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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1999 Commission File Number 0-26912
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VODAVI TECHNOLOGY, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 86-0789350
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8300 EAST RAINTREE DRIVE
SCOTTSDALE, ARIZONA 85260
- --------------------------------------- ---------
(Address of principal executive offices) (Zip Code)
(480) 443-6000
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not 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-K or any amendment to this
Form 10-K. [ ]
At March 20, 2000, there were outstanding 4,326,688 shares of the registrant's
common stock, $.001 par value, which excludes 226,800 treasury shares. The
aggregate market value of common stock held by nonaffiliates of the registrant
(2,990,083 shares) based on the closing price of the common stock as reported on
the Nasdaq National Market on March 20, 2000, was $15,324,175. For purposes of
this computation, all officers, directors and 10% beneficial owners of the
registrant are deemed to be affiliates. Such determination should not be deemed
an admission that such officers, directors or 10% beneficial owners are, in
fact, affiliates of the registrant.
Documents incorporated by reference: Portions of the Registrant's definitive
Proxy Statement for the 2000 Annual Meeting of Stockholders are incorporated by
reference into Part III of this Report.
VODAVI TECHNOLOGY, INC.
ANNUAL REPORT ON FORM 10-K
FISCAL YEAR ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
PAGE
----
PART I
ITEM 1. BUSINESS ....................................................... 1
ITEM 2. PROPERTIES ..................................................... 20
ITEM 3. LEGAL PROCEEDINGS............................................... 21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 22
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS............................................. 22
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA............................ 23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS ...................................... 24
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...... 27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA...................... 28
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ....................................... 28
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.............. 28
ITEM 11. EXECUTIVE COMPENSATION.......................................... 28
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT...................................................... 28
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................. 28
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K........................................................ 28
SIGNATURES.................................................................. 31
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
THE STATEMENTS CONTAINED IN THIS REPORT ON FORM 10-K THAT ARE NOT PURELY
HISTORICAL ARE FORWARDING-LOOKING STATEMENTS WITHIN THE MEANING OF APPLICABLE
SECURITIES LAWS. FORWARD-LOOKING STATEMENTS INCLUDE STATEMENTS REGARDING OUR
"EXPECTATIONS," "ANTICIPATION," "INTENTIONS," "BELIEFS," OR "STRATEGIES"
REGARDING THE FUTURE. FORWARD-LOOKING STATEMENTS ALSO INCLUDE STATEMENTS
REGARDING REVENUE, MARGINS, EXPENSES, AND EARNINGS ANALYSIS FOR FISCAL 2000 AND
THEREAFTER; TECHNOLOGICAL DEVELOPMENTS; FUTURE PRODUCTS OR PRODUCT DEVELOPMENT;
OUR PRODUCT AND DISTRIBUTION CHANNEL DEVELOPMENT STRATEGIES; POTENTIAL
ACQUISITIONS OR STRATEGIC ALLIANCES; THE SUCCESS OF PARTICULAR PRODUCT OR
MARKETING PROGRAMS; AND LIQUIDITY AND ANTICIPATED CASH NEEDS AND AVAILABILITY.
ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS REPORT ARE BASED ON INFORMATION
AVAILABLE TO US AS OF THE FILING DATE OF THIS REPORT, AND WE ASSUME NO
OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. OUR ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THE FORWARD-LOOKING STATEMENTS. AMONG THE FACTORS
THAT COULD CAUSE RESULTS TO DIFFER MATERIALLY ARE THE FACTORS DISCUSSED IN ITEM
1, "SPECIAL CONSIDERATIONS."
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PART I
ITEM 1. BUSINESS
INTRODUCTION
We design, develop, market, and support a broad range of business
telecommunications solutions, including telephony products, voice processing
products, and computer-telephony products for a wide variety of business
applications. Our telecommunications solutions incorporate sophisticated
features, such as automatic call distribution and Internet protocol, or IP,
gateways. Our voice processing products include interactive voice response
systems, automated attendant, and voice and fax mail. Our computer-telephony
products enable users to integrate the functionality of their telephone systems
with their computer systems. We market our products primarily in the United
States as well as in foreign countries through a distribution model consisting
of wholesale distributors, direct dealers, and our own direct sales personnel.
Our goal is to develop, deliver, and support high-quality
telecommunications products and services that meet the demands of the markets we
serve. Key elements of our strategy to achieve that goal include the following:
* expand our core business of supplying telephone systems, voice
processing systems, and computer-telephony integration, or CTI,
products;
* emphasize sales through our dealer programs;
* focus on the integration of existing and newly developed products to
provide complete, industry standard-based business communications
solutions to our customers;
* expand our strategic relationship with LG Information &
Communications, Ltd., or LGIC, which is a member of the
multi-billion dollar, Korean-based LG Group with which we have
enjoyed a long-term relationship; and
* enhance our existing products and expand our product lines by
expanding our technological expertise and distribution channels
through
-- business acquisitions, license arrangements, and other strategic
relationships, and
-- internal research and development efforts.
Our corporate offices are located at 8300 East Raintree Drive,
Scottsdale, Arizona, and our telephone number is (480) 443-6000. Our Web site,
which is not a part of this Report, is located at www.vodavi.com. All references
to our business operations in this Report include the operations of Vodavi
Technology, Inc. and our subsidiaries.
OUR BUSINESS
INDUSTRY OVERVIEW
Virtually every business today relies upon its business communications
system as an essential tool to speed and enhance the effectiveness of
communications among employees, customers, and vendors; to contact decision
makers regardless of their location; to increase employee productivity; to
provide better customer service; and to reduce operating costs. Many factors
have stimulated the growth of the telecommunications industry, including the
following:
* successive technological developments that have resulted in enhanced
features and services,
* advances in telephone and computer hardware and software,
* emphasis on the use of communications systems to provide
cost-effective customer service,
* development of the Internet as an alternative to traditional
telephone networks, and
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* regulatory changes.
These factors have resulted in continual development of full-featured business
communications systems designed for use by small- and medium-sized businesses
that can be offered at affordable prices.
Accelerated technological advances in recent years have enabled
telecommunications system providers to develop sophisticated systems that offer
a wide variety of applications in addition to traditional call switching
functions. Businesses of all sizes now demand affordable telecommunications
systems that provide the capacity for
* voice processing systems, which automate call answering, provide
voice mail and automated call distribution functions, and provide
the capacity to manage facsimile messages;
* interactive voice response, or IVR, which enables a business to
provide its customers with automated access to the business's
database via telephone or the Internet; and
* computer-telephony integration, which greatly enhances efficiency
and productivity by integrating businesses' voice and data networks.
Automatic call distribution, IP telephony, and other innovations represent
significant opportunities for sales of new product lines and applications to
further increase employee mobility and efficiency. We also believe that
international sales of voice processing products will increase in the future as
demand for features such as voice mail, interactive voice response, and unified
messaging increases.
The following table summarizes recent estimates provided by Frost &
Sullivan with respect to total market revenue, compound annual market growth
rates, and average retail prices for each business communications product
category listed.
AVERAGE
ESTIMATED COMPOUND RETAIL
1999 PROJECTED ANNUAL PRICE PER
PRODUCT SEGMENT REVENUE REVENUE GROWTH RATE STATION OR PORT
--------------- ------- ------- ----------- ---------------
(in millions) (in millions)
Key Telephone Systems $2,510.0 $2,570.0(1) 2.0% $ 303
Voice Messaging 959.2 2,138.4(2) 14.4% $1,000 - $6,000
Interactive Voice Response 962.0 2,091.3(2) 21.3% $1,320 - $3,730
Server/PC-Based PBX 78.8 1,028.9(1) 58.0% $ 200 - $1,100
Internet Telephony 244.8(4) 3,158.5(3) 132.0% $1,055
- ----------
(1) Represents projected market revenue for 2005.
(2) Represents projected market revenue for 2004.
(3) Represents projected market revenue for 2002.
(4) Represents estimated revenue for 1998.
OUR PRODUCTS
We currently design, develop, market, and support a broad range of
* telephony products, which include digital and analog key telephone
systems and commercial grade telephones;
* voice processing products, including IVR systems, automated
attendant, automatic call distribution, voice mail and fax mail, and
unified messaging systems; and
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* computer-telephony products, including Windows-based application
products (such as PC telephones and attendant consoles), local area
network (known as LAN) to PBX connection packages, IP gateways, and
Internet messaging systems.
TELEPHONY PRODUCTS
KEY TELEPHONE SYSTEMS
Sales of key telephone systems represented approximately 70% of our
revenue during 1999 and approximately 75% during 1998. A key telephone system
consists primarily of a sophisticated switching unit located at the user's place
of business, along with the individual telephone sets and other devices, such as
facsimile machines or modems, located at individual "stations." We supply
several models of key telephone sets, several of which are CTI compatible, with
progressive features for use in conjunction with each of our key telephone
systems.
We currently market various lines of key telephone systems, under our
STARPLUS, Triad, and INFINITE brand names, for businesses requiring as few as
three incoming lines and eight stations up to 144 lines and 250 stations (a
384-port system). We sell the STARPLUS and Triad lines through large wholesale
distributors and the INFINITE line through telephone sales and installation
companies known as "direct dealers."
We market both digital and analog key telephone systems and related
products. Our digital telephone systems employ a digital architecture in order
to provide digital voice transmission and system control, while our analog
telephone systems employ a microprocessor-based architecture and solid state
switching for voice transmission and system control. Most of our telephone
systems feature flexible software combined with modular hardware and card slot
design, which allow cost-effective system customization and expansion to meet
the needs of individual users. Our telephone systems are fully compatible with
industry-standard commercial grade telephones and contain an extensive array of
standard features that add sophistication generally found only in larger
telephone systems. We design our key telephone systems to permit expansion or
customization for specific business applications by installation of a variety of
voice processing or computer-telephony integration products.
Our digital systems enable customers to upgrade their telephone systems
as their businesses grow and as technology advances by adding or replacing
components in stages without replacing their entire systems. As a result, it is
generally more economical for the end users to expand their STARPLUS, Triad, or
INFINITE systems than to switch to a competitor's system. We believe that the
economy and flexibility we provide our customers through this migration strategy
provides us with a competitive advantage.
COMMERCIAL GRADE TELEPHONES
We market several models of commercial grade telephones through
wholesale distributors for use with analog or digital key systems, PBX systems,
or telephone company central office, or Centrex, switching systems. Businesses,
the hospitality industry, and school districts represent the principal
purchasers of our commercial grade telephones. All of our commercial grade
telephones meet industry standards for commercial telephone units and may be
used with telephone systems sold by us or by competing manufacturers.
Our commercial grade telephones offer a myriad of features, functions,
and designs ranging from simple, traditionally styled desk and wall-mounted
telephones to programmable telephones with contemporary styling. Our more
advanced commercial grade telephones contain a central processing unit, built-in
memory, built-in data jacks, built-in speakerphones, and the capability to use
custom calling features provided by local telephone companies.
During 1999, we discontinued sales of our previous line of commercial
grade telephones and introduced a new series of commercial grade telephones
primarily targeted to the business and hospitality markets. Our new line of
commercial grade telephones offers more advanced features, including built-in
Caller ID and other functions. Sales of commercial grade telephones represented
approximately 10% of our revenue during 1999 as compared with approximately 12%
during 1998.
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VOICE PROCESSING PRODUCTS
Voice processing includes functions designed to improve customer
service and reduce labor costs while providing faster, more efficient routing of
incoming calls and speeding and simplifying message delivery and storage. We
design our voice processing products to integrate with the telephone systems we
sell as well as those sold by competing manufacturers. While we frequently
market our voice processing products independently of our telephone systems,
during 1999 we increased the percentage of sales of our voice processing
products that were bundled with sales of our key telephone systems. We also
cultivate the expansion of our existing base of telephone systems by offering
digitally integrated voice processing systems for our STARPLUS, Triad, and
INFINITE product lines to differentiate them from our competitors' products and
to provide a value-added basis for increased sales and profit margins. Sale of
voice processing products accounted for approximately 20% of our revenue during
1999 and approximately 13% during 1998.
VOICE MAIL SYSTEMS
Voice mail enables callers to leave detailed messages and permits
recipients to retrieve messages when they return to their offices or by dialing
into the system from remote telephones. Each voice mailbox can be customized to
the individual user's needs. Voice messages can be stored, replayed, saved, or
erased as desired by the user. The menu routing functions included in some of
our voice mail systems enable business users to program the systems to create
custom, multi-level menus that permit callers to automatically access
organizational departments or product, service, or event information by dialing
menu choices.
In addition to our larger voice processing systems, we market a line of
self-contained, competitively priced voice processing systems designed for
small- to medium-sized organizations. These systems, which work in conjunction
with key telephone systems sold by us as well as other manufacturers, can be
expanded from two ports up to eight ports, feature a full range of automated
attendant and voice mail functions, and include a serial port for administration
via the user's laptop PC.
ADVANCED MESSAGING PLATFORM
Our Microsoft(R) Windows NT-based messaging systems, which provide
virtually unlimited port capacities, combine voice mail functions with facsimile
messaging capabilities (known as fax mail) as well as the ability to share
messages with other voice messaging systems over the Internet. Fax mail provides
the ability to receive, store, retrieve, and forward facsimile messages in the
same manner that voice mail handles voice messages. Our fax mail system
digitizes and stores facsimile messages and notifies the user that messages have
been received. The user can retrieve and print the facsimiles from his or her
office or remote locations (such as a hotel room) and can also instruct the
system to forward facsimiles to other recipients. "Fax-on-demand" enables
callers to access information stored by a business, such as sales and marketing
brochures, technical specifications, and pricing data, and request the system to
transmit the desired information to the caller's facsimile machine.
Our Windows NT-based system also uses Internet e-mail protocols to
enable voice messages to be transported over the Internet or other electronic
fields for efficient, low-cost information exchange between remote systems. In
addition, our Windows NT-based Internet fax delivery systems connect the user's
telephone and computer to enable the user to transmit facsimile messages or
documents to conventional facsimile machines via the Internet. These systems
provide ease of use and avoid problems associated with e-mail attachments,
mismatched data encryption techniques, or private or switched network costs. Our
Internet fax delivery systems provide spoken prompts that guide the user through
the transmission process and also transmit delivery confirmations to the user's
mailbox. As a result, a business with multiple offices can extend its voice
messaging system so as to permit employees in different locations to create,
receive, answer, or forward voice and facsimile messages via the Internet more
quickly, efficiently, and economically than traditional long-distance telephone
calls.
Our Windows NT-based system also uses Microsoft(R) Exchange technology
to provide unified messaging. Unified messaging enables users to access e-mail,
voice mail, facsimiles, and paging messages in a single session
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at a personal computer. The system displays a listing of all of the user's
messages and enables the user to access and control all of his or her messages
with a click of the computer mouse.
INTERACTIVE VOICE RESPONSE
Our IVR system connects a business's telephone system to its host
computer in order to permit the use of any telephone to access and store certain
information in the business's database. This interactive connectivity permits
callers to conduct transactions, such as placing orders, checking inventory,
tracking order shipments, or querying account information, from any telephone.
IVR uses voice prompts to communicate the steps required to enable the caller to
input information to or retrieve information from the database and to
communicate information to the caller. The open architecture design of our IVR
system provides unlimited scalability by permitting users to increase the number
of ports or voice storage capacity simply by plugging in more voice cards or
disk drives and by linking multiple devices into networks to create virtually
unlimited configurations. Users may enhance the system by adding independent
off-the-shelf software modules that can be seamlessly integrated to provide
additional features, such as call routing, voice messaging, web-based IVR,
speech recognition, and text-to-speech capabilities.
