrued expenses, and deposit liabilities are at their approximate fair value due to their short-term
maturities. Available for sale securities are stated at quoted market price.




15


---



Impairment of long-lived
assets  The Company periodically reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable from the estimated future net cash flows expected to result from the use of the asset. Any indicated
impairment would be measured as the amount by which the carrying amount of the asset exceeds its fair value. Long-lived assets to be disposed of are
reported at the lower of carrying amount or fair value less cost to sell. No indications of impairment are evident as a result of such
review.




Communication systems and
maintenance services revenuesRevenues from communication systems and parts include the sales of integrated communications equipment and all
the related installation and implementation services. The Company recognizes revenues from the communications systems it installs upon completion of
the installation services and acceptance by the customer due to the customized nature of each installation. The Company recognizes service revenues for
maintenance contracts over the life of the service contracts on a straight-line basis, and for other services as the service is provided. 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 Bulleting No. 104, Revenue Recognition in Financial
Statements.




Cash  Cash is
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, as 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.




Property and equipment
 Property and equipment is recorded at cost. Depreciation and amortization are provided using the straight-line method over the shorter of
the assets estimated useful life or lease term as follows:







|                                        |  | Estimated
      useful life (years)
|--------------------------------------- |  | -----------------------------------
|Office
        and production equipment |  |                                    
|Furniture
        and fixtures          |  |                                    
|Internal
        use software           |  |                                    
|Leasehold improvements                  |  |                                    



When assets are sold, retired or
otherwise disposed of, their cost and related accumulated depreciation are removed from the accounts, and any gain or loss is credited or charged to
income. Significant improvements to leased property are capitalized and amortized over the term of the lease. Maintenance and repairs are
expensed.




Purchased software 
Purchased software for internal use is recorded at cost, and amortized using the straight-line method over the estimated useful life of 3 to 5
years.




Accounting for legal costs
expected to be incurred in connection with a loss contingency  The Company policy to account for legal costs in relation to a loss
contingency is to account for such costs as incurred.




16


---



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.




Advertising 
Advertising is charged to expense as incurred. There was no advertising expense for fiscal year 2006 because Suppliers Advertisement Funds offset it.
This expense for fiscal year 2005 was $5,272.




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
net 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.




Stock based
compensationAt present, the Company does not have any stock assigned to Stock-Based Compensation agreements. However there are 375,000 common
stock shares segregated for such purposes in the future. Upon the issuance of any such agreement, the Company will have to apply SFAS No. 123(R),
Accounting for Stock-Based Compensation. This Statement requires that when an entity exchanges its own equity instruments for goods or services,
the transaction should be accounted at the fair value of the shares surrendered.




ReclassificationCertain balances disclosed in the 2005 Notes to the Financial Statements have been reclassified to conform to the
current year presentation.


|2. |  | INVENTORIES:
|-- |  | ------------






|Purchased
components                                        |  |  |  | $ | 123 | 
|----------------------------------------------------------- |  |  |  | - | --- | 
|Component and
materials related to installations in process |  |  |  |   | 82  | 
|Parts and
materials                                         |  |  |  |   | 46  | 
|                                                            |  |  |  | $ | 251 | 

|3. |  | PROPERTY AND EQUIPMENT:
|-- |  | -----------------------






|Furniture and
fixtures                         |  |  |  | $ | 163  |  
|---------------------------------------------- |  |  |  | - | ---- | -
|Leasehold
improvements                         |  |  |  |   | 89   |  
|Computer
equipment                             |  |  |  |   | 90   |  
|                                               |  |  |  |   | 342  |  
|Less
accumulated depreciation and amortization |  |  |  |   | (226 | )
|                                               |  |  |  | $ | 116  |  



The accumulated amortization of
leasehold improvements was $52,000.




