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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, 1998 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
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(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 26, 1999, there were outstanding 4,342,238 shares of the registrant's
Common Stock, $.001 par value. The aggregate market value of Common Stock held
by nonaffiliates of the registrant (2,982,208 shares) based on the closing price
of the Common Stock as reported on the Nasdaq National Market on March 26, 1999,
was $8,201,072. 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 1999 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, 1998
TABLE OF CONTENTS
PAGE
----
PART I
ITEM 1. BUSINESS ...................................................... 1
ITEM 2. PROPERTIES .................................................... 21
ITEM 3. LEGAL PROCEEDINGS.............................................. 22
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.......................................... 23
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA........................... 24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.................................... 25
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..... 29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA..................... 29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE..................................... 29
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............. 29
ITEM 11. EXECUTIVE COMPENSATION......................................... 29
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................... 29
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................. 29
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K..................................................... 30
SIGNATURES.................................................................. 32
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 THE COMPANY'S "EXPECTATIONS," "ANTICIPATION," "INTENTIONS," "BELIEFS,"
OR "STRATEGIES" REGARDING THE FUTURE. FORWARD-LOOKING STATEMENTS ALSO INCLUDE
STATEMENTS REGARDING REVENUE, MARGINS, EXPENSES, AND EARNINGS ANALYSIS FOR
FISCAL 1999 AND THEREAFTER; TECHNOLOGICAL DEVELOPMENTS; FUTURE PRODUCTS OR
PRODUCT DEVELOPMENT; THE COMPANY'S 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 THE COMPANY AS OF THE FILING DATE OF THIS
REPORT, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING
STATEMENTS. THE COMPANY'S 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."
-i-
PART I
ITEM 1. BUSINESS
INTRODUCTION
The Company 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's telephone systems incorporate sophisticated
features, such as automatic call distribution, and its voice processing products
include interactive voice response systems, automated attendant, and voice and
fax mail. The Company's computer-telephony products allow users to combine the
functionality of their telephone system with their computer systems. 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 business strategy includes (i) expanding the Company's
core business of supplying telephone systems, commercial grade telephones, voice
processing systems, and computer-telephony integration ("CTI") products; (ii)
focusing on the integration of existing and newly developed products to provide
complete industry standards-based business communications solutions to its
customers; (iii) pursuing its strategic relationship with LG Information &
Communications, Ltd. ("LGIC"), a member of the multi-billion dollar,
Korean-based LG Group with which the Company has had a long-term relationship;
and (iv) expanding its technological expertise and distribution channels through
business acquisitions, license arrangements and other strategic relationships,
and internal research and development efforts in order to enhance existing
products, introduce new products, and expand product lines.
Unless the context indicates otherwise, all references to the "Company"
refer to Vodavi Technology, Inc., its predecessors and its subsidiaries. The
Company's corporate headquarters are located at 8300 East Raintree Drive,
Scottsdale, Arizona 85260. Effective April 1, 1999, the Company's telephone
number is (480) 443-6000.
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
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 regulatory changes. These factors have resulted in continual development of
full-featured business communications systems designed for use by small- and
medium-sized businesses and 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 (i) voice processing systems, which
automate call answering, provide voice mail and automated call distribution
functions, and provide the capacity to manage facsimile messages; (ii)
interactive voice response, which enables a business to provide its customers
with automated access to the business' database via telephone or the Internet;
and (iii) computer-telephony integration, which greatly enhances efficiency and
productivity by integrating businesses' voice and data networks. Wireless
technologies, computer-telephony integration, expanded use of the Internet, and
other innovations represent significant opportunities for sales of new product
lines and applications to further increase employee mobility and efficiency. The
Company also believes that
1
international sales of voice processing products will increase substantially in
the future as demand for features such as voice mail and interactive voice
response increases.
The following table summarizes the most recent published estimates of
market revenue between 1998 and 2004, compound annual market growth rates, and
average prices for each business communications product category listed.
COMPOUND AVERAGE
1998 2004 ANNUAL PRICE PER
PRODUCT SEGMENT REVENUE(1) REVENUE(1) GROWTH RATE STATION OR PORT
--------------- ---------- ----------- ----------- ---------------
Key Telephone Systems $2,150.0 $2,720.0 4.1% $ 410
Voice Messaging 783.4 3,670.0 14.4 $1,000 - $6,000
Interactive Voice Response 835.8 2,091.3 16.2 $1,320 - $3,730
Wireless PBX/Key
Telephone Systems 202.1 1,340.0 38.8 $1,135
Server/PC-Based PBX 38.8 1,412.0 88.2 $ 200 - $1,100
Internet Protocol Telephony 244.8 3,158.5(2) 132.0 $1,055
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(1) Dollars in millions
(2) Represents projected market revenue for 2002.