AUTOMATIC CALL DISTRIBUTION
We market our automatic call distribution, or ACD, software systems and
ACD reporting packages for use with our digital key telephone systems. The
automatic call distribution functions enable businesses that receive a large
volume of customer calls, such as catalog sales operations, to manage incoming
calls efficiently by directly routing them to the proper person or group. Our
ACD systems reduce the number of abandoned calls by reducing the number of calls
placed on hold and by minimizing the length of time that calls are kept on hold.
When all group member telephones are busy, ACD plays a custom "hold" message for
the caller and connects the call to the first available person or sales agent.
ACD saves employee time by eliminating the necessity of continually answering
and transferring calls to the same groups. ACD enables agents with display
telephones to see the number of calls waiting in queue as well as the length of
the longest waiting call in order to speed call handling at times of heavy
calling activity. Our ACD reporting package provides real-time statistics and
comprehensive reports on calling activity for review by the user's management.
COMPUTER-TELEPHONY INTEGRATION PRODUCTS
We design, develop, and market CTI products that use an open
architecture to integrate computer and telephone systems into a user-friendly
information processing and storage system. We believe that developing more
value-added CTI applications for our telephone systems will enhance the appeal
of our product lines and enable us to sell more key telephone systems,
full-featured telephones, and other software packages and add-on peripheral
products. We market CTI products that enable a user to use the Internet to
access voice, facsimile, and e-mail messages via personal computer; incorporate
telephone functions with computer software to speed call handling and permit the
user to personalize telephone functions; identify incoming callers and
immediately access computer files relating to the caller; connect Windows-based
local area networks to the user's telephone system; and quickly and
inexpensively access and analyze call accounting information.
NEW PRODUCT DEVELOPMENT
We engage in an ongoing program to develop enhancements to our existing
product lines and to develop new products that address the increasing demands of
business organizations for low-cost productivity enhancing communications tools.
We believe that continuous development of new products and features will be
necessary to enable us to offer telephony systems, voice processing products,
computer-telephony products, and related business communications products that
will be in greatest demand and that will provide the best opportunities for our
growth and profitability on an ongoing basis. Since 1994, we have developed and
introduced several new or enhanced products and product lines, including new ACD
reporting packages, additional enhancements to our Windows NT-based voice
messaging systems and our IVR systems, a new line of digital key telephone
systems, a new line of commercial grade telephones, and an IP gateway.
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We currently are focusing our new product development efforts on
developing and refining enhancements that will deliver greater features,
sophistication, functionality, and value to our current product offerings. For
example, we currently are developing
* a 144-port digital switch for our STARPLUS DHS line of products;
* desktop telephones with large-screen LCD displays;
* a new caller ID telephone for our line of commercial grade
telephones;
* new software releases for our Triad and INFINITE product lines; and
* a LAN card that will enable our digital switches to network with a
business LAN and to serve as an imbedded IP gateway for connecting
with voice over IP networks. This will allow users of our existing
technologies to migrate towards the benefits of IP telephony.
We have strategic alliances with LGIC and other third parties related
to the development of new products, product lines, or product features. For
example, we are working with LGIC to develop a full IP-based telecommunications
solution. We may enter into additional strategic alliances for new product
development in the future.
SALES, MARKETING, AND DISTRIBUTION
We currently market our products in all 50 states and, to a limited
extent, internationally through a distribution network consisting primarily of
large wholesale distributors and telephone sales and installation companies
known as "direct dealers." We also maintain an in-house direct sales force that
makes direct sales of our IVR products to businesses as well as an in-house
sales support staff assisting our direct dealers and distributors. We derived
approximately 75% of our total revenue in 1999 from sales to distributors, 19%
from sales to direct dealers, and 6% from direct sales to IVR customers. In the
past we have and in the future we may market our products on a private label
basis to original equipment manufacturers, or OEMs. The following diagram
illustrates the current distribution channels for our product lines.
VODAVI
TRIAD STARPLUS INFINITE IVR INTERNATIONAL
| | | | |
| | | | |
Distributor Distributor International
Distributor
| | | | |
| | | | |
Authorized Dealer Authorized | |
Dealer | Dealer | |
| | | | |
| | | | Dealer
| | | | |
| | | | |
End User End User End User End User End User
WHOLESALE DISTRIBUTORS
We design and market our STARPLUS brand of products for sale through
wholesale distributors. The distributors resell our products primarily to small
local interconnect companies and independent telephone companies. The
interconnects and independent telephone companies in turn resell our products to
end users,
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install the systems at the end users' businesses, and provide service and
technical support following the sale. We provide ongoing support and training to
enable distributors to sell our products more effectively and to provide the
interconnects and independent telephone companies with technical assistance they
may request with respect to installation, maintenance, and customer support.
We believe that sales through distributors offers several advantages,
including the following:
* established distribution systems and access to a large number of
customer accounts;
* maintenance of customer credit facilities and an established
inventory of our products;
* availability of products in over 600 locations throughout the United
States;
* security of receivables;
* reduced needs for direct training by us;
* effective promotion of our products at trade shows;
* geographically dispersed sales forces that can reach customers more
effectively than we would otherwise be able to do; and
* lower support and carrying costs compared with the costs associated
with direct sales to a large number of direct dealers.
Distributors that currently resell our products include Graybar
Electric Co., Inc., Alltel Supply, Inc., Sprint/North Supply, Famous Telephone
Supply, ADI, Target, and Power & Telephone Supply Company. Graybar accounted for
41% of our sales during 1999 and 39% in 1998. Alltel accounted for 11% of our
sales during 1999 and 12% during 1998.
Our sales and marketing personnel stimulate demand for our products
with the interconnects and independent telephone companies that purchase our
products from Graybar, Alltel, and other distributors and install these products
at the end users' premises. These interconnects and independent telephone
companies provide the "pull through" demand for our products from Graybar,
Alltel, and other distributors. As a result, we believe that a decrease in
purchases by Graybar, Alltel, or other distributors would result in only a
temporary adverse effect on our operations if interconnects and independent
telephone companies would continue to demand our products from other
distributors, which in turn would increase the purchases by these other
distributors of our products.
TRIAD DISTRIBUTORS AND DEALERS
During 1998, we introduced our Triad line of digital telephone systems
for sale through distributors to a limited number of authorized Triad dealers.
The Triad product line includes a full array of digital telephone systems
ranging from three lines and eight stations up to 384 ports, as well as voice
messaging, ACD, CTI, and other products. The authorized Triad dealers must
commit to minimum purchases of Triad or STARPLUS products and must be trained
and certified through our formal product and sales training program. Our goal is
to encourage the Triad dealers to promote the Triad line to their customers as
the preferred line of digital telephone systems. We provide the authorized Triad
dealers with order fulfillment, marketing, sales, and product support services.
We had approximately 150 authorized Triad dealers as of March 20, 2000.
INFINITE DIRECT DEALERS
We developed our INFINITE line of telephone systems and related
products for sales to direct dealers. These direct dealers are medium and large
interconnect companies or local dealers that resell our products directly to end
users. We believe that the principal advantages of this distribution channel
include greater visibility of our product lines and the ability to exert
additional control over factors such as pricing of our products. Sales to direct
dealers, however, generally involve greater credit risks, the necessity to
provide increased direct marketing
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and technical support, and additional costs associated with developing and
training the independent sales staff of the various direct dealers to enable
them to solicit purchases of our products.
We increased the number of direct dealers that sell our INFINITE
products from 70 at December 31, 1995 to approximately 115 at December 31, 1999.
During 1999, however, we initiated a program to upgrade and strengthen our
dealer network. Under this program, we plan to focus on selling to fewer, but
larger and better-established, dealers. During the first quarter of 2000 we
signed up approximately 35 large-volume, well-qualified new dealers and
discontinued sales to approximately 20 dealers that have not provided a
sufficient level of sales or support for our INFINITE line. The new dealers
maintain large customer bases and possess the resources needed to provide
quality sales presentations and support to their customers. As a result of this
program, a total of approximately 130 direct dealers sell our INFINITE products
as of March 20, 2000.
IN-HOUSE SALES STAFF
We maintain a sales staff of five employees who make direct sales of
our IVR products in the United States. Our sales force also develops
relationships with strategic partners, which purchase some of our products as a
base platform, enhance the platform with specialized software that they have
developed, and then resell the combined systems.
We have an in-house sales support staff of 12 employees who provide
dealers and distributors with order fulfillment, marketing, sales, and technical
support. We believe that our commitment to support dealers that sell our
products on a pre-sale and post-sale basis provides us with a competitive
advantage with our dealer customers.
INTERNATIONAL SALES
To date, sales of our products in foreign countries have not
represented a significant portion of our revenue. We believe, however, that
sales of our voice processing and other products in international markets may
increase in the future as demand for features such as voice mail and interactive
voice response increases, as touchtone technologies and cellular telephone
service become more available and other installed communications infrastructures
are improved, and as regulatory differences between countries are eliminated.
All of our sales in foreign countries are denominated in U.S. dollars.
RESEARCH AND DEVELOPMENT; STRATEGIC ALLIANCES WITH LGIC AND OTHER COMPANIES
We believe that the continued development of software that
distinguishes the functions and features of our products from those of our
competitors represents a critical factor in determining our ongoing success. Our
engineering staff consists of highly trained and experienced software
professionals who focus on providing and supporting high-quality, user-friendly
business communications systems and related products. The availability of
in-house software and systems development expertise at our facilities in Arizona
and Georgia provides us with product control, permits faster turnaround and
reaction time to changing market conditions, and provides a solid base of
maintenance and support services to end users. We use product and market
development groups that interact with customers in order to anticipate and
respond to customer needs through development of new product programs and
enhancement of existing product lines.
We conduct joint development activities with LGIC for the design and
development of hardware incorporated into some of our existing or planned
telephone system and commercial grade telephone product lines. Under our joint
development projects with LGIC, we provide market analysis, product management,
functional and performance standards, software development, quality control
program development, sales and distribution, and customer service and support,
while LGIC provides hardware research, design and development, development of
components such as integrated circuits and semiconductor chips, and
manufacturing and production engineering. Generally, LGIC contributes the
ongoing research and development costs for the product hardware in return for an
arrangement under which LGIC produces the finished goods developed under the
alliance. As a result of this arrangement, we have been able to obtain access to
LGIC's research and development expertise and resources while controlling our
capital expenditures for much of our product development efforts. In addition,
our arrangement with LGIC enables us to minimize the risks inherent in making
significant
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investments in research and development infrastructure or personnel. To the
extent that we develop new hardware in conjunction with LGIC or another
development partner, the development partner typically retains ownership rights
to the new hardware and we retain the right to sell products incorporating that
hardware throughout North America. See Item 1, "Business - Manufacturing" and
Item 1, "Special Considerations - We rely on LGIC as a strategic partner." We
have successfully engaged in such projects with LGIC in the past and believe
that we will continue to have access to LGIC's advanced hardware research and
development capabilities as we develop new product lines.
We enhance our software development expertise through acquisitions of
or licensing arrangements and other strategic alliances with independent
third-party developers. We have active strategic alliance relationships with
other companies that possess expertise in automatic call distribution, small
digital key telephone systems, computer telephony, and Internet telephony. We
believe that our strategic alliances with other companies enable us to develop
products and bring them to market more quickly and at a lower cost than we would
be able to achieve by developing the products internally. We intend to pursue
additional opportunities to enter into strategic alliances with other companies
that possess established expertise in specific technologies in order to
co-develop proprietary products, or to acquire such companies in order to
develop new products internally.
MANUFACTURING
We obtain our key telephone systems, some of our voice processing
systems, and our full-featured commercial grade telephones under manufacturing
arrangements with various third-party manufacturers, including LGIC. We also
purchase certain of our voice processing products from third parties on an OEM
basis. We own a significant portion of the tooling used by the third-party
manufacturers to manufacture our products. Our agreements with the third-party
manufacturers generally require the manufacturers to produce our products
according to our technical specifications, to perform quality control functions
or otherwise meet our quality standards for manufacturing, and to test or
inspect the products prior to shipment. Under the manufacturing agreements, the
manufacturers provide us with warranties that the products are free of defects
in material and workmanship. The agreements also require the manufacturers to
repair or replace, at their expense, products that fail to conform with the
warranties within specified periods. We perform final assembly, systems
integration, and testing of some of our automated call distribution, voice mail,
automated attendant, interactive voice response, and computer-telephony
integration products at our Arizona and Georgia facilities.
We obtain some of our digital telephone systems, commercial grade
telephones, and voice mail products from LGIC, which owns the rights to produce
this equipment. We purchase products manufactured by LGIC in Korea on a purchase
order basis. During 1999, we purchased $11.6 million of product from LGIC, which
represented 41% of our total purchases in 1999. LGIC currently owns
approximately 18.8% of our outstanding common stock. See Item 1, "Special
Considerations - We rely on LGIC as a strategic partner" and "Special
Considerations - Certain conflicts of interest may arise as a result of LGIC's
ownership interest in our company."
We obtain some of our analog telephone systems and most of our
commercial grade telephones and replacement parts for such telephones from LG
Srithai, Ltd., or LGST, a joint venture between LGIC and Srithai Group, a
Thailand-based entity. Under an agreement with our company, LGST granted us the
right to distribute and sell throughout the United States and Canada the
products that LGST manufactures for us in Thailand. Our agreement with LGST
prohibits us from purchasing the products covered by the agreement from any
other manufacturer during the term of the agreement. The agreement renews
automatically for successive one-year terms unless either party provides notice
to the other of its intent to cancel the agreement at least three months prior
to the end of the then-current term. We make all purchases pursuant to the
agreement on a purchase order basis. During 1999, we purchased $6.8 million of
product from LGST, which represented 24% of our total purchases in 1999. See
Item 1, "Special Considerations - We rely on LGIC as a strategic partner" and
"Special Considerations - Certain conflicts of interest may arise as a result of
LGIC's ownership interest in our company."
We also obtain some of our digital key telephone systems from Tecom
Co., Ltd., a Republic of China company. Under an agreement with our company,
Tecom granted us the right to sell and distribute throughout all of North and
South America the products that Tecom manufactures for us. The term of the
agreement with
9
Tecom will remain in effect until either party gives the other party at least
120 days' advance notice of termination. We make all purchases pursuant to the
agreement on a purchase order basis.
We currently maintain a $3.8 million insurance policy to cover lost
revenue in the event of significant interruptions in purchases from our overseas
manufacturers. See Item 1, "Special Considerations - We depend on third parties
for manufacturing" and Item 1, "Special Considerations - We face risks
associated with international manufacturing sources."
QUALITY CONTROL
We recognize that product quality and reliability are critical factors
in distinguishing our products from those of our competitors. We design our
products to include components meeting specified quality standards in order to
ensure reliable performance. We also require our third-party manufacturers to
comply with specified quality standards regarding materials and assembly methods
used in manufacturing our products. In addition, we maintain a rigorous quality
assurance program designed to ensure that the manufacture of our products
conforms with specified standards and to detect substandard products before
shipment. We have an inspection program in which we examine varying numbers of
our products as they arrive at our warehouse in Arizona, depending upon the
manufacturer and the type of product.