17


---

|4. |  | OTHER ACCRUED LIABILITIES:
|-- |  | --------------------------






|Reorganization costs      |  |  |  | $ | 65  | 
|------------------------- |  |  |  | - | --- | 
|Payroll and
payroll taxes |  |  |  |   | 90  | 
|Commissions               |  |  |  |   | 80  | 
|Other                     |  |  |  |   | 144 | 
|                          |  |  |  | $ | 379 | 

|5. |  | 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 fiscal year 2006.







|                      |  |  |  | July 31, 2005 Liability Balance |     | Additions |  | Deductions |     | July 31, 2006 Liability Balance
|--------------------- |  |  |  | ------------------------------- | --- | --------- |  | ---------- | --- | -------------------------------
|Maintenance
Contracts |  |  |  | $                               | 250 |           |  | $          | 424 |                                

|6. |  | PRODUCT WARRANTY:
|-- |  | -----------------



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 technicians labor and
freight.




The Company recognizes warranty
revenue over the term of the warranty period. The costs related to warranties exercised are recognized directly as cost of sales when
incurred.




The following table summarizes
the activity relating to the warranty reserve during the fiscal year 2006.







|                         |  |  |  | July
      31, 2005
      Liability Balance |    | Addition |  | Deductions |     | July
      31, 2006
      Liability Balance
|------------------------ |  |  |  | ------------------------------------------- | -- | -------- |  | ---------- | --- | -------------------------------------------
|
|Warranty
        Reserve |  |  |  | $                                           | 39 |          |  | $          | 125 |                                            

|7. |  | RELATED PARTY TRANSACTIONS:
|-- |  | ---------------------------



During the years ended July 31,
2006 and 2005, the Company purchased approximately $62,000 and $567,000, respectively, in merchandise from a related party.




As of July 31, 2006, the balances
due to related parties are non-interest bearing, unsecured, and are due in the normal course of business. Also, a $304,000 note receivable from a
related party, assigned to the Company upon the spin-off from eOn Communications Corporation, on July 31, 2002, was settled during this fiscal year.
This note was presented originally in the financial statements as a reduction of stockholders equity.




18


---

|8. |  | INCOME TAXES:
|-- |  | -------------



As a Puerto Rico corporation not
doing business in the United States, the Company is exempt from Federal taxes.




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 enjoys preferential tax rates, as
follows:







|Tax       |  | Benefit          
|--------- |  | -----------------
|Income    |  | 7% flat
      tax
|Property  |  | 90% exemption    
|Municipal |  | 60% exemption    



Under the decree, the Company
will be required to comply with certain levels of employment. The tax decree did not result in any income tax benefit for the years ended July 31, 2006
and 2005.




The Company has available income
tax carryforward losses to offset future taxable income that expire as follows:







|Year |  |  |  | Income covered by the decree |       | Other Income
|---- |  |  |  | ---------------------------- | ----- | ------------
|2009 |  |  |  | $                            |      |             
|2010 |  |  |  |                              | 1,508 |             
|2011 |  |  |  |                              | 1,453 |             
|2012 |  |  |  |                              | 856   |             
|2013 |  |  |  |                              | 248   |             
|     |  |  |  | $                            | 4,065 |             



Reconciliation between the income
tax expense recognized in the Companys statement of operations and the income tax expense (benefit) computed by applying the Puerto Rico
statutory income tax rate to income before income taxes for taxable income is as follows:




19


---



|                                                                                   |  |  |  | 2006 |     | 2005
|---------------------------------------------------------------------------------- |  |  |  | ---- | --- | ----
|Current income
tax, assuming no carryforward benefit at Puerto Rico tax rate (39%) |  |  |  | $    | 63  |     
|Current
        income tax benefit at Puerto Rico tax rate (39%)                   |  |  |  |      | 17  |     
|Difference in
method in recognizing doubtful accounts receivable                   |  |  |  |      | (56 | )   
|Difference in
method in recognizing inventory write-downs                          |  |  |  |      | 18  |     
|Differences in
accrued expenses                                                    |  |  |  |      | 4   |     
|Differences in
deferred revenues                                                   |  |  |  |      | 26  |     
|Utilization of
carryforward benefit                                                |  |  |  |      | (63 | )   
|Effect of decree
on tax determination                                              |  |  |  |      | 12  |     
|Change in
valuation allowance                                                      |  |  |  |      | (21 | )   
|Total income tax
expense                                                           |  |  |  | $    |    |     