PRODUCTS
The Company currently designs, develops, markets, and supports a broad
range of (i) telephony products, which include digital and analog key telephone
systems and commercial grade telephones; (ii) voice processing products,
including interactive voice response systems, automated attendant, automatic
call distribution, voice mail and fax mail, and unified messaging systems; and
(iii) computer-telephony products, including Windows-based application products
(such as PC telephones and attendant consoles), local area network ("LAN") to
PBX connection packages, and Internet messaging systems.
KEY TELEPHONE SYSTEMS
Sales of key telephone systems represented approximately 72.4% and
74.7% of the Company's revenue during 1997 and 1998, respectively. 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."
The Company supplies several models of key telephone sets, several of which are
CTI compatible, with progressive features for use in conjunction with each of
its key telephone systems.
The Company currently markets various lines of key telephone systems,
under its STARPLUS 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). The Company sells the STARPLUS line through large wholesale
distributors and the INFINITE line through telephone sales and installation
companies known as "direct dealers." See Item 1, "Business - Sales, Marketing,
and Distribution." The INFINITE brand telephone systems incorporate the base
platform and software of the STARPLUS Triad key telephone systems, which enables
the Company to leverage its research and development, support, and operational
resources.
The Company markets both digital and analog key telephone systems and
related products. The Company's digital telephone systems employ a digital
architecture in order to provide digital voice transmission and system control,
while the Company's analog telephone systems employ a microprocessor-based
architecture and solid state switching for voice transmission and system
control. Most of the Company's 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. The
Company's telephone systems are fully
2
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. The Company designs its key telephone systems
to readily permit expansion or customization for specific business applications
by installation of a variety of voice processing or computer-telephony
integration products. See Item 1, "Business - Products - Voice Processing
Products" and Item 1, "Business Products - Computer-Telephony Integration
Products."
The Company's 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 or INFINITE systems than to switch to a competitor's system. The
Company believes that the economy and flexibility provided to its customers by
this migration strategy offers a competitive advantage to the Company.
COMMERCIAL GRADE TELEPHONES
The Company markets several models of commercial grade telephones
through wholesale distributors for use with analog or digital key systems, PBX
systems, or telephone company central office ("Centrex") switching systems.
Businesses, school districts, and the hospitality industry represent the
principal purchasers of the Company's commercial grade telephones. Sales of
commercial grade telephones accounted for approximately 15.7% and 11.9% of the
Company's revenue during 1997 and 1998, respectively. All of the Company's
commercial grade telephones meet industry standards for commercial telephone
units and may be used with telephone systems sold by the Company or by competing
manufacturers. The Company's 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. The Company's more advanced commercial grade telephones contain a
central processing unit, built-in memory, built-in data jacks, built-in
speakerphones, and the capability to utilize custom calling features provided by
local telephone companies.
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. The
Company designs its voice processing products to integrate with telephone
systems sold by the Company as well as competing manufacturers and frequently
markets its voice processing products independently of its telephone systems.
The Company, however, cultivates the expansion of its existing base of telephone
systems by offering digitally integrated voice processing systems for its
STARPLUS Triad and INFINITE product lines to differentiate them from its
competitors' products and to provide a value-added basis for increased sales and
profit margins.
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 certain of
the Company's 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 its larger voice processing systems, the Company markets
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 the Company 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. As a result of the increased
functionality, ease of installation and use, and competitive pricing of these
systems, total sales of the Company's voice processing systems increased from
7.5% of the Company's revenue in 1997 to 11.6% of revenue in 1998.
3
ADVANCED MESSAGING PLATFORM
The Company's Microsoft(R) Windows NT-based messaging systems, which
provide 4 to 48 port capacities, combine voice mail functions with facsimile
messaging capabilities ("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. The Company's 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.
The Windows NT-based system also utilizes 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, the Company's 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. The Company's 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.
The Company's Windows NT-based system also utilizes 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 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
The Company's interactive voice response ("IVR") system connects the
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 the Company's 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
The Company markets its automatic call distribution systems software
("ACD") and a PC-based ACD reporting package for use with its digital key
telephone systems. The automatic call distribution functions provided by ACD
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. ACD reduces 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
4
the longest waiting call in order to speed call handling at times of heavy
calling activity. The PC-based ACD reporting package provides real-time
statistics and comprehensive reports on calling activity for review by
management.
COMPUTER-TELEPHONY INTEGRATION PRODUCTS
The Company designs, develops, and markets CTI products that utilize an
open architecture to integrate computer and telephone systems into a
user-friendly information storage, processing, and system. The Company believes
that developing more value-added CTI applications for its telephone systems will
enhance the appeal of its product lines and enable it to sell more key telephone
systems, full-featured telephones, and other software packages and add-on
peripheral products. The Company markets CTI products that enable a user to (i)
utilize the Internet to access voice, facsimile, and e-mail messages via
personal computer; (ii) incorporate telephone functions with computer software
to speed call handling and permit the user to personalize telephone functions;
(iii) identify incoming callers and immediately access computer files relating
to the caller; (iv) connect Windows-based local area networks to the user's
telephone system; and (v) quickly and inexpensively access and analyze call
accounting information.