SUPPORT SERVICES
We provide limited warranties against defective materials and
workmanship on each of the products that we sell. We provide a complete support
service for all of our products by maintaining a 24-hour toll-free telephone
number and e-mail support that the dealers' or interconnects' service
representatives can contact for trouble shooting and diagnostic assistance. We
also maintain a technical support page on our Web site that includes frequently
asked questions, technical tips, and product-related notifications. We maintain
an operating set-up of each of our telephone systems, key telephone units, and
peripheral systems at our headquarters facility, supported by a staff of
technicians trained to handle service assistance calls. When a dealer or
interconnect calls with a question relating to performance malfunctions or an
operational system question, our personnel attempt to replicate any problem the
user is encountering, diagnose the cause, and provide a solution via telephone.
If our technicians cannot determine the cause of the malfunction over the
telephone, we dispatch a service representative to the user's place of business
in order to locate the source of the problem and take corrective measures.
Prior to June 24, 1999, we operated our own repair center and performed
repairs on certain of our products. On June 24, 1999, we sold the repair center
and entered into a seven-year repair and refurbishment agreement with the buyer.
Under this agreement, we appointed the buyer as the exclusive authorized repair
center for our products. We believe that this arrangement will enable us to
continue to provide fast turn-around time and consistent quality of repairs
without the overhead and other expenses associated with operating the repair
facility.
COMPETITION
Markets for communications products are extremely competitive. We
currently compete principally on the basis of the technical innovation and
performance of our products, including their ease of installation and use,
reliability, cost, and the technical support both before and after sales to end
users. Our competitors for the sale of telephone systems and telephones include
Lucent Technologies, Inc., Nortel, Toshiba Information Systems, Inc., Comdial
Corporation, Panasonic Communications & Systems Co., Nitsuko, Iwatsu, InterTel,
and NEC Corp.
Competitors in the market for voice processing systems include Active
Voice Corporation and Applied Voice Technology as well as PBX and key system
telephone manufacturers that offer integrated voice processing systems of their
own design and under various original equipment manufacturer agreements.
Competition in the interactive voice response market includes Intervoice
Communications, Inc., Edify Corp., and Syntellect.
In the computer telephony market, we compete with many of the same
companies indicated above. Some of our product lines compete with products and
services provided by the regional Bell operating companies, or
10
RBOCs, which offer key telephone systems and commercial grade telephones
produced by several of the competitors named above as well as Centrex systems
that provide automatic call distribution facilities and features through
equipment located in the telephone company's central switching offices.
PATENTS, TRADEMARKS, AND LICENSES
As of December 31, 1999, we owned six United States patents expiring on
various dates beginning in 2000 and ending in 2008. We intend to continue to
seek patents on our inventions used in our products. The process of seeking
patent protection can be expensive and can consume significant management
resources. We believe that our patents strengthen our negotiating position with
respect to future disputes that may arise regarding our technology. However, we
believe that our continued success depends primarily on such factors as the
technological skills and innovative abilities of our personnel rather than on
our patents. We cannot assure you that patents will issue from our pending or
future applications or that any patents that are issued will provide meaningful
protection or other commercial advantage.
We own a number of registered and unregistered trademarks that we
consider to be an important factor in marketing our products. Our ability to
compete may be enhanced by our ability to protect our proprietary information,
including the issuance of patents, copyrights, and trademarks. We also have
taken steps to protect our proprietary information through a "trade secrets"
program that includes copy protection of our software programs and obtaining
confidentiality agreements with our employees. We cannot assure you, however,
that these efforts will be effective in preventing misappropriation, reverse
engineering, or independent development of our proprietary information by our
competitors. While none of our intellectual property rights have been
invalidated or declared unenforceable, we cannot assure you that our rights will
be upheld in the future. Accordingly, we believe that, due to the rapid pace of
technological change in the telecommunications industry, the technical and
creative skills of our engineers and other personnel will be extremely important
in determining our future technological success.
During 1999, we entered into a non-exclusive licensing agreement with
Santa Barbara Connected Systems Corporation to acquire the licensing and
manufacturing rights to certain of our voice processing systems. Since 1997, we
had purchased these products from Connected Systems for private-labeled sales to
our distribution partners and customers. By acquiring the licensing rights and
having LGIC manufacture these products for us, we obtained a more dependable
source and better margins for several of our more popular products.
We have a license agreement with Executone that gives us a
non-exclusive license to use Executone's technology for certain of our digital
telephone systems. Under the license agreement, we purchase all of the
proprietary components for those digital telephone systems at Executone's cost
plus 5%, and we pay Executone a royalty fee of 5.3% of the manufactured cost of
all of our products that use the technology covered by the agreement. The
license agreement expires in 2014. We have discontinued manufacturing the line
of products that use this licensed technology, and we anticipate that we will
sell our remaining inventory of those products over the next 18 months.
We license from third parties the rights to the software included in
certain of our products, including our ACD products. These licenses generally
give us a non-exclusive right to use and sell the licensed software included in
our products during the term of the applicable agreement. We pay the licensors
fees based on the number of units that we purchase from them.
The telecommunications industry is characterized by rapid technological
development and frequent introduction of new products and features. In order to
remain competitive, we and other telecommunications manufacturers continually
find it necessary to develop products and features that provide functions
similar to those of other industry participants, often with incomplete knowledge
of whether patent or copyright protection may have been applied for or obtained
by other parties. As a result, we receive notices from time to time alleging
possible infringement of patents and other intellectual property rights of
others. To date, we have been able to successfully defend these claims or to
negotiate settlements to these claims on terms we believe to be favorable. In
the future, however, the defense of such claims, fees paid in settlement of such
claims, or costs associated with
11
licensing rights to use the intellectual property of others or to develop
alternative technology may have a material adverse impact on our operations.
GOVERNMENT REGULATION
The U.S. government from time to time has imposed anti-dumping duties
on some telephone products manufactured in some of the countries where our
products are manufactured. Most recently, duties on certain of our products were
phased out between 1997 and 2000. We cannot assure you that similar duties will
not be imposed in the future on telephone products, including our products,
manufactured in these or other foreign countries in the future. The imposition
of such additional duties on our products could have a material adverse effect
our operating results.
EMPLOYEES
As of March 20, 2000, we employed a total of 145 persons, consisting of
143 full-time employees and two part-time employees at our facilities in
Scottsdale, Arizona, and Norcross, Georgia. This number includes 25 persons in
engineering and product development, 80 in sales, marketing, and technical
support, 18 in warehouse and distribution functions, and 22 in administration,
including executive personnel. We consider our relationship with our employees
to be good, and none of our employees currently are represented by a union in
collective bargaining with us.
Various third-party manufacturers provide the personnel engaged in the
manufacture and assembly of our products in South Korea, Thailand, Taiwan, and
the People's Republic of China under the agreements between the respective
manufacturers and us.
EXECUTIVE OFFICERS
The following table sets forth information concerning each of our
executive officers:
NAME AGE POSITION
---- --- --------
William J. Hinz............... 54 Chairman of the Board
Gregory K. Roeper............. 39 President, Chief Executive Officer, and
Director
Tammy M. Powers............... 30 Vice President - Finance, Chief Financial
Officer, and Treasurer
Stephen L. Borcich............ 53 Vice President - Sales and Marketing
WILLIAM J. HINZ has served as Chairman of the Board of our company
since October 1997 and as a director of our company since April 1997. Since
October 1999, Mr. Hinz has served as Group President for the Triumph Components
Group, which is a group of seven divisional companies within Triumph Group,
Inc., a publicly held company. Mr. Hinz served as President of Stolper-Fabralloy
Company, a precision aerospace engine component manufacturer that is a
subsidiary of Triumph Group, Inc., from September 1997 until October 1999, and
as Executive Vice President of Operations of Stolper-Fabralloy from March 1996
until September 1997. Mr. Hinz was Vice President of Global Repair and Overhaul
Operations for AlliedSignal Aerospace Company from June 1994 until March 1996.
During this period, Mr. Hinz also was responsible for aerospace aftermarket
merger and acquisition activity. Mr. Hinz served as President of European
Operations for AlliedSignal Aerospace Company from December 1991 until June 1994
and served in various other manufacturing management positions with AlliedSignal
Aerospace Company from 1968 to 1991.
GREGORY K. ROEPER has served as President of our company since December
1998 and as Chief Executive Officer and a director of our company since December
1999. Mr. Roeper served as our Chief Operating Officer from June 1998 until
December 1999. Between November 1994 and June 1998, Mr. Roeper held a variety of
other executive positions with our company, including Chief Financial Officer,
Executive Vice President - Finance, Administration, and Operations; Secretary;
and Treasurer. From 1982 to 1994, Mr. Roeper was
12
employed by Arthur Andersen LLP, most recently as a Senior Manager. Mr. Roeper
is a Certified Public Accountant in the state of Arizona.
TAMMY M. POWERS has served as Vice President - Finance, Chief Financial
Officer, and Treasurer of our company since July 1999. From September 1998 until
July 1999, Ms. Powers served as Chief Financial Officer, Treasurer, and
Secretary of Automotive Performance Group, Inc., a public company specializing
in high-performance automotive businesses. From January 1997 until September
1998, Ms. Powers served as Chief Financial Officer and Secretary of Unitech
Industries, Inc., a public company engaged in the international manufacturing
and distribution of portable power supplies for mobile telephones. From January
1992 to January 1997, Ms. Powers was an accountant with Deloitte & Touche, LLP,
most recently as an audit manager. Ms. Powers is a Certified Public Accountant
in the state of Arizona.
STEPHEN L. BORCICH has served as Vice President - Sales and Marketing
of our company since April 1999. Mr. Borcich served as Vice President - Sales
for Voice Technologies Group, a manufacturer and distributor of digital
integration technology from August 1998 until March 1999. From February 1997
until July 1998, Mr. Borcich served as Vice President - Sales and Marketing of
Q.SyS, Inc., a manufacturer of computer telephony applications. Mr. Borcich was
Vice President - Sales of Microlog Corporation from December 1990 until
September 1995.
SPECIAL CONSIDERATIONS
YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS, IN ADDITION TO
THOSE DISCUSSED ELSEWHERE IN THIS REPORT, IN EVALUATING OUR COMPANY AND OUR
BUSINESS.
WE DEPEND ON THIRD PARTIES FOR MANUFACTURING.
We depend upon third parties to manufacture our products. We do not own
most of the equipment, tools, and molds used in the manufacturing process, and
we have only limited control over the manufacturing processes. As a result,
certain difficulties could have a material adverse effect on our business,
including any difficulties encountered by the third-party manufacturers that
result in
* product defects,
* production delays,
* cost overruns, or
* the inability to fulfill orders on a timely basis.
Our operations would be adversely affected if we were to lose our relationship
with any of our suppliers, if any of our suppliers' operations were interrupted
or terminated, or if overseas or air transportation services were disrupted even
for a relatively short period of time. We do not maintain an inventory of
sufficient size to provide protection for any significant period against an
interruption of supply, particularly if we were required to locate and use
alternative sources of supply.
WE FACE RISKS ASSOCIATED WITH INTERNATIONAL MANUFACTURING SOURCES.
We currently obtain some of our products under various manufacturing
arrangements with third-party manufacturers in South Korea, Thailand, Taiwan,
and the People's Republic of China. We believe that production of our product
lines overseas enables us to obtain these items on a cost basis that enhances
our ability to market them profitably. Our reliance on third-party manufacturers
to provide personnel and facilities in these countries, our maintenance of
equipment and inventories abroad, and the potential imposition of quota
limitations on imported goods from certain Far East countries expose us to
certain economic and political risks, including the following:
* the business and financial condition of our third-party
manufacturers;
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* political and economic conditions abroad;
* the possibility of expropriation, supply disruption, currency
controls, and exchange fluctuations; and
* changes in tax laws, tariffs, and freight rates.
The countries in which some of our products are manufactured have been
subject to natural disasters and civil disturbances in the past. These
circumstances could affect our ability to obtain some of our products from our
overseas manufacturers. Except for a fire that interrupted production at one
plant in China during late 1993 and the first part of 1994, we have not
experienced any significant shipment interruptions to date. The termination of
any of the arrangements with our manufacturers or our inability to obtain
products pursuant to such arrangements, even for a relatively short period of
time, could have a material adverse effect on our operations.
The countries in which most of our products are manufactured also have
been subject to economic problems in the past. Although the economic situation
in Asia in recent years has not resulted in any adverse changes in our ability
to obtain products or the prices that we pay for our products, an extended
period of financial pressure on overseas markets or currency devaluations that
result in a financial setback to our overseas manufacturers could have an
adverse impact on our operations.
Protectionist trade legislation in either the United States or foreign
countries, such as a change in the current tariff structures, export compliance
laws, or other trade policies, could adversely affect our ability to purchase
our products from foreign suppliers or the price at which we can obtain those
products. In November 1999, the United States and China signed an agreement that
will lift trade barriers between the two countries and that advances China's
efforts to join the World Trade Organization. Special interest groups have
raised objections to these efforts, and we cannot be certain whether or to what
extent trade relations with China will continue to improve. Any developments
that adversely affect trade relations between the United States and China in the
future could impact our ability to obtain some of our products from our
manufacturers in China.
WE RELY ON LGIC AS A STRATEGIC PARTNER.
We rely on LGIC to supply some of our key telephone systems, commercial
grade telephones, and voice mail products as well as on LGIC's engineering,
hardware and circuit development, and manufacturing capabilities. We purchase a
significant portion of our key telephone systems and commercial grade telephones
from LGIC and LGST, an affiliate of LGIC. During 1999, we purchased $18.4
million of product from LGIC and LGST, constituting approximately 65% of our
total purchases in 1999. During 1998, we purchased $16.3 million of product from
LGIC, LG Electronics, Inc., and LGST, constituting approximately 60% of our
total purchases in 1998. We currently obtain products from LGIC and LGST on a
purchase order basis and cannot provide assurance that we will be able to secure
long-term manufacturing arrangements for the products we currently obtain from
LGIC and LGST. LGIC has no formal commitments to support our business or
operations.
MARKETS FOR OUR PRODUCTS ARE INTENSELY COMPETITIVE, AND WE CANNOT ASSURE YOU
THAT WE WILL BE ABLE TO COMPETE SUCCESSFULLY IN THE FUTURE.
We engage in an intensely competitive business that has been
characterized by price erosion, rapid technological change, and foreign
competition. We compete with major domestic and international companies. Many of
our competitors have greater market recognition and substantially greater
financial, technical, marketing, distribution, and other resources than we
possess. Emerging companies also may increase their participation in the
telephone systems and peripherals markets. Our ability to compete successfully
depends on a number of factors both within and outside our control, including
the following:
* the quality, performance, reliability, features, ease of use,
pricing, and diversity of our product lines;
* the quality of our customer services;
* our ability to address the needs of our customers;
14
* our success in designing and manufacturing new products, including
those implementing new technologies;
* the availability of adequate sources of raw materials, finished
components, and other supplies at acceptable prices;
* our suppliers' efficiency of production;
* the performance of our distributors and dealers;
* the rate at which end users upgrade or expand their existing
telephone systems, applications, and services;
* new product introductions by our competitors;
* the number, nature, and success of our competitors in a given
market; and
* general market and economic conditions.
We currently compete principally on the basis of the technical innovation and
performance of our telephone systems, voice processing products,
computer-telephony products, and commercial grade telephones, including their
ease of use, reliability, cost, timely introduction, delivery schedules, and
after-sale service and technical support. We may not continue to be able to
compete successfully in the future.
WE DEPEND ON NEW PRODUCTS AND TECHNOLOGIES.