The components of the net
deferred tax asset for taxable income at July 31, 2006 are as follows:







|                                            |  |  |  | 2006
|------------------------------------------- |  |  |  | ----
|Deferred
        tax assets resulting from: |  |  |  |     
|Allowance for
doubtful accounts             |  |  |  | $   
|Inventory
allowance                         |  |  |  |     
|Other accrued
liabilities                   |  |  |  |     
|Net operating
loss carryforwards            |  |  |  |     
|                                            |  |  |  |     
|Less
valuation allowance                    |  |  |  |     
|                                            |  |  |  | $   



The Company cannot conclude that
it is more likely than not that deferred tax assets will be realized in the future. Accordingly, a valuation allowance has been recorded for the total
amount of the deferred tax asset.


|9. |  | COMMITMENTS AND CONTINGENCIES:
|-- |  | ------------------------------



Claims:




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




20


---



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) a personal property tax audit for years 1999 and 2000, as a result of certain alleged debts arising in
CRIMs system for years 2001 through 2004, in the principal amount of $313,000 ($475,000 as of July 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.




Leases:




The Company leases its principal
facilities from the Municipality of Caguas under an operating lease agreement that expires on November 30, 2007. Rent expense related to this agreement
for the year ended July 31, 2006 and 2005 amounted to $46,000 and $39,000, respectively. The Company also leases warehouse facilities from the Puerto
Rico Industrial Development Company (PRIDCO) under an operating lease agreement that expires on December 30, 2012. Rent expense related to this
agreement for the year ended July 31, 2006 and 2005 amounted to $25,000 and $24,000, respectively.




Future minimum lease payments
under these agreements for the next five years are as follows:







|Year
      ending
            July 31, |  |  |  | Amount
|-------------------------------------- |  |  |  | ------
|2007                                   |  |  |  | $     
|2008                                   |  |  |  |       
|2009                                   |  |  |  |       
|2010                                   |  |  |  |       
|2011                                   |  |  |  |       
|                                       |  |  |  | $     



During the years ended July 31,
2006 and 2005, rent expense related to other operating leases amounted to approximately $23,000 and $19,000, respectively.




10. EMPLOYEE BENEFITS:




The Company provides its
employees a savings plan (the plan). Under the terms of the plan, employees may contribute from 1% to 10% of pretax annual compensation, but cannot
exceed $8,000. However, effective January 2003, the Company no longer contributes to the plan. Previously the Company matched 50% of employees
contributions up to 6% of the employees compensation, as defined, with a maximum limitation of $2,000 for any one employee.




21


---

|11. |  | SHAREHOLDERS EQUITY:
|--- |  | ---------------------



The Board of Directors of the
Company is authorized from time to time to divide the preferred stock into series and to determine the number of shares of each series and the relative
designation, powers, rights and preferences of each such series. As of July 31, 2006, there were no outstanding shares of preferred
stock.




On June 9, 2003, the Board of
Directors approved the addition of 250,000 common stock shares to be reserved for an equity incentive plan. As of July 31, 2006, the equity incentive
plan has not been established.




Treasury stock represents 10,000
shares at their acquisition cost.


|12. |  | INCOME 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:







|                                                     |  |  |  | 2006 |           | 2005
|---------------------------------------------------- |  |  |  | ---- | --------- | ----
|
|Basic and
diluted income per share:                  |  |  |  |      |           |     
|                                                     |  |  |  |      |           |     
|Net
income                                           |  |  |  | $    | 201       |     
|                                                     |  |  |  |      |           |     
|Weighted average
number of common shares outstanding |  |  |  |      | 1,597,203 |     
|                                                     |  |  |  |      |           |     
|Income from
operations per share                     |  |  |  | $    | 0.13      |     



22


---

|ITEM
8 |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
|------ |  | ------------------------------------------------------------------------------------



None.


|ITEM
8A |  | CONTROLS AND PROCEDURES
|------- |  | -----------------------



Under the supervision and with
the participation of our management, including the Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of
the design and operation of our 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 our internal control over financial reporting during the fiscal year ended July 31, 2006 that have materially
affected, or are reasonably likely to materially affect, our internal controls over financial reporting.


|ITEM
8B |  | OTHER INFORMATION
|------- |  | -----------------



None.


23

---

PART III



|ITEM 9 | DIRECTORS,
EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
|------ | ---------------------------------------------------------------------------------------------------------------

On October 1, 2006 the Board of Directors (the
Board) accepted the resignation of Walter D. Duffey as Chief Executive Officer of the Company and formally appointed the
President of the Company, Juan Carlos Ramos, to serve as Chief Executive Officer.  Mr. Duffey will continue to serve on the
Companys Board as a director.  The Company also announced the appointment of Robert A. Gordon to serve on the Companys
Board as an additional director.  Mr. Gordon was also appointed to serve on the compensation committee of the Board.

Mr. Ramos became President of the Company in 2005
and served as General Manager from October 2004 to September 2005.  Mr. Ramos was an independent associate consultant of Business
Advisers Inc. from February 2004 to October 2004.  Mr. Ramos served as a General Manager of Alliance Networks from November 2002 to
February 2004.  From April 2000 to July 2002, Mr. Ramos was Strategy Business consultant for Europraxis Consulting Group (Indra).

Mr. Gordon started his Arizona-based design,
manufacturing and distribution communications consulting company, R. Gordon & Associates, Inc., in 1991.  In 1997, Mr. Gordon
founded and became president of Mobicel Systems, Inc., a corporation that designs and markets small business wireless enterprise
communications systems.  Mr. Gordon has served as president of ATEL Telefonia Inalambrica, S.A. of Guatemala, a provider of rural
telephony service, since 2000.  In 2003, Mr. Gordon established New Bamboo, a company that specializes in import/export trade of
Asian manufactured telecom technology for resale distribution in Latin America.

Executive Officers

The following table sets forth information as to the
persons who served as our executive officers as of July 31, 2006.  The Companys board of directors may appoint additional
executive officers from time to time.

|Name              | Age | Title                                                                   
|----------------- | --- | ------------------------------------------------------------------------
|Walter D.
Duffey  | 61  | Chief Executive
Officer                                                 
|Juan Carlos
Ramos | 37  | President                                                               
|Francisco
Sanchez | 59  | Vice President
 Finance and Administration, and Chief Financial Officer



WALT DUFFEY became Chief Executive Officer of the
Company in September 2005 and served until October 2006.  Mr. Duffey has also served as a Director of the Company since January
2005.  He has been Vice President of Operations of Cortelco, Inc. since March 1998.  Prior to his appointment to Vice President of
Operations, he held the positions of Director of Operations and Product Manager after joining Cortelco in 1996.  From 1987-1996, Mr.
Duffey held the positions of Material Manager and Operations Manager with CECO Door Products.  Prior to 1987, he held numerous
supervisory and management positions with ITT Telecommunications.  Mr. Duffey has over thirty years of experience in various
business activities related to product and inventory management, accounting, manufacturing, distribution management and operations
management.  He is a certified practitioner of the American Production and Inventory Control
Society and holds a Bachelor of Science degree in Business Administration with minors in Accounting and Economics from Union
University in Jackson, Tennessee.