We operate in an industry that is characterized by fast-changing
technology. As a result, we will be required to expend substantial funds for and
commit significant resources to the conduct of continuing product development,
including research and development activities and the engagement of additional
engineering and other technical personnel. Any failure on our part to anticipate
or respond adequately to technological developments, customer requirements, or
new design and production techniques, or any significant delays in product
development or introduction, could have a material adverse effect on our
operations.
Our future operating results will depend to a significant extent on our
ability to identify, develop, and market enhancements or improvements to
existing product lines as well as to introduce new product lines that compare
favorably on the basis of time to introduction, cost, and performance with the
product lines offered by our competitors. The success of new product lines
depends on various factors, including proper market segment selection,
utilization of advances in technology, innovative development of new product
concepts, timely completion and delivery of new product lines, efficient and
cost-effective features, and market acceptance of our products. Because of the
complexity of the design and manufacturing processes required by our products,
we may experience delays from time to time in completing the design and
manufacture of improvements to existing product lines or the introduction of new
product lines. In addition, customers or markets may not accept new product
lines. Our failure to design and implement enhancements to existing product
lines or failure to introduce new products on a timely and cost-effective basis
would adversely affect our future operating results.
Complex software programs, such as those we develop or those developed
by other software sources and incorporated into our products, occasionally
contain errors that are discovered only after the product has been installed and
used by many different customers in a variety of business operations. Although
we conduct extensive testing of the software programs included in our products,
we may not successfully detect and eliminate all such errors in our products
prior to shipment. Significant programming errors in product software could
require substantial design modifications that may create delays in product
introduction and shipment and that could result in an adverse impact on our
goodwill as well as on our operating results.
WE RELY ON AN INDEPENDENT DISTRIBUTION NETWORK.
We currently market our products through a distribution network
consisting primarily of large wholesale distributors and telephone sales and
installation companies known as "direct dealers." Distributors generally
maintain inventories in amounts that they consider sufficient to fill
anticipated orders for at least a two-month
15
period of time. A decline in the volume of sales made by distributors, however,
could result in their inventory levels exceeding their anticipated sales, which
could delay purchases of additional products from us until the distributors'
inventories reach re-ordering levels. Direct dealers generally stock inventories
only in quantities they deem sufficient to fill anticipated short-term orders.
As a result, distributors and direct dealers may cancel orders and delay or
change volume levels on short notice to us. Because the sale of key telephone
systems, voice processing products, and related products typically involves a
long sales cycle, we may not be able to accurately forecast our own inventory
levels. Our reliance on third-party distributors and dealers to sell our
products could further exaggerate any inventory shortages or excesses that we
might experience, particularly if our distributors or dealers are not able to
give us adequate notice of anticipated changes in demand for our products.
We depend upon independent distributors and direct dealers to sell our
products to end users, to perform installation services, and to perform service
and support functions after the sale. Other telephone system manufacturers
compete intensely for the attention of the same distributors and direct dealers,
most of which carry products that compete directly with our products. We may not
be able to maintain favorable relationships with the distributors and direct
dealers that currently carry our product lines in order to encourage them to
promote and sell our products instead of those of our competitors. In addition,
we may not be able to develop such relationships with additional distributors
and dealers in the future.
Graybar accounted for 41% of our sales during 1999 and 39% during 1998.
Accounts receivable from Graybar comprised approximately 33% of total accounts
receivable at December 31, 1999. Alltel accounted for 11% of our sales during
1999 and 12% during 1998. Accounts receivable from Alltel comprised
approximately 10% of total accounts receivable at December 31, 1999.
WE FACE RISKS ASSOCIATED WITH PATENTS, LICENSES, AND INTELLECTUAL PROPERTY.
Our success depends in part upon our ability to protect our proprietary
technology. We rely on a combination of copyright, trademark, and trade secret
laws, nondisclosure and other contractual agreements, and technical measures to
protect our proprietary technology. We have acquired certain patents and patent
licenses, and we intend to continue to seek patents on our inventions and
manufacturing processes. We face risks associated with our intellectual
property, including the following:
* the steps we have taken to protect our proprietary rights may be
inadequate to protect misappropriation of such rights;
* third parties may independently develop equivalent or superior
technology;
* the process of seeking patent protection can be long and expensive,
and patents may not issue from future applications;
* existing patents or any new patents that are issued may not be of
sufficient scope or strength to provide us meaningful protection or
any commercial advantage;
* we may be subject to or may initiate interference proceedings in the
U.S. Patent and Trademark Office, which can demand significant
financial and management resources; and
* we may commence litigation to enforce patents or other intellectual
property rights, or to defend us against claimed infringement of the
rights of others, which could result in substantial cost to us and
diversion of our management's attention.
As is typical in the telecommunications industry, we have received from
time to time, and in the future may receive, allegations of possible
infringement of patents or other intellectual property rights of others. Based
on industry practice, we believe that in most cases we could obtain any
necessary licenses or other rights on commercially reasonable terms. In the
event that a third party alleges that we are infringing its rights, we may not
be able to obtain licenses on commercially reasonable terms from the third
party, if at all, or the third party may commence litigation against us. The
failure to obtain necessary licenses or other rights or the occurrence of
litigation arising out of such claims could materially and adversely affect us,
our result of operations, or prospects.
16
WE MUST BE ABLE TO MANAGE OUR GROWTH.
Our failure to manage our growth in an effective manner could have a
material adverse effect on our operations. Our ability to manage our growth
effectively in the future will require us to
* enhance our operational, financial, and management systems;
* expand our facilities and equipment;
* successfully hire, train, and motivate additional employees,
including the technical personnel necessary to design the software
used in our telephone systems, voice processing products, and
computer-telephony products; and
* integrate new software systems with evolving hardware technologies.
We may be required to increase staffing and other expenses as well as
our capital expenditures in order to meet the demand for our products and
services. Customers, however, generally do not commit to firm purchase orders
for more than a short time in advance. Any increase in our expenditures in
anticipation of future orders would adversely affect our profitability if those
orders do not materialize. The development of new products or product
enhancements or unexpected customer orders also may require rapid increases in
design and production services. Such increases in design and production services
could place excessive short-term burdens on our resources.
THE TELECOMMUNICATIONS INDUSTRY IS CYCLICAL.
The telecommunications industry has experienced economic downturns at
various times, characterized by diminished product demand, accelerated erosion
of average selling prices, and production overcapacity. We have sought to reduce
our exposure to industry downturns by targeting our product lines towards small-
and medium-sized businesses, which we believe will sustain continued growth in
the near and long term, resulting in a steadily increasing demand for enhanced
and upgraded telephone systems and voice processing products. However, we may
experience substantial period-to-period fluctuations in future operating results
because of general industry conditions or events occurring in the general
economy. In addition, although we have not experienced significant quarterly
sales fluctuations in the past, the size and timing of sales of our new voice
processing and computer-telephony products may vary from quarter to quarter to a
greater extent in future periods. The expanding importance of these new products
could result in significant variations in our overall operating results on a
quarterly basis.
WE MUST FINANCE THE EXPANSION OF OUR BUSINESS AND THE DEVELOPMENT OF NEW
PRODUCTS.
To remain competitive, we must continue to make significant investments
in research and development, equipment, and facilities. As a result of the
increase in fixed costs and operating expenses related to these capital
expenditures, our failure to increase net sales sufficiently to offset the
increased costs may adversely affect our operating results. From time to time,
we may seek additional equity or debt financing to provide for the capital
expenditures required to maintain or expand our design and production facilities
and equipment. We cannot predict the timing and amount of any such capital
requirements. Such financing may not be available or, if available, may not be
available on terms satisfactory to us. If such financing is not available on
satisfactory terms, we may be unable to expand our business or develop new
products at the rate desired and our operating results may be adversely
affected. Debt financing increases expenses and must be repaid regardless of our
operating results. Equity financing could result in additional dilution to
existing stockholders. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources."
WE MAY EXPERIENCE SHORTAGES OF RAW MATERIALS AND SUPPLIES.
The principal raw materials and components used in producing our
products consist of
17
* semiconductor components,
* unfinished printed circuit boards,
* molded plastic parts,
* metals, and
* packaging materials.
The third-party manufacturers of our products acquire these raw materials
primarily from Asian sources, which indirectly subjects us to certain risks,
including supply interruptions and currency price fluctuations. Purchasers of
these materials, including our third-party manufacturers and us, from time to
time experience difficulties in obtaining these materials. The suppliers of
these materials currently are adequately meeting our requirements. We also
believe that there are alternate suppliers for most of these materials.
WE DEPEND ON MANAGEMENT AND OTHER KEY PERSONNEL.
Our development and operations to date have been, and our proposed
operations will be, substantially dependent upon the efforts and abilities of
our senior management and technical personnel. Although we have employment
agreements with William J. Hinz, our Chairman of the Board, and Gregory K.
Roeper, our President and Chief Executive Officer, we do not have employment
agreements with any of our other executive officers. However, we maintain
agreements with each of our officers and employees that prohibit them from
disclosing confidential information obtained while employed with us. The loss of
existing key personnel or the failure to recruit and retain necessary additional
personnel would adversely affect our business prospects. We cannot provide
assurance that we will be able to retain our current personnel or that we will
be able to attract and retain necessary additional personnel. Our internal
growth and the expansion of our product lines will require additional expertise
in such areas as software development, operational management, and sales and
marketing. Such growth and expansion activities will increase further the demand
on our resources and require the addition of new personnel and the development
of additional expertise by existing personnel. Our failure to attract and retain
personnel with the requisite expertise or to develop internally such expertise
could adversely affect the prospects for our success.
CERTAIN CONFLICTS OF INTEREST MAY ARISE AS A RESULT OF LGIC'S OWNERSHIP INTEREST
IN OUR COMPANY.
LGIC currently owns approximately 18.8% of our outstanding common
stock. We obtain some of our digital telephone systems, commercial grade
telephones, and voice mail products from LGIC and obtain some of our analog
telephone systems and most of our commercial grade telephone and replacement
parts for such telephones from LGST, an affiliate of LGIC. See Item 1, "Business
- - Manufacturing" and "Special Considerations -We rely on LGIC as a strategic
partner." As a result of LGIC's indirect ownership interest in us, an inherent
conflict of interest exists in establishing the volume and terms and conditions
of our purchases from LGIC and LGST. In order to mitigate such conflicts, all
decisions with respect to such purchases will be made by our officers and
reviewed by our directors who have no relationship with LGIC.
We, LGIC, and some of our other stockholders are parties to a
stockholders' agreement. At any time that we issue shares of our common stock in
an amount representing 1% or more of our outstanding common stock, the
stockholders' agreement gives LGIC the right to purchase a sufficient number of
shares from us as may be required to enable LGIC to maintain the percentage of
ownership of our common stock that existed immediately prior to such issuance.
OUR STOCK PRICE MAY BE VOLATILE.
The trading price of our common stock in the public securities market
could be subject to a variety of factors, including the following:
* wide fluctuations in response to quarterly variations in our
operating results or the operating results of our competitors,
18
* actual or anticipated announcements of technological innovations or
new product developments by us or our competitors,
* significant actual or anticipated expenditures for property or
equipment, research and development, sales and marketing activities,
or other planned or unanticipated events,
* changes in analysts' estimates of our financial performance,
* developments or disputes concerning proprietary rights,
* regulatory developments,
* general industry conditions, and
* worldwide economic and financial conditions.
The trading volume of our common stock in the past has been limited, which may
increase the volatility of the market price for our stock and reduce the
liquidity of an investment in shares of our common stock. During certain
periods, the stock markets have experienced extreme price and volume
fluctuations. In particular, prices for many technology stocks often fluctuate
widely, frequently for reasons unrelated to the operating performance of such
companies. These broad market fluctuations and other factors may adversely
affect the market price of our common stock.
RIGHTS TO ACQUIRE OUR COMMON STOCK COULD RESULT IN DILUTION TO OTHER HOLDERS OF
OUR COMMON STOCK.
As of March 20, 2000, we had outstanding options to acquire 606,225
shares of our common stock at a weighted average exercise price of $4.03 per
share. An additional 91,275 shares remain available for grant under our 1994
Stock Option Plan. In addition, we sold to the underwriter of our initial public
offering warrants to purchase 133,333 shares of common stock. Those warrants
have an exercise price per share of $7.20 and are exercisable until October
2000. In February 1999, we issued warrants to acquire an aggregate of 122,500
shares of common stock to an investor relations firm. Those warrants have
exercise prices ranging from $4.00 to $6.50 per share and are exercisable until
February 2004, subject to earlier expiration six months after the date our
agreement with the investor relations firm is terminated if the termination
occurs prior to October 2003. During the terms of these options and warrants,
the holders thereof will have the opportunity to profit from an increase in the
market price of the common stock. The existence of these options and warrants
may adversely affect the terms on which we can obtain additional financing, and
the holders of these options and warrants can be expected to exercise such
options or warrants at a time when we, in all likelihood, would be able to
obtain additional capital by offering shares of our common stock on terms more
favorable to us than those provided by the exercise of these options or
warrants.
SALES OF ADDITIONAL SHARES OF COMMON STOCK COULD HAVE A NEGATIVE EFFECT ON THE
MARKET PRICE OF OUR COMMON STOCK.
Sales of substantial amounts of our common stock in the public market
could adversely affect prevailing market prices and could impair our ability to
raise capital through the sale of our equity securities. Approximately 1,548,000
restricted shares of common stock currently are eligible for sale in the public
market, subject to compliance with the requirements of Rule 144 under the
securities laws. Shares issued upon the exercise of stock options granted under
our stock option plan generally will be eligible for sale in the public market.
We also have the authority to issue additional shares of common stock and shares
of one or more series of preferred stock. The issuance of such shares could
dilute the voting power of the currently outstanding shares of our common stock
and could dilute earnings per share.
IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US, EVEN IF THE ACQUISITION
WOULD BE IN THE BEST INTEREST OF STOCKHOLDERS.
We are subject to provisions under Delaware corporate law that would
require us to obtain certain approvals from our Board of Directors or
stockholders in order to engage in a business combination with an interested
stockholder under certain circumstances. Our Amended Certificate of
Incorporation and Bylaws also
19
contain a number of other provisions relating to corporate governance and to the
rights of stockholders. These provisions
* authorize the Board of Directors to fill vacancies on the Board of
Directors;
* authorize the Board of Directors to issue preferred stock in series
with such voting rights and other powers as the Board of Directors
may determine; and
* require the affirmative vote of two-thirds of the directors then in
office to approve:
-- a public offering of our capital stock;
-- the merger with or the acquisition of another business or the
acquisition of a significant amount of the assets of another
business;
-- the sale of a significant amount of our assets;
-- our entering into contracts with our stockholders or directors;
-- our assumption or acquisition of debt in excess of $1.0 million;
and
-- any amendment of our Amended Certificate of Incorporation and
Bylaws of our wholly owned subsidiary Vodavi Communications
Systems, Inc.
These provisions in our Amended Certificate of Incorporation and Bylaws and
Delaware corporate law may have the effect of making more difficult or delaying
attempts by others to obtain control of us, even when these attempts may be in
the best interests of stockholders.
WE DO NOT PAY CASH DIVIDENDS.
We have never paid any cash dividends on our common stock and do not
anticipate that we will pay dividends in the foreseeable future. Instead, we
intend to retain any earnings to provide funds for use in our business.
Furthermore, the terms of the revolving line of credit facility between our
wholly owned subsidiary Vodavi Communications Systems, Inc. and General Electric
Capital Corporation prohibit our subsidiary from paying dividends to us without
the consent of GE Capital. This restriction could limit our ability to pay
dividends in the future.
OUR OPERATING RESULTS COULD DIFFER MATERIALLY FROM THE FORWARD-LOOKING
STATEMENTS INCLUDED IN THIS REPORT.
Some of the statements and information contained in this Report that
are not historical facts are forward-looking statements, as such term is defined
in the securities laws. These include statements concerning future, proposed,
and anticipated activities of our company; certain trends with respect to our
revenue, operating results, capital resources, and liquidity; and certain trends
with respect to the markets where we compete or the telecommunications industry
in general. Forward-looking statements, by their very nature, include risks and
uncertainties, many of which are beyond our control. Accordingly, actual results
may differ, perhaps materially, from those expressed in or implied by such
forward-looking statements. Factors that could cause actual results to differ
materially include those discussed elsewhere under this Item 1, "Special
Considerations."
ITEM 2. PROPERTIES
We lease, for a term expiring in December 2001, approximately 60,000
square feet of space in Scottsdale, Arizona, where we maintain engineering and
design laboratories, a sound engineering laboratory, software development
facilities, testing laboratories, product development facilities, customer
service support facilities, an employee training facility, warehouse and
distribution areas, sales and marketing offices, and administrative and
executive offices.
We also lease approximately 16,200 square feet of space in Norcross,
Georgia, for a term expiring in August 2002. We maintain software development
facilities, engineering and design laboratories, product development facilities,
product assembly and testing facilities, warehouse and distribution areas, and
sales, marketing, and administrative offices at this location.
20
We lease, for a term ending in December 2004, approximately 19,500
square feet of space in Scottsdale, Arizona. We used this facility for our
telecommunications equipment repair operations until we sold those operations in
June 1999. Following the sale of the repair operations, we sub-leased this
facility to a third party.
We believe our facilities are adequate for our reasonably anticipated
needs.
ITEM 3. LEGAL PROCEEDINGS
On September 20, 1996, we and our subsidiary, Vodavi-CT, filed a
lawsuit against Michael Mittel and Fereydoun Taslimi, former officers and
directors of Vodavi-CT. The lawsuit alleged, among other things, that Messrs.
Mittel and Taslimi violated federal and Arizona securities laws and engaged in
fraudulent activities in connection with our acquisition of Vodavi-CT in 1995;
breached certain terms of their respective employment contracts with Vodavi-CT;
and converted certain corporate assets of Vodavi-CT, breached their fiduciary
duties to Vodavi-CT, and misappropriated certain corporate opportunities for
their own benefit. On September 24, 1996, Messrs. Mittel and Taslimi filed a
lawsuit against Vodavi-CT and our company. The lawsuit alleged that Vodavi-CT
breached Messrs. Mittel's and Taslimi's respective employment agreements by
terminating their employment.
On September 27, 1999, the court entered an order granting the motion
of our company and Vodavi-CT for summary judgment as to the claims of Messrs.
Mittel and Taslimi for breach of their respective employment agreements. In
addition, the court denied Messrs. Mittel's and Taslimi's motions for summary
judgment as to the claims of our company and Vodavi-CT with respect to
fraudulent misrepresentation and/or nondisclosure, negligent misrepresentation,
conversion or misappropriation of corporate assets, breach of contract, breach
of implied covenant of good faith and fair dealing, breach of fiduciary duty,
constructive fraud, and misappropriation of corporate assets. The court granted
the motion of Messrs. Mittel and Taslimi for summary judgment as to the claims
of our company and Vodavi-CT with respect to unjust enrichment and constructive
trust.
In January 2000, we entered into a settlement agreement with Messrs.
Mittel and Taslimi. Under the agreement, the parties executed mutual releases
and we repurchased 210,000 shares of our common stock from Messrs. Mittel and
Taslimi for an aggregate of $499,800.
On February 16, 2000, Messrs. Mittel and Taslimi filed a lawsuit in the
United States District Court for the Northern District of Georgia, Atlanta
Division, against our company and Gregory K. Roeper, our President and Chief
Executive Officer (Case No. 1-00-CV-0410). The plaintiffs allege that our
company and Mr. Roeper violated federal securities laws, made false
representations and omitted material facts, and breached fiduciary duties to the
plaintiffs in connection with the repurchase of their shares of our common stock
in the settlement described above. The plaintiffs are seeking an unspecified
amount of compensatory and punitive damages as well as their expenses of
litigation. In March 2000, we and Mr. Roeper filed responses denying the
plaintiffs' allegations and asserting various affirmative defenses. We intend to
vigorously defend this lawsuit.
On November 9, 1998, Paradygm Communications, Inc. and R.C. Patel filed
a lawsuit against our subsidiary, Vodavi Communications Systems, Inc., or VCS.
The complaint alleges that VCS (i) breached its strategic alliance agreement
with Paradygm, as well as its warranty of product fitness under the strategic
alliance agreement; (ii) failed to provide reasonable technical and sales
training assistance to Paradygm's employees to support Paradygm in its efforts
to sell products under the agreement; and (iii) engaged in conduct that
constitutes intentional or negligent misrepresentation. The complaint requests
compensatory, punitive, incidental, and consequential damages, attorneys' fees,
plus any additional relief. VCS answered the complaint denying the foregoing
allegations, asserting that the complaint fails to state a claim and, for
various reasons, the relief sought by Paradygm and Patel is barred. VCS also has
filed a counterclaim against Paradygm alleging that Paradygm breached the
agreement because of its failure to meet its payment obligations to VCS. The
counterclaim requests amounts due pursuant to the strategic alliance agreement,
the costs of litigation, and reasonable attorneys' fees. On March 24, 1999, the
plaintiffs filed an amended compliant to add our subsidiary Vodavi-CT as an
additional defendant. The amended complaint alleges claims against Vodavi-CT
similar to those alleged in the original complaint. On July 28, 1999, Vodavi-CT
filed an answer and denied those allegations on the same basis as VCS' original
answer. The parties currently are conducting discovery. We are vigorously
defending this lawsuit.
21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Our common stock has been quoted in the Nasdaq National Market under
the symbol "VTEK" since October 6, 1995. The following table sets forth the high
and low closing sales prices of our common stock on the Nasdaq National Market
for the periods indicated.
HIGH LOW
---- ---
1997:
First quarter.......................................... $4.75 $3.30
Second quarter......................................... 5.38 2.63
Third quarter.......................................... 5.50 4.13
Fourth quarter......................................... 6.00 4.13
1998:
First quarter.......................................... $4.50 $3.25
Second quarter......................................... 3.97 2.75
Third quarter.......................................... 3.25 1.75
Fourth quarter......................................... 3.50 1.81
1999:
First quarter.......................................... $3.63 $2.06
Second quarter......................................... 3.13 2.25
Third quarter.......................................... 3.00 2.16
Fourth quarter......................................... 3.19 1.94
2000:
First quarter (through March 20, 2000)................. $7.00 $2.75
On March 20, 2000, the closing sales price of our common stock was
$5.13 per share. As of March 20, 2000, there were 34 holders of record of our
common stock.
We have not declared or paid any cash dividends on our common stock and
do not intend to declare or pay any cash dividends in the foreseeable future. In
addition, our credit facility with GE Capital restricts our ability to pay cash
dividends.
22
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below as of and for
the fiscal years ended December 31, 1999 are derived from our consolidated
financial statements, which have been audited by Arthur Andersen LLP,
independent public accountants. The selected consolidated financial information
provided below should be read in conjunction with Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements of our company and related notes thereto.
No dividends were paid during the periods presented.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
OPERATING DATA: 1995 1996 1997 1998 1999
---------- ----------- ---------- ----------- ----------
Revenue .................... $ 39,601 $ 46,154 $ 47,675 $ 47,983 $ 49,662
---------- ----------- ---------- ----------- ----------
Gross margin ............... 12,404 15,312 15,667 15,859 17,955
Operating expenses ......... 10,399 13,749 13,828 14,415 15,321
Asset impairment and
restructuring charges ..... -- 4,805 819 -- --
---------- ----------- ---------- ----------- ----------
Operating income (loss) .... 2,005 (3,242) 1,020 1,444 2,634
Interest expense ........... 1,130 840 663 791 676
---------- ----------- ---------- ----------- ----------
Income (loss) before
income taxes .............. 875 (4,082) 357 653 1,958
Provision for (benefit from)
income taxes .............. 417 327 142 (330) 718
---------- ----------- ---------- ----------- ----------
Net income (loss) .......... $ 458 $ (4,409) $ 215 $ 983 $ 1,240
========== =========== ========== =========== ==========
Net income (loss) per share,
diluted ................. $ 0.17 $ (1.02) $ 0.05 $ 0.23 $ 0.29
========== =========== ========== =========== ==========
Weighted average shares
outstanding, diluted ...... 2,769,434 4,342,238 4,342,238 4,342,238 4,344,003
========== =========== ========== =========== ==========
AS OF DECEMBER 31,
-------------------------------------------------------------------
(IN THOUSANDS)
BALANCE SHEET DATA: 1995 1996 1997 1998 1999
------- ------- ------- ------- -------
Assets:
Current assets ............... $17,719 $16,591 $19,507 $16,766 $19,645
Property and equipment, net... 1,731 2,465 2,616 2,663 2,356
Goodwill, net ................ 7,089 2,547 2,395 2,244 1,906
Other, net ................... 931 815 1,146 1,169 1,307
------- ------- ------- ------- -------
$27,470 $22,418 $25,664 $22,842 $25,214
======= ======= ======= ======= =======
Liabilities:
Current liabilities .......... $13,591 $12,627 $15,743 $12,044 $13,208
Other long-term obligations... 69 391 306 199 186
------- ------- ------- ------- -------
Total liabilities ............. 13,660 13,018 16,049 12,243 13,394
Stockholders' equity .......... 13,810 9,400 9,615 10,599 11,820
------- ------- ------- ------- -------
$27,470 $22,418 $25,664 $22,842 $25,214
======= ======= ======= ======= =======
23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
INTRODUCTION
We were incorporated in Delaware on March 10, 1994. On April 11, 1994,
we acquired the operating assets of the Vodavi Communications Systems Division
(the Vodavi Division) of Executone. The Vodavi Division and its predecessor had
engaged in the design, development, and marketing of key telephone systems,
commercial grade telephones, and related products since 1983. In October 1995,
we completed our initial public offering and acquired Vodavi-CT, Inc. (formerly
Enhanced Systems, Inc.). Vodavi-CT develops and markets voice processing,
interactive voice response, and call accounting software products for small,
medium, and large businesses, universities, and government organizations in the
United States and internationally. In July 1995, we acquired from an affiliate
of LGIC certain of the assets and liabilities of a telecommunications equipment
repair business located in Scottsdale, Arizona. We sold our repair operations in
June 1999.
RESULTS OF OPERATIONS
ANNUAL RESULTS
The following table sets forth, for the periods indicated, the
percentage of total revenue represented by certain revenue and expense items.
The table and the discussion below should be read in conjunction with the
Consolidated Financial Statements and Notes thereto that appear elsewhere in
this Report.
YEARS ENDED DECEMBER 31,
----------------------------
1997 1998 1999
------ ------ ------
% % %
----- ----- -----
Revenue......................................... 100.0% 100.0% 100.0%
Cost of goods sold ............................. 67.1% 67.0% 63.8%
----- ----- -----
Gross margin ................................. 32.9% 33.0% 36.2%
Operating expenses:
Engineering and product development ............ 4.4% 3.4% 2.7%
Selling, general, and administrative ........... 24.6% 26.7% 28.2%
Asset impairment and restructuring charges...... 1.7% 0% 0%
----- ----- -----
Operating income (loss) ........................ 2.2% 2.9% 5.3%
Other income (expense), net .................... (1.4)% (1.6)% (1.4)%
----- ----- -----
Pretax income (loss) ........................... 0.8% 1.3% 3.9%
Income tax expense (benefit) ................... 0.3% (0.7)% 1.4%
----- ----- -----
Net income (loss) .............................. 0.5% 2.0% 2.5%
===== ===== =====
REVENUE
Revenue in 1999 was approximately $49.7 million, an increase of $1.7
million, or 3.5%, over 1998 revenue of approximately $48.0 million. Sales for
the INFINITE product line accounted for an increase of approximately $1.9
million, a 25% increase in sales of those products over 1998. Approximately $1.5
million of the increase in INFINITE sales is attributable to voice mail sales.
Sales of our voice mail products increased due to the introduction of digital
voice mail in early 1999 and sales incentives that we offered throughout 1999.
These sales incentives encouraged the purchase of voice mail with key telephone
systems, or bundling. Revenue for all of our voice processing products through
all of our distribution channels increased by $2.8 million, or 40%, in 1999 to
approximately $9.7 million.
The increase in total revenue during 1999 was partially offset by the
migration from our older digital key telephone systems, which we discontinued in
January 2000, to our newer Triad and DHS systems, as well as the
24
migration of our commercial grade telephones to the new 2700 series of
commercial grade telephones, which replaced our 2600 series beginning in June
1999. These product migrations had a negative impact on our revenue of
approximately $1.3 million. In addition, we sold our repair center in the second
quarter of 1999. Repair revenue was approximately $772,000 in 1999 as compared
with $1,514,000 in 1998.
Revenue in 1998 increased slightly to $48.0 million over revenue of
approximately $47.7 million in 1997. Sales of key telephone products increased
by approximately $1.3 million over sales of those products in 1997 and sales of
voice mail systems increased by approximately $2.0 million over sales of those
products in 1997. These sales increases were offset, however, by an
approximately $1.8 million decrease in sales of commercial grade telephones and
an approximately $1.6 million decrease in sales to OEMs.
COST OF GOODS SOLD
Gross margins increased to 36.2% of revenue in 1999 as compared with
33.0% in 1998. The improvement in gross margin in 1999 was attributable to a
number of factors, including changes in product mix as sales of higher-margin
voice processing products increased from 13% of total revenue in 1998 to 20% of
total revenue in 1999. Other factors include the elimination of expenses related
to our repair center division, which we sold during the second quarter of 1999,
negotiated discounts from our vendors, a decrease in import duties, decreased
discounts provided to wholesale distributors, and increased participation in
rebate programs provided by our vendors.
During 1999, margins were also favorably impacted by our acquisition of
the licensing and manufacturing rights to our "Talkpath" and "Dispatch" voice
processing product lines from Connected Systems in May 1999. Our acquisition of
the rights to this technology has allowed us to contract directly with LGIC to
manufacture these products, which improved our margin on sales of these systems.
Gross margins increased slightly to 33.0% of revenue in 1998 as
compared with 32.9% in 1997. Although sales of higher-margin voice mail systems
increased substantially during 1998, overall gross margins remained relatively
constant as a result of increased rebates that we provided, primarily to
wholesale distributors and the interconnects to which those distributors sell
our products.
ENGINEERING AND PRODUCT DEVELOPMENT
Engineering and product development expenditures decreased to
approximately $1.4 million in 1999 as compared with $1.6 million in 1998 and
$2.1 million and 1997. These decreases are due to the elimination of several
engineering and product development positions within our company during fiscal
1998 as a result of the termination of a PBX development project.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative, or SG&A, expenses increased to
approximately $14.0 million in 1999 as compared with $12.8 million in 1998. As a
percentage of revenue, SG&A expenses increased to 28.2% from 26.7% in 1998. This
increase is primarily a result of the addition of several new sales personnel
and the completion of our executive management team. The increase in SG&A also
can be attributed to increased efforts in our marketing and sales programs.