JUAN CARLOS RAMOS became Chief Executive Officer of
the Company in October 2006 and became President of the Company in September 2005 and served as a General Manager from October 2004
to September 2005.  Mr. Ramos was an independent associate consultant of Business Advisers Inc. from February 2004 to October 2004.
Mr. Ramos served as a General Manager of Alliance Networks from November 2002 to February 2004.  From April 2000 to July 2002, Mr.
Ramos was Strategy Business consultant for Europraxis Consulting Group (Indra).  Mr. Ramos has taken courses toward a Ph.D. in
Electronics and Telecom Engineering from the University of Surrey and University of Catalonia.  Mr. Ramos received a masters
degree in business administration from ESADE Business School and a bachelors degree in Physics from the University of
Barcelona.

24

---

FRANCISCO SANCHEZ became Chief Financial Officer of
the Company in July 2000 and became Vice President  Finance and Administration in April 1999.  Mr. Sanchez served as a director of
the Company from January 2002 to September 2002.  He was Vice President  Finance and Administration of CPR from July 1998 until
April 1999.  From June 1987 to June 1998, Mr. Sanchez was Caribbean Region Comptroller for H.B. Fuller Company.  From June 1978 to
May 1987, Mr. Sanchez held executive positions, Assistant Comptroller in manufacturing, sales and marketing at ITT Industries, Inc.
Mr. Sanchez received a masters degree from Metropolitan University and a BBA from Puerto Rico University.

Information set forth under the captions
Election of Directors and Section 16(a) Beneficial Ownership Reporting Compliance in the Companys
definitive Proxy Statement for the 2006 Annual Meeting of Shareholders to be held on January 9, 2007 (the Proxy
Statement), which will be filed with the Securities and Exchange Commission not later than 120 days after July 31, 2006, are
incorporated herein by reference in response to this item.

We have adopted a Code of Ethics that applies to all
employees, which is incorporated herein by reference.

|ITEM 10 | EXECUTIVE
COMPENSATION
|------- | ----------------------

Information set forth under the caption
Executive Compensation in the Proxy Statement is incorporated herein by reference in response to this item.

|ITEM 11 | SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS
|------- | -----------------------------------------------------------------------------------------------

Information set forth under the caption Stock
Ownership in the Proxy Statement is incorporated herein by reference in response to this item.

|ITEM 12 | CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS
|------- | ----------------------------------------------

Information set forth under the caption
Certain Transactions in the Proxy Statement is incorporated herein by reference.

|ITEM 13 | EXHIBITS
|------- | --------

The exhibits listed in the Exhibit Index following
the signature page of this report are filed as part of this report or are incorporated by reference herein.

Financial Statements

The following information appears in Item 7 of Part II
of this Report:

- Independent Auditors Report

- Balance Sheet as of July 31, 2006

- Statements of Operations for the
Years Ended July 31, 2006 and 2005

- Statements of Changes in
Stockholders Equity for the Years Ended July 31, 2006 and 2005

- Statements of Cash Flows for the
Years Ended July 31, 2006 and 2005

- Notes to Financial Statements

All other schedules are omitted because they are not
required, not applicable, or the required information is otherwise shown in the consolidated financial statements or the notes
thereto.



|ITEM 14 | PRINCIPAL
ACCOUNTANT FEES AND SERVICES
|------- | --------------------------------------

Information set forth under the caption Fees
Paid to the Independent Auditors in the Proxy Statement is incorporated herein by reference.



25

---

SIGNATURES

In accordance with Section 13 or 15(d) of the
Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



CORTELCO
SYSTEMS PUERTO RICO, INC.