SG&A expenses increased to approximately $12.8 million in 1998 as
compared with $11.7 million in 1997. As a percentage of revenue, SG&A expenses
increased to 26.7% in 1998 from 24.6% in 1997. This increase can be attributed
primarily to an increase in personnel in sales and marketing functions.
ASSET IMPAIRMENT AND RESTRUCTURING CHARGES
We established a provision of $411,000 in 1997 for restructuring,
legal, and other reserve charges. Included in accrued liabilities at December
31, 1997, 1998, and 1999 were $702,000, $94,000, and $0, respectively, of the
reserve established in prior years. We charged $184,000, $608,000, and $94,000
against the reserves during 1997, 1998, and 1999, respectively.
25
INTEREST EXPENSE
Interest expense decreased from approximately $791,000 in 1998 to
approximately $676,000 in 1999. The $115,000 decrease can be attributed to
decreased average borrowings during 1999 as a result of reduced levels of
inventory throughout the year.
Interest expense increased to approximately $791,000 in 1998 as
compared with $663,000 in 1997. The $128,000 increase in interest expense in
1998 can be attributed to an increase in borrowings as a result of increased
levels of inventory and receivables.
INCOME TAXES
We have provided for income taxes using an effective rate of 36.7% in
1999, as compared with a tax benefit of $330,000, or 50.5%, in 1998 and an
effective rate of 39.8% in 1997. We utilized research and development tax
credits of approximately $135,000 in 1999, $509,000 in 1998, and $100,000 in
1997, which favorably impacted the effective tax rate in each of those years.
LIQUIDITY AND CAPITAL RESOURCES
We had cash of approximately $1.5 million at December 31, 1999. Our
cash accounts are swept regularly and applied against our line of credit with GE
Capital. Effective September 30, 1999, we negotiated an increase in our line of
credit from $12.0 million to $15.0 million. The line of credit expires in April
2003 and bears interest at 2.5% over the 30-day commercial paper rate, a total
of 8.05% at December 31, 1999. Advances under the line of credit are based upon
eligible accounts receivable and inventory of our wholly owned subsidiary, VCS,
and are secured by substantially all of our assets. We had borrowings of
approximately $8.7 million against our available operating line of credit at
December 31, 1999, which represents an increase of $1.0 million from borrowings
of $7.7 million at December 31, 1998. This increase was primarily due to the
timing of payments received on accounts receivable balances from customers. At
December 31, 1999, our net eligible borrowing availability under the line of
credit was approximately $2.5 million.
The revolving line of credit contains covenants that are customary for
similar credit facilities and also prohibits our operating subsidiaries from
paying dividends to our company without the consent of GE Capital. At December
31, 1999, we were in compliance with these covenants.
Working capital increased to approximately $6.4 million at December 31,
1999 from approximately $4.7 million at December 31, 1998. This increase was
attributable to increases in accounts receivables (primarily due to timing of
receipts), inventory, and prepaid and other current assets, partially offset by
increases in accounts payable and the line of credit. Our current ratio was 1.5
for 1999 as compared with 1.4 for 1998. The industry average for this ratio is
2.0 and the S&P 500 average is 1.2.
During May 1999, we entered into a non-exclusive licensing agreement
with Santa Barbara Connected Systems Corporation to acquire the licensing and
manufacturing rights to our "Talkpath" and "Dispatch" voice processing product
lines. Since 1997, we had purchased these products from Connected Systems for
private-labeled sales to distribution partners and customers. Under the
agreement, we paid Connected Systems $500,000 during 1999. No additional
payments are due under this agreement. The purchase of this technology has
allowed us to contract directly with the end manufacturer, which has resulted in
significant cost savings on these products.
On June 24, 1999, we sold our repair center division's net inventory,
property, and other assets with a net book value of approximately $531,000. The
buyer paid to us consideration of $100,000 in cash, a note receivable of
$200,000 that the buyer paid on July 31, 1999, and a note receivable of
approximately $195,000 with monthly payments of approximately $16,000 for 12
months commencing August 1, 1999. Payments on the note were current at December
31, 1999. We also incurred liabilities of approximately $50,000 in connection
with this transaction, which we paid in the fourth quarter of 1999. As part of
this transaction, we entered into a seven-year repair and refurbishment
agreement with the buyer. Under this agreement, we appointed the buyer as the
exclusive authorized repair center for our products.
26
In October 1999, our Board of Directors approved a buy-back of up to
400,000 shares of our outstanding common stock through April 2000. Financing for
the buy-back is provided through our line of credit, as amended on October 31,
1999. As of December 31, 1999, we had repurchased 16,800 shares at a total cost
of $45,000. Except for the repurchase of 210,000 shares of common stock in
connection with the settlement of a lawsuit, we have not made any further
repurchases as of the filing date of this Report. We are accounting for the
repurchase program under the cost method.
We are a defendant in various lawsuits. See Item 3, "Legal
Proceedings." We have not made any provisions in our financial statements for
these lawsuits. The imposition of damages in any of these matters could have a
material adverse effect on our results of operations and financial position.
From time to time we also are subject to certain asserted and
unasserted claims encountered in the normal course of business. We believe that
the resolution of these matters will not have a material adverse effect on our
financial position or results of operations. We cannot provide assurance,
however, that damages that result in a material adverse effect on our financial
position or results of operations will not be imposed in these matters.
We believe that our working capital and credit facilities are
sufficient to finance our internal growth in the near term. Although we
currently have no acquisition targets, we intend to continue to explore
acquisition opportunities as they arise and may be required to seek additional
financing in the future to meet such opportunities.
INTERNATIONAL MANUFACTURING SOURCES
We currently obtain some of our products under various manufacturing
arrangements with third-party manufacturers in Asia. As of the date of this
report, we do not believe that the current economic situations in Asia will have
any adverse impact on our operations.
YEAR 2000 COMPLIANCE
During 1999, we engaged a third-party consultant to evaluate our entire
internal computer system and to upgrade some of our existing financial and
accounting systems, including software related to order entry, inventory
management, materials planning, and accounts payable and receivable. These
upgrades improved the content, quality, and flow of information within our
company and addressed Year 2000 issues. These upgrades were completed and tested
prior to December 31, 1999. As of the filing date of this Report, we have not
experienced any material disruption to our operations as a result of any failure
of any of our systems to function properly as of January 1, 2000. We also have
not experienced any Year 2000 failures related to any of our significant vendors
or suppliers, including our third party manufacturers in Asia.
Year 2000 compliance has many elements and potential consequences, some
of which may not be foreseeable or may be realized in future periods. In
addition, unforeseen circumstances may arise, and we may not in the future
identify equipment or systems that are not Year 2000 compliant.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At December 31, 1999, we did not participate in any derivative
financial instruments or other financial and commodity instruments for which
fair value disclosure would be required under Statement of Financial Accounting
Standards No. 107. We do not hold investment securities that would require
disclosure of market risk.
Our market risk exposure is limited to interest rate risk associated
with our credit instruments. We incur interest on loans made under a revolving
line of credit at variable interest rates of 2.5% over the 30 day commercial
prime rate, a total of 8.05% at December 31, 1999. The principal of loans under
this line of credit is due in April 2003. At December 31, 1999, we had
outstanding borrowings on the line of credit of approximately $8.7 million.
27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
Reference is made to the financial statements, the report thereon, and
the notes thereto commencing at page F-1 of this Report, which financial
statements, report, and notes are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item relating to our directors is
incorporated herein by reference to the definitive Proxy Statement to be filed
pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended,
for our 2000 Annual Meeting of Stockholders. The information required by this
Item relating to our executive officers is included in Item 1, "Business -
Executive Officers."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement to be filed pursuant to Regulation
14A of the Exchange Act for our 2000 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement to be filed pursuant to Regulation
14A of the Exchange Act for our 2000 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement to be filed pursuant to Regulation
14A of the Exchange Act for our 2000 Annual Meeting of Stockholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
(1) Financial Statements are listed in the Index to Consolidated Financial
Statements on page F-1 of this Report.
(2) Financial Statement Schedules: Schedule II, Valuation and Qualifying
Accounts is set forth on page S-2 of this Report.
(b) REPORTS ON FORM 8-K.
Not applicable.
28
(C) EXHIBITS
EXHIBIT
NUMBER EXHIBIT
- ------ -------
3.1 Amended Certificate of Incorporation of the Registrant(l)
3.2 Amended and Restated Bylaws of the Registrant(l)
4.1 Form of Certificate representing shares of Common Stock, par value $.001
per share(1)
4.2 Form of Underwriter's Warrant(l)
4.3 Common Stock Purchase Warrant dated February 22, 1999, issued to
Continental Capital & Equity Corporation
10.2 Security Agreement dated as of April 11, 1994 between Vodavi
Communications Systems, Inc. and General Electric Capital Corporation(l)
10.3 Stock Pledge and Security Agreement dated as of April 11, 1994 between
the Registrant and General Electric Capital Corporation(l)
10.7 Patent Collateral Assignment Agreement dated as of April 11, 1994
between V Technology Acquisition Corp. and General Electric Capital
Corporation(l)
10.8 Trademark Security Agreement dated as of April 11, 1994 between V
Technology Acquisition Corp. and General Electric Capital Corporation(l)
10.9 Vodavi Technology, Inc. Second Amended and Restated 1994 Stock Option
Plan(8)
10.10 Stockholders' Agreement among the Registrant, V Technology Holdings
Corp., GoldStar Telecommunication Co., Ltd., The Sherman Group, The
Opportunity Fund, Steven A. Sherman, and Glenn R. Fitchet, dated March
28, 1994, and Amendment Agreement dated April 5, 1995(1)
10.12 Vodavi Key System Agreement dated April 4, 1994 between GoldStar
Telecommunication Co., Ltd., and Vodavi Communication Systems, a
division of Executone Information Systems, Inc.(l)
10.13 Vodavi Single Line Telephone Agreement dated April 4,1994 between
Srithai GoldStar Co., Ltd., and Vodavi Communication Systems, Inc., a
division of Executone Information Systems, Inc.(l)
10.13A Vodavi Single Line Telephone Agreement Extension dated April 4, 1997
between Vodavi Communications Systems, Inc. and L.G. Srithai Electronics
Co., Ltd.(2)
10.15 Assignment and Assumption Agreement dated April 11, 1994 between
Executone Information Systems, Inc. and V Technology Acquisition
Corp.(l)
10.19 OEM Agreement dated as of June 19, 1995, between Tecom Co., Ltd. and
Vodavi Communications Systems, Inc.(3)
10.21 Master Lease Agreement dated May 31, 1996, between Matrix Funding
Corporation and Vodavi Communications Systems, Inc.(4)
10.22 Master Lease Agreement dated October 7, 1996, between Matrix Funding
Corporation and Vodavi Communications Systems, Inc.(5)
10.23 Amended and Restated Credit Agreement dated as of April 11, 1994 between
Vodavi Communications Systems, Inc. and General Electric Capital
Corporation, as Amended and Restated as of June 11, 1997(2)
10.24 First Amendment to Stock Pledge and Security Agreement dated as of June
11, 1997, between Vodavi Technology, Inc. and General Electric Capital
Corporation(2)
10.25 Security Agreement dated as of June 11, 1997 between Enhanced Systems,
Inc. and General Electric Capital Corporation(2)
10.26 Security Agreement dated as of June 11, 1997 between Arizona Repair
Services, Inc. and General Electric Capital Corporation(2)
10.27 Guaranty Agreement dated as of June 11, 1997, by and among Arizona
Repair Services, Inc., Enhanced Systems, Inc., and General Electric
Capital Corporation(2)
10.28 Trademark Security Agreement, dated as of June 11, 1997, by and between
Vodavi Communications Systems, Inc. and General Electric Capital
Corporation(2)
10.29 Trademark Security Agreement dated as of June 11, 1997, by and between
Enhanced Systems, Inc. and General Electric Capital Corporation(2)
10.31 OEM Agreement dated August 15, 1997 between Vodavi Communications
Systems, Inc. and Fujitsu Business Communication Systems, Inc.(6)
29
10.32 OEM Purchase Agreement dated as of April 11, 1997, between Santa Barbara
Connected Systems Corporation and Enhanced Systems, Inc.(8)
10.33 Consulting Agreement dated as of December 5, 1997 between Vodavi
Technology, Inc. and Steven A. Sherman(8)
10.34 Bill of Sale and Assignment dated June 24, 1999, between Vodavi
Communications Systems, Inc. and Aztec International LLC.(9)
10.35 Repair and Refurbishment Agreement dated June 24, 1999, between Vodavi
Communication Systems, Inc. and Aztec International LLC(9)
10.36 License Agreement dated May 17, 1999, between Santa Barbara Connected
Systems Corporation and Vodavi Technology, Inc.(9)
10.37 Object Code Software License Agreement dated May 24, 1999, between D2
Technologies, Inc. and Vodavi Technology, Inc.(9)
10.38 Fourth Amendment to Credit Agreement between Vodavi Communications
Systems, Inc. and General Electric Capital Corporation(10)
10.39 Stock Option Agreement dated February 20, 1998, between Vodavi
Technology, Inc. and Larry L. Steinmetz(11)
10.40 Employment Agreement dated October 1, 1999, between William J. Hinz and
Vodavi Technology, Inc.
10.41 Employment Agreement dated October 1, 1999, between Gregory K. Roeper
and Vodavi Technology, Inc.
10.42 Second Amendment to Amended and Restated Credit Agreement dated October
31, 1999, between Vodavi Communications Systems, Inc. and General
Electric Capital Corporation
21 List of Subsidiaries
23.1 Consent of Arthur Andersen LLP
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule
- ----------
(1) Incorporated by reference to Registration Statement on Form S-1 (No.
33-95926) and amendments thereto which became effective on October 6, 1995.
(2) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1997, as filed on August 11, 1997.
(3) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995, as filed on April 1, 1996.
(4) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1996, as filed on August 14, 1996.
(5) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1996, as filed on November 14, 1996.
(6) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1997, as filed on November 14, 1997.
(7) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1996, as filed on March 28, 1997.
(8) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1997, as filed on March 31, 1998 and
as amended on Form 10-K/A filed on April 30, 1998.
(9) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1999, as filed on August 16, 1999.
(10) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1999, as filed on November 12, 1999.
(11) Incorporated by reference to the Registration Statement on Form S-8 (No.
333-95607) as filed on January 28, 2000.
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
VODAVI TECHNOLOGY, INC.
Date: March 23, 2000 By: /s/ Gregory K. Roeper
-------------------------------------
Gregory K. Roeper
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ William J. Hinz Chairman of the Board March 23, 2000
- ----------------------------
William J. Hinz
/s/ Gregory K. Roeper President, Chief Executive March 23, 2000
- ---------------------------- Officer, and Director
Gregory K. Roeper (Principal Executive Officer)
/s/ Tammy M. Powers Vice President - Finance, Chief March 23, 2000
- ---------------------------- Financial Officer, and Treasurer
Tammy M. Powers (Principal Financial and
Accounting Officer)
/s/ J. H. Bae Director March 23, 2000
- ----------------------------
J. H. Bae
/s/ Gilbert H. Engels Director March 23, 2000
- ----------------------------
Gilbert H. Engels
/s/ Stephen A McConnell Director March 23, 2000
- ----------------------------
Stephen A McConnell
/s/ Emmett E. Mitchell Director March 23, 2000
- ----------------------------
Emmett E. Mitchell
31
VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Public Accountants ................................. F-2
Consolidated Balance Sheets as of December 31, 1998 and 1999 ............. F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1997, 1998, and 1999 ..................................... F-4
Consolidated Statements of Changes in Stockholders' Equity for
the Years Ended December 31, 1997, 1998, and 1999 ..................... F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1998, and 1999 ..................................... F-6
Notes to Consolidated Financial Statements ............................... F-7
Report of Independent Public Accountants ................................. S-1
Schedule II, Valuation and Qualifying Accounts ............................S-2
F-1
ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Vodavi Technology, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of VODAVI
TECHNOLOGY, INC. (a Delaware corporation) AND SUBSIDIARIES (the Company) as of
December 31, 1998 and 1999, and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1999. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audits to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes 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 the Company as of December 31,
1998 and 1999 and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1999, in conformity with
accounting principles generally accepted in the United States.
/s/ Arthur Andersen LLP
Phoenix, Arizona,
February 10, 2000, (except with
respect to the matters discussed
in Note 10, as to which the date
is February 16, 2000.)
F-2
VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
IN THOUSANDS EXCEPT SHARE AMOUNTS
December 31,
------------------------
1998 1999
-------- --------
ASSETS
CURRENT ASSETS:
Cash $ 796 $ 1,528
Accounts receivable, net of reserve for
doubtful accounts and sales returns of
$674 in 1998 and $1,239 in 1999 8,888 10,530
Inventories 6,385 6,550
Prepaid expenses and other 697 1,037
-------- --------
Total current assets 16,766 19,645
PROPERTY AND EQUIPMENT, net 2,663 2,356
GOODWILL, net 2,244 1,906
OTHER LONG-TERM ASSETS, net 1,169 1,307
-------- --------
$ 22,842 $ 25,214
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 2,321 $ 1,342
Accrued liabilities 1,370 1,074
Accrued rebates 483 472
Payable to related parties 34 1,648
Revolving credit facility 7,711 8,672
Long-term debt 125 --
-------- --------
Total current liabilities 12,044 13,208
-------- --------
OTHER LONG-TERM OBLIGATIONS 199 186
-------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, 1,000,000
shares authorized, no shares issued -- --
Common stock, $.001 par value, 10,000,000
shares authorized; 4,342,238 shares issued;
4,342,238 and 4,325,438 shares outstanding
at December 31, 1998 and 1999, respectively 4 4
Additional paid-in capital 12,308 12,334
Accumulated deficit (1,713) (473)
Treasury stock, at cost, 16,800 shares -- (45)
-------- --------
10,599 11,820
-------- --------
$ 22,842 $ 25,214
======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
F-3
VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
IN THOUSANDS EXCEPT PER SHARE AMOUNTS
Years Ended December 31,
---------------------------------
1997 1998 1999
-------- -------- --------
REVENUE, net $ 47,675 $ 47,983 $ 49,662
COSTS OF GOODS SOLD (including
products acquired from related
parties (LGIC) of $17.8 million,
$18.0 million, and $18.8 million,
respectively) 32,008 32,124 31,707
-------- -------- --------
Gross margin 15,667 15,859 17,955
OPERATING EXPENSES:
Engineering and product development 2,101 1,616 1,352
Selling, general and administrative 11,727 12,799 13,969
Restructuring charge 819 -- --
-------- -------- --------
OPERATING INCOME 1,020 1,444 2,634
INTEREST EXPENSE 663 791 676
-------- -------- --------
INCOME BEFORE INCOME TAXES 357 653 1,958
PROVISION FOR (BENEFIT FROM)
INCOME TAXES 142 (330) 718
-------- -------- --------
NET INCOME $ 215 $ 983 $ 1,240
======== ======== ========
BASIC EARNINGS PER SHARE $ .05 $ .23 $ .29
======== ======== ========
DILUTED EARNINGS PER SHARE $ .05 $ .23 $ .29
======== ======== ========
WEIGHTED AVERAGE SHARES
OUTSTANDING - BASIC 4,342 4,342 4,340
======== ======== ========
WEIGHTED AVERAGE SHARES
OUTSTANDING - DILUTED 4,342 4,342 4,344
======== ======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
F-4
VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
IN THOUSANDS EXCEPT SHARE AMOUNTS
Common Stock Additional Treasury Stock
----------------- Paid-In ------------------- Accumulated
Shares Amount Capital Shares Value Deficit Total
------ ------ ------- ------ ----- ------- -----
BALANCE, December 31, 1996 4,342,238 $ 4 $12,308 -- $ -- $(2,911) $ 9,401
Net income -- - -- -- -- 215 215
--------- ---- ------- ------- -------- ------- --------
BALANCE, December 31, 1997 4,342,238 4 12,308 -- -- (2,696) 9,616
Net income -- - -- -- -- 983 983
--------- ---- ------- ------- -------- ------- --------
BALANCE, December 31, 1998 4,342,238 4 12,308 -- -- (1,713) 10,599
Net income -- - -- -- -- 1,240 1,240
Purchase of common stock -- - -- (16,800) (45) -- (45)
Warrants issued -- - 26 -- -- -- 26
--------- ---- ------- ------- -------- ------- --------
BALANCE, December 31, 1999 4,342,238 $ 4 $12,334 (16,800) $ (45) $ (473) $ 11,820
========= ==== ======= ======= ======== ======= ========
The accompanying notes are an integral part of
these consolidated financial statements.
F-5
VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
IN THOUSANDS
Years Ended December 31,
-------------------------------
1997 1998 1999
------- ------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 215 $ 983 $ 1,240
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 750 765 830
Asset impairment 408 -- --
Rent equalization 44 17 (13)
Loss on sale of repair center division -- -- 86
Changes in working capital:
Accounts receivable, net (1,944) 794 (1,529)
Inventories (1,137) 1,901 (407)
Prepaid expenses and other (352) 209 (338)
Other long-term assets (451) (56) 300
Accounts payable and payables to related parties (144) (1,965) 635
Accrued liabilities and accrued rebates (199) (562) (307)
------- ------- -------
Net cash flows provided by (used in)
operating activities (2,810) 2,086 497
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for license agreement -- -- (500)
Cash paid to acquire property and equipment (577) (629) (387)
Proceeds from disposition of repair center division -- -- 331
Accrued acquisition costs paid (36) -- --
------- ------- -------
Net cash flows used in investing activities (613) (629) (556)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (payments) on revolving credit facility 3,242 (917) 961
Payments on capital leases (260) (378) (125)
Purchase of common stock -- -- (45)
Financing costs paid (77) -- --
------- ------- -------
Net cash flows provided by (used in)
financing activities 2,905 (1,295) 791
------- ------- -------
CHANGE IN CASH (518) 162 732
CASH, beginning of period 1,152 634 796
------- ------- -------
CASH, end of period $ 634 $ 796 $ 1,528
======= ======= =======
The accompanying notes are an integral part of
these consolidated financial statements.
F-6
VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
Vodavi Technology, Inc. (the Company), a Delaware corporation, designs,
develops, markets, and supports a broad range of business telecommunications
solutions, including digital telephone systems, voice processing systems, and
computer-telephony products for a wide variety of business applications. The
Company markets its products primarily in the United States as well as in
foreign countries through a distribution network consisting of wholesale
distributors, direct dealers, and its own sales personnel. The Company's sales
efforts have been concentrated on major wholesale distributors as well as a
direct dealer network. During 1997, 1998, and 1999, sales to the Company's
largest distributor accounted for 40%, 39%, and 41% of total revenues,
respectively. During 1997, 1998, and 1999, sales to the Company's second largest
customer accounted for an additional 10%, 12%, and 11% respectively. Accounts
receivable from these two largest distributors comprise 43% of total accounts
receivable for both December 31, 1998 and 1999, respectively.
The Company currently obtains most of its products from manufacturers located in
South Korea, Thailand, Taiwan, and the People's Republic of China. While the
Company believes that production of its product lines overseas enhances its
profitability, these arrangements expose the Company to certain economic and
political risks. Certain of these purchases are made from related parties (See
Note 8).
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries Vodavi Communication Systems, Inc. (VCS), and
Vodavi-CT, Inc. (Vodavi-CT), formerly known as Enhanced Systems, Inc. (together
referred to as the Company). All material intercompany transactions have been
eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires the Company's 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 revenue and expenses during the
reporting period. Actual results could differ from those estimates.
F-7
INVENTORIES
Inventories consist primarily of purchased products from manufacturers and are
stated at the lower of cost (first-in, first-out method) or market. For these
items, the Company takes title to products when they are finished goods. The
tooling and manufacturing equipment included within property and equipment below
is owned by the Company and used by third party manufacturers.
IMPAIRMENT OF LONG-LIVED ASSETS
Statement of Financial Accounting Standards (SFAS) No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF,
requires that long-lived assets be reviewed for impairment whenever events or
circumstances indicate that the carrying amount of the assets may not be
recoverable. If the sum of the expected future cash flows (undiscounted and
without interest charges) from an asset to be held and used in operations is
less than the carrying value of the asset, an impairment loss must be recognized
in the amount of the difference between the carrying value and the fair value.
Assets to be disposed of must be valued at the lower of carrying value or fair
value less costs to sell.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is computed using the
straight-line method. Property and equipment and the related useful lives
consist of the following as of December 31, 1998 and 1999, respectively:
Useful Life
Type of Asset in Years 1998 1999
------------- -------- ---- ----
IN THOUSANDS
Office and computer equipment 5 $ 2,185 $ 2,423
Furniture and fixtures 10 339 345
Tooling and manufacturing equipment 5-8 1,725 1,636
Property and equipment in progress -- 42 85
------- -------
4,291 4,489
Less - accumulated depreciation (1,628) (2,133)
------- -------
$ 2,663 $ 2,356
======= =======
Property and equipment in progress relates to assets under development that have
not yet been placed in service. Depreciation expense was $482,000, $582,000, and
$604,000, for December 31, 1997, 1998, and 1999, respectively.
F-8
GOODWILL
Goodwill represents the cost in excess of the estimated fair values of tangible
assets and liabilities acquired. Goodwill is being amortized on the
straight-line method over 20 years. Amortization expense was $151,000, $151,000,
and $141,000, for December 31, 1997, 1998, and 1999, respectively. Accumulated
amortization was $697,000 and $769,000 at December 31, 1998 and 1999,
respectively.
OTHER LONG TERM ASSETS
Included in other long-term assets is a licensing agreement the Company entered
into in 1999 to acquire the licensing and manufacturing rights to certain
product lines for $500,000. This agreement is being amortized, in accordance
with SFAS No. 86, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE TO BE SOLD,
LEASED, OR OTHERWISE MARKETED, utilizing a useful life of three years.
Amortization expense for 1999 was $42,000.
The remaining balance in other long term assets is comprised of deferred tax
assets and various development costs which are being amortized over their
remaining useful lives.
INCOME TAXES
The Company utilizes the liability method of accounting for income taxes as set
forth in SFAS No. 109, ACCOUNTING FOR INCOME TAXES. Under the liability method,
deferred taxes are provided based on the temporary differences between the
financial reporting basis and the tax basis of the Company's assets and
liabilities.
REVENUE RECOGNITION
Revenue from product sales, net of an allowance for product returns, is
recognized upon shipment to the customer. Revenue from custom software is
recognized upon substantial completion of the Company's obligation. Revenue from
extended maintenance contracts is recognized over the lives of the respective
contracts, generally twelve months.
EARNINGS PER SHARE
In accordance with SFAS No. 128, EARNINGS PER SHARE, the Company displays basic
and diluted earnings per share (EPS). Basic EPS is determined by dividing net
income by the weighted average number of common shares outstanding. The basic
weighted average number of common shares outstanding excludes all dilutive
securities. Diluted EPS is determined by dividing net income by the weighted
average number of common shares and dilutive securities outstanding. No dilutive
securities were included in the diluted EPS calculation for each of the years
ended December 31, 1997 and 1998, as all outstanding dilutive securities were
out of the money.
F-9
A reconciliation of the numerator and denominator (weighted average number of
shares outstanding) of the basic and diluted EPS computation for the year ended
December 31, 1999, is as follows:
Income Shares
(numerator) (denominator) EPS
----------- ------------- ---
Basic EPS $1,240,000 4,339,966 $0.29
Effect of stock options -- 4,037 --
---------- ---------- -----
Diluted EPS $1,240,000 4,344,003 $0.29
========== ========== =====
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is
made in accordance with the requirements of SFAS No. 107, DISCLOSURES ABOUT FAIR
VALUE OF FINANCIAL INSTRUMENTS.
The carrying value of cash, accounts receivable, accounts payable, payable to
related parties, and accrued liabilities approximate fair values due to the
short-term maturities of these instruments. As the revolving credit facility
bears a variable interest rate at 2.5% over the 30-day commercial paper rate,
the carrying value approximates fair value.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1998, the Company adopted SFAS No. 131, DISCLOSURES ABOUT
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, which established revised
standards for the reporting of financial and descriptive information about
operating segments in financial statements.
The Company has determined that it operates in one reportable segment, the
distribution of telecommunications equipment. The Company has three product
categories - telephony, voice processing, and computer-telephony; however, each
of these does not meet the segment criteria for SFAS No. 131.
As a result of the foregoing, the Company has determined that it is appropriate
to present one reportable segment consistent with the guidance of SFAS No. 131.
Accordingly, the Company has not presented separate financial information for
each product category as the Company's consolidated financial statements present
its one reportable segment.
2. RESTRUCTURING CHARGE
Included in accrued liabilities at December 31, 1998 and 1999 are $94,000 and
$0, respectively, for restructuring, legal, and other reserve charges
established during 1996 and 1997. $592,000, $608,000, and $94,000 was charged
against these reserves during 1997, 1998, and 1999, respectively.
F-10
3. REVOLVING CREDIT FACILITY
As of December 31, 1999, the Company maintains a $15.0 million revolving credit
facility with a financial institution. Borrowings under the facility, which are
based on inventory and accounts receivable, carry interest payable monthly at a
variable rate based on commercial paper plus 2.5% (7.8% and 8.05% at December
31, 1998 and 1999, respectively). The credit facility expires in April 2003 and
is secured by substantially all of the Company's assets. At December 31, 1999,
$8.7 million was outstanding on the revolving credit facility and $2.5 million
was the total eligible availability.
The credit agreement contains certain financial covenants that are customary for
similar credit facilities and also prohibits the Company's operating
subsidiaries from paying dividends to the Company without the consent of the
financial institution. At December 31, 1999, the Company was in compliance with
these covenants.
4. LONG-TERM DEBT
During 1997, the Company entered into several capital lease agreements with
interest rates ranging from 9% to 13%. These agreements had terms of 24 months
and provided the Company with an option to purchase the equipment for a nominal
amount at the end of the lease term. The remaining balance of $125,000 at
December 31, 1998 was paid and the equipment was acquired during 1999.
5. COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS
On November 9, 1998, Paradygm Communications, Inc. (Paradygm) and R.C. Patel
(Patel) filed a lawsuit against the Company's wholly owned subsidiary VCS in the
Superior Court of Gwinnett County, Georgia (Case No. 98-A-8744-6). The complaint
alleges that VCS (i) breached its strategic alliance agreement with Paradygm, as
well as its warranty of product fitness under the strategic alliance agreement;
(ii) failed to provide reasonable technical and sales training assistance to
Paradygm's employees to support Paradygm in its efforts to sell products under
the agreement; and (iii) engaged in conduct that constitutes intentional or
negligent misrepresentation. The complaint requests compensatory, punitive,
incidental, and consequential damages, attorneys' fees, plus any additional
relief. VCS answered the complaint denying the foregoing allegations, asserting
that the complaint fails to state a claim and, for various reasons, the relief
sought by Paradygm and Patel is barred. VCS also has filed a counterclaim
against Paradygm alleging that Pardygm breached the agreement because of its
failure to meet its payment obligations to VCS. The counterclaim requests
amounts due pursuant to the strategic alliance agreement, the costs of
litigation, and reasonable attorneys' fees.