By /s/ Juan Carlos Ramos

Juan Carlos Ramos, President

Chief Executive Officer

(Principal Executive Officer)



By /s/ Francisco Sanchez

Francisco Sanchez, Vice President,

Chief Financial Officer, Treasury

(Principal Financial Officer and

Principal Accounting Officer)

Dated:  October 27, 2006



In accordance with the Exchange Act, this report has
been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

|Name                                   |  | Title                                                                                                            |  | Date            
|-------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----------------
|                                       |  |                                                                                                                  |  |                 
|/s/ Juan
Carlos RamosJuan Carlos Ramos |  | President,
Chief Executive Officer (Principal Executive Officer)                                                 |  | October 27,
2006
|/s/
Francisco SanchezFrancisco Sanchez |  | Vice
President, Chief Financial Officer, Treasury (Principal Financial Officer and Principal Accounting Officer) |  | October 27,
2006
|/s/ Sergio
MorenSergio Moren           |  | Director                                                                                                         |  | October 27,
2006
|/s/ Alan L.
LaffoonAlan L Laffoon      |  | Director                                                                                                         |  | October 27,
2006
|/s/ Gloria
LeeGloria Lee               |  | Director                                                                                                         |  | October 27,
2006
|/s/ Walt
DuffeyWalt Duffey             |  | Director                                                                                                         |  | October 27,
2006
|/s/ Robert
A. GordonRobert A. Gordon   |  | Director                                                                                                         |  | October 27,
2006

26

---

EXHIBIT INDEX

Documents listed below are being filed as exhibits
herewith. Exhibits identified by asterisks (*) are being incorporated herein by reference and, pursuant to Rule 12b-32 of the
General Rules and Regulations promulgated by the Commission under the Securities Exchange Act of 1934, reference is made to such
documents as previously filed exhibits with the Commission.

Exhibit

NumberDescription of Document

|3.1 *  | Amended and
Restated Certificate of Incorporation of Cortelco Systems Puerto Rico, Inc. ("CSPR").    | 
|------ | ---------------------------------------------------------------------------------------------------- | 
|3.2 *  | Amended and
Restated Bylaws of CSPR.                                                                 | 
|4.1 *  | Amended and
Restated Certificate of Incorporation of CSPR (filed as Exhibit 3.1).                    | 
|4.2 *  | Amended and
Restated Bylaws of CSPR (filed as Exhibit 3.2).                                          | 
|4.3*   | Form of
certificate representing common stock, par value $.01 per share, of CSPR.                    | 
|10.1*  | Distribution
Agreement dated as of January 30, 2002, between eOn and CSPR (filed as Exhibit 2.1).    | 
|10.2 * | Employee
Matters Agreement dated as of January 30, 2002 between eOn and CSPR (filed as Exhibit 2.2).
|       |                                                                                                      | 

|10.3 * | Confidential
Disclosure Agreement dated as of January 30, 2002 between eOn and CSPR (filed as Exhibit 2.3).
|------ | -----------------------------------------------------------------------------------------------------------

|10.4 * | CSPR 2002
Equity Incentive Plan.                                                       | 
|------ | -------------------------------------------------------------------------------------- | 
|10.5 * | Lease Agreement
dated as of March 1, 1999, between CSPR and Cortelco Puerto Rico, Inc.

|10.6(a) * | Sales Agency
Agreement dated as of December 19, 1995, between Celulares Telefonica, Inc. and CSPR (Spanish).            
|--------- | ------------------------------------------------------------------------------------------------------------------------
|10.6(b) * | Sales Agency
Agreement dated as of December 19, 1995, between Celulares Telefonica, Inc. and CSPR (English translation).
|10.7 *    | Mitel Caribbean
VAR Agreement dated as of December 7, 2001, between Mitel Networks, Inc. and CSPR.                      

|10.8 * | Asset Purchase
Agreement dated as of May 14, 2001, between CSPR and Ochoa Telecom, Inc.       
|------ | ----------------------------------------------------------------------------------------------
|10.9 * | Form of Dealer
Agreement between eOn and CSPR.                                                
|14.1   | Code of Ethics
(filed as an exhibit to the Registrants 10-KSB for the period ended 07/31/05).
|31.1   | 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.                                          
|       |                                                                                               

* Incorporated by reference to
CSPR's Registration Statement on Form 10 or amendments thereto, filed with the Securities Exchange Commission on February 12, 2002.





27