On December 21, 1998, the case was removed from the Superior Court to the United
States District Court for the Northern District of Georgia - Atlanta Division.
On March 24, 1999, the plaintiffs filed an amended complaint to add the
Company's subsidiary Vodavi-CT as an
F-11
additional defendant. The amended complaint alleges claims against Vodavi-CT
similar to those alleged in the original complaint. On July 28, 1999, Vodavi-CT
filed an answer and denied those allegations on the same basis as VCS' original
answer. The parties currently are conducting discovery.
The Company is vigorously defending this lawsuit. As the Company can not
reasonably estimate any potential ultimate exposure with respect to this matter,
no provision has been made in its financial statements.
OPERATING LEASES
The Company has entered into long-term lease agreements for all of its office
and warehouse facilities. Minimum payments under the Company's lease agreements
are as follows:
Years Ending December 31, Operating
IN THOUSANDS Leases
---------
2000 $ 1,165
2001 1,206
2002 317
2003 179
2004 179
-------
Total minimum lease committments 3,046
Total minimum noncancelable sublease rentals (912)
-------
$ 2,134
=======
Rent expense is recognized on a straight-line basis and was $1,107,000,
$1,107,000, and $1,112,000 for the years ended December 31, 1997, 1998, and
1999, respectively. The difference between rent expensed and paid is included in
other long-term obligations.
ROYALTIES
VCS acquires certain proprietary components from a third party under the terms
of a license agreement which expires in 2014. Under the terms of the agreement,
VCS will pay a 5.3% royalty over the manufactured cost of all products utilizing
the proprietary components. Total royalties related to this agreement were
$449,000, $264,000, and $161,000 in 1997, 1998, and 1999, respectively. The
Company has discontinued manufacturing the line of products that use this
licensed technology and anticipates that the remaining products in inventory
will be sold over the next 18 months.
401(k) PROFIT SHARING PLAN
The Company sponsors a profit sharing plan (the 401(k) Plan) pursuant to Section
401(k) of the Internal Revenue Code of 1986. The 401(k) Plan covers
substantially all full-time employees who meet the eligibility requirements and
provides for a discretionary profit sharing contribution by the Company and an
employee elective contribution with a discretionary
F-12
Company matching provision. The Company expensed discretionary contributions
pursuant to the 401(k) Plan in the amounts of $75,000, $70,000, and $68,000 for
the years ended December 31, 1997, 1998, and 1999, respectively.
6. STOCKHOLDERS' EQUITY
TREASURY STOCK
In the fourth quarter of 1999, the Company began acquiring shares of its common
stock in connection with a stock repurchase program authorized by the Company's
Board of Directors in October 1999. That program authorizes the Company to
purchase up to 400,000 common shares over a six-month period on the open market
or pursuant to negotiated transactions at price levels the Company deems
attractive. The Company purchased 16,800 shares of common stock in 1999 at an
aggregate cost of $45,000.
WARRANTS
In connection with the initial public offering, the Company sold to its
underwriter warrants to purchase up to 133,333 shares of its common stock at a
price of $7.20 per share. The warrants are exercisable during a four-year period
commencing on October 12, 1996.
Pursuant to a marketing agreement with its investor relations firm, on February
22, 1999, the Company issued warrants for 122,500 shares of the Company's common
stock at prices between $4.00-$6.50 per share. The Company valued these warrants
at $26,000 utilizing the Black-Scholes option pricing model. This amount is
being amortized over a 12-month period. The warrants are exercisable for a
five-year period commencing on February 22, 1999, subject to earlier expiration
six months from the date of termination of the investor relations firm under the
agreement. Piggyback registration rights were granted for the common shares
underlying these warrants.
OTHER OPTIONS
Pursuant to a separation agreement, on February 20, 1998, the Company issued
options for 58,750 shares of the Company's common stock at $4.00 per share. The
options are exercisable for a five year period commencing on February 20, 1998.
VODAVI TECHNOLOGY, INC. 1994 STOCK OPTION PLAN
The Vodavi Technology, Inc. 1994 Stock Option Plan (the Plan), as amended,
provides for the granting of (a) options to purchase shares of the Company's
common stock, (b) stock appreciation rights, (c) shares of the Company's common
stock, or (d) other cash awards related to the value of the Company's common
stock. Under the Plan, options and other awards may be issued to key personnel
of the Company. The options issued may be incentive stock options or
nonqualified stock options. The Plan also includes an automatic program under
which
F-13
nonqualified options are automatically granted to the Company's non-employee
directors. If any options terminate or expire without having been exercised in
full, the stock underlying such options will again be available for grant under
the Plan. A total of 850,000 shares of common stock may be issued under the
Plan. The Plan expires in 2004.
To the extent that granted options are incentive stock options, the terms and
conditions of those options must be consistent with the qualification
requirements set forth in Section 422 of the Internal Revenue Code of 1986.
The maximum number of shares of common stock that can be granted to any one
employee, including officers, during the term of the Plan may not exceed 50% of
the shares of common stock covered by the Plan.
The expiration date, maximum number of shares purchasable, and the other
provisions of the options are established at the time of grant. Options may be
granted for terms of up to ten years and become exercisable in whole or in one
or more installments at such time as may be determined by the plan administrator
upon grant of the options. The exercise prices of options are determined by the
plan administrator, but may not be less than 100% (110% if the option is granted
to a stockholder who at the time the option is granted owns stock representing
more than ten percent of the total combined voting power of all classes of the
Company's stock) of the fair market value of the common stock at the time of the
grant.
The following summarizes activity under the Plan for the years ended:
December 31, 1997 December 31, 1998 December 31, 1999
-------------------- ----------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Number Exercise Number Exercise
of Options Price of Options Price of Options Price
---------- ----- ---------- ----- ---------- -----
Options outstanding at
beginning of period: 498,500 $5.08 816,900 $ 4.80 592,400 $ 4.88
Granted 380,600 4.45 157,500 3.90 267,500 2.62
Forfeited (62,200) 5.13 (382,000) 4.42 (80,100) 4.95
-------- ----- --------- -------- -------- -------
Options outstanding
at end of period 816,900 $4.80 592,400 $ 4.88 779,800 $ 4.03
======== ===== ========= ======== ======== =======
Options available
for grant 33,100 257,600 70,200
======== ========= ========
Exercisable at end
of period 178,125 $4.00 327,325 $ 4.99 384,100 $ 4.83
======== ===== ========= ======== ======== =======
Weighted average fair
value of options granted $ 2.93 $ 2.43 $ 1.69
======== ========= ========
F-14
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- ----------------------------
Weighted-
Average Weighted- Weighted-
Number Remaining Average Number Average
RANGE OF Outstanding at Contractual Exercise Exercisable at Exercise
EXERCISE PRICES December 31, 1999 Life (in years) Price December 31, 1999 Price
- --------------- ----------------- --------------- ----- ----------------- -----
$2.375 - $4.25 545,000 7.9 $3.31 195,000 $3.94
$4.625 - $7.00 234,800 5.4 $5.68 189,100 $5.74
------- -------
$2.375 - $7.00 779,800 7.1 $4.03 384,100 $4.83
======= =======
The Company has elected to account for its stock-based compensation plans under
APB Opinion (APB) No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. Accordingly,
no compensation cost is recognized in the accompanying financial statements for
stock-based employee awards. Entities electing to remain with the accounting in
APB No. 25 must make pro forma disclosures of net income and earnings per share,
as if the fair value based method of accounting defined in SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION had been applied. The Company has
computed, for pro forma disclosure purposes, the value of all options granted
during 1997, 1998, and 1999, using the Black-Scholes option pricing model with
the following weighted average assumptions:
Year Ended December 31,
---------------------------------
1997 1998 1999
---- ---- ----
Risk free interest rate 6.16% 5.50% 5.23%
Expected dividends none none none
Expected lives in years 5 5 4.8
Expected volatility 62.47% 70.09% 71.62%
If the Company had accounted for its stock-based compensation plan using a fair
value based method of accounting, the Company's net income (loss) and earnings
(loss) per share would have been reported as follows:
Year Ended December 31,
---------------------------------
1997 1998 1999
---- ---- ----
IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
Net income (loss):
Pro forma $(150) $806 $1,035
Earnings (loss) per share:
Pro forma - Basic $(.03) $.19 $ .24
Pro forma - Diluted (.03) .19 .24
F-15
7. INCOME TAXES
The Company files a consolidated federal income tax return. The income tax
provision (benefit) is comprised of the following:
1997 1998 1999
----- ----- -----
IN THOUSANDS
Current $ 203 $(167) $ 808
Deferred (61) (163) (90)
----- ----- -----
$ 142 $(330) $ 718
===== ===== =====
The Company provides for deferred income taxes resulting from temporary
differences between amounts reported for financial accounting and income tax
purposes. The components of the net deferred income tax asset at December 31,
1998 and 1999, were as follows:
1998 1999
------ ------
Deferred tax assets:
IN THOUSANDS
Inventory and receivable reserves $ 375 $ 363
UNICAP adjustment 87 88
Other accruals 256 255
Research and development credit 326 219
------ ------
1,044 925
------ ------
Deferred tax liabilities:
IN THOUSANDS
Depreciation differences (264) (300)
Amortization differences (37) (44)
------ ------
(301) (344)
------ ------
Net deferred tax asset $ 743 $ 581
====== ======
Reconciliation of the federal income tax rate to the Company's effective income
tax rate is as follows:
1997 1998 1999
----- ----- -----
Federal statutory tax rate 34.0% 34.0% 34.0%
State taxes, net 4.6 4.6 3.0
Research and development tax credits (10.8) (93.4) (10.0)
Non-deductible expenses and
other permanent differences 12.0 4.3 9.7
----- ----- -----
39.8% (50.5)% 36.7%
===== ===== =====
F-16
In 1997, the Company recorded $100,000 in research and development tax credits
made available through filing amended tax returns for prior years.
In 1998, the Company finalized its research and development tax credit analysis
and identified $509,000 in available tax credits. $183,000 in research and
development tax credits were utilized through carrybacks to prior years and
application to the 1998 tax returns. In addition, a deferred tax asset of
$326,000 was recorded.
The Company has estimated that it generated $135,000 in research and development
tax credits during 1999. The Company will finalize this analysis prior to filing
its 1999 tax returns. The realization of these deferred tax assets will depend
on future income. The Company believes that operating income will more likely
than not be sufficient to fully realize the net deferred tax asset of $581,000.
8. RELATED PARTIES TRANSACTIONS
LG Information and Communications, Ltd. (LGIC), the Company's principal
supplier, owned approximately 18.8% of the Company's outstanding common stock at
December 31, 1999. The Company purchased approximately $18.8 million, $16.3
million, and $18.4 million of key telephone systems, commercial grade
telephones, and voice mail products from LGIC and an affiliate of LGIC during
1997, 1998, and 1999, respectively. Management believes that the purchases from
LGIC and its affiliate approximate terms which would be charged to non-related
parties.
9. SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest and income taxes for the years ended December 31, 1997,
1998, and 1999 were as follows:
1997 1998 1999
---- ---- ----
IN THOUSANDS
Interest paid $663 $791 $676
Income taxes paid $630 $ 58 $677
On June 24, 1999, the Company sold its repair center division's net inventory,
property, and other assets with a net book value of $531,000. The buyer paid
consideration of $100,000 cash, a note receivable of $200,000 that the buyer
paid on July 31, 1999, and a note receivable of $195,000 with monthly payments
of $16,000 for twelve months commencing August 1, 1999. This note was current at
December 31, 1999. The Company also incurred liabilities of $50,000 in
connection with this transaction, which were paid in the fourth quarter of 1999.
The Company recorded a loss of $86,000 in connection with the sale. As part of
this transaction, the Company entered into a seven-year repair and refurbishment
agreement with the buyer. Under this agreement, the Company appointed the buyer
as the exclusive authorized repair center for the Company's products.
F-17
Supplemental schedule of non-cash investing and financing activities for
the sale of the repair center division is as follows:
IN THOUSANDS
Carrying amount of net assets sold $ 531
Notes receivable from buyer (114)
Loss on sale (86)
-----
Cash proceeds from disposition of repair center division $ 331
=====
The Company also issued warrants to an investor relations firm during 1999,
which were valued utilizing the Black-Scholes option pricing model. This
calculation resulted in a value of $26,000, which is being amortized over twelve
months.
10. SUBSEQUENT EVENTS
SETTLEMENT OF LAWSUIT
In January 2000, the Company finalized a settlement agreement with the former
owners of Vodavi-CT, (formerly Enhanced Systems, Inc.). The settlement ends a
three-year dispute between the Company and the former owners of Vodavi-CT. In
connection with this settlement, the Company repurchased 210,000 shares of the
Company's common stock for $500,000 from the former owners of Vodavi-CT. This
repurchase represents treasury stock and is being accounted for under the
program authorized by the Company's Board of Directors in October 1999 (See Note
6).
LITIGATION FILED SUBSEQUENT TO DATE OF FINANCIAL STATEMENTS
On February 16, 2000, the former owners of Vodavi-CT filed suit in the United
States District Court for the Northern District of Georgia, Atlanta Division
against the Company and the Company's President and Chief Executive Officer. The
plaintiffs allege that the Company and its President violated federal securities
laws, made false representations and omitted material facts, and breached
fiduciary duties to the plaintiffs in connection with the repurchase of their
shares of the Company's common stock in the settlement described above. The
plaintiffs are seeking an unspecified amount of compensatory and punitive
damages as well as their expenses of litigation. The Company intends to
vigorously defend this lawsuit.
F-18
ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Vodavi Technology, Inc. and Subsidiaries:
We have audited, in accordance with auditing standards generally accepted in the
United States, the financial statements of VODAVI TECHNOLOGY, INC. AND
SUBSIDIARIES (the Company) included in this Form 10-K, and have issued our
report thereon dated February 10, 2000. Our audit was made for the purpose of
forming an opinion on those statements taken as a whole. The schedule included
at page S-2 is the responsibility of the Company's management and is presented
for purposes of complying with the Securities and Exchange Commission's rules
and is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audit of the basic financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
/s/ Arthur Andersen LLP
Phoenix, Arizona,
February 10, 2000.
S-1
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
For the years ended December 31, 1997, 1998 and 1999
IN THOUSANDS
1997 1998 1999
---- ---- ----
Reserve for doubtful accounts and sales returns:
Balance at beginning of year $ 234 $ 249 $ 674
Provision 83 451 589
Write-offs (68) (26) (24)
----- ----- -------
Balance at end of year $ 249 $ 674 $ 1,239
===== ===== =======
Restructuring reserve :
Balance at beginning of year $ 475 $ 702 $ 94
Provision (a) 411 -- --
Payments (a) (184) (608) (94)
----- ----- -------
Balance at end of year $ 702 $ 94 $ --
===== ===== =======
- ----------
(a) - The difference between the restructuring provision and the amount
reported on the Consolidated Statements of Operations for the year ended
December 31, 1997, represents asset write downs taken in connection with
the restructuring.
S-2