The Company's CTI product lines include software applications designed
to operate in conjunction with Microsoft(R) Windows operating systems software
in order to unite personal computers and telephones to help business users
better manage their communications and information systems. The Company's
current CTI product lines provide the choice of either (i) a CTI module that
connects one of the Company's digital telephones to the user's PC, or (ii) a CTI
board that slides into the user's PC and replaces the traditional desktop
telephone altogether. The second option includes either a handset or headset
that plugs into the computer terminal for use in private conversations. After
the CTI module or board is installed, the Company's CTI software incorporates
the fixed and flexible feature buttons of the Company's digital telephones (such
as the dial pad, call status display, directory window, and dial display) onto
the computer screen. The user can then access all telephone features, place
calls, and process incoming calls from the computer, or, if a CTI module is
used, the desktop telephone. For instance, the user can click on the directory
icon to access the desired telephone directory, type in the name of the person
to be called, and click on the "dial out" icon to automatically dial the
telephone number. The system also permits the user to answer incoming calls
without having to exit a Windows application. In addition, the Company's CTI
products enable users to customize and enhance message handling efficiency by
using programmable feature buttons to create user-specific functions, such as
conference calling or speed dial numbers; permit users to access voice mail and
activate voice mail options, such as fast-forward, rewind, or delete by using
the mouse, computer keyboard, or telephone keypad; and permit users to create
multiple directories with up to 1,000 names in each directory.
NEW PRODUCT DEVELOPMENT
The Company engages in an ongoing program to develop enhancements to
its existing product lines and to develop new products that address the
increasing demands of business organizations for low-cost productivity enhancing
communications tools. The Company believes that continuous development of new
products and features will be necessary to enable it 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 growth and profitability of the Company on an ongoing
basis. Since 1994, the Company has developed and introduced several new or
enhanced products and product lines, including new ACD reporting packages, a
wireless key telephone adjunct for its digital key telephone systems, additional
enhancements to its Windows NT-based voice messaging systems and its IVR
systems, and a new line of digital key telephone systems.
The Company currently is focusing its new product development efforts
on developing and refining enhancements that will deliver greater features,
sophistication, functionality, and value to its current product offerings. For
example, the Company currently is developing digital voice mail integration, a
new line of commercial grade telephones, and an Internet telephony gateway. In
addition, the Company is focusing research and development efforts on the
integration of existing and newly developed products to provide complete
industry
5
standards-based business communications solutions to its customers. The Company
from time to time enters into strategic alliances with third parties related to
the development of new products, product lines, or product features. See Item 1,
"Business - Research and Development; Strategic Alliances with LGIC and Other
Companies."
SALES, MARKETING, AND DISTRIBUTION
The Company currently markets its 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." The Company also maintains an in-house
sales staff that makes direct sales of its IVR products to businesses. The
Company in the past has and in the future may market its products on a private
label basis to original equipment manufacturers ("OEMs"). The Company derived
approximately 80.3%, 15.8%, 2.5% and 1.0% of its total revenue in 1998 from
sales to distributors, direct dealers, IVR customers, and OEMs, respectively.
The following diagram illustrates the distribution channels for the Company's
product lines.
VODAVI
INFINITE
STARPLUS DIGITAL SYSTEMS IVR INTERNATIONAL(1)
-------- --------------- --- -------------
| | | |
| | | International
Distributor | | Distributor
| | | |
| | | |
Interconnect Dealer | Dealer
| | | |
| | | |
End User End User End User End User
- ----------
(1) The Company currently only sells certain of its voice processing
products in international markets.
WHOLESALE DISTRIBUTORS
The Company designs and markets its STARPLUS brand of products for sale
through wholesale distributors. The distributors resell the Company's products
primarily to small local interconnect companies and independent telephone
companies, which in turn resell the Company's products to end users, install the
systems at the end users' businesses, and provide service and technical support
following the sale. The Company provides ongoing support and training to enable
distributors to sell more effectively the Company's products and to provide the
interconnects and independent telephone companies with technical assistance in
installation, maintenance, and customer support.
The Company believes that sales through distributors offers several
advantages, including (i) established distribution systems and access to a large
number of customer accounts; (ii) maintenance of customer credit facilities and
an established inventory of the Company's products; (iii) availability of
products in over 600 locations throughout the United States; (iv) security of
receivables; (v) reduced needs for direct training by the Company; (vi)
effective promotion of the Company's products at trade shows; (vii)
geographically dispersed sales forces that can reach customers more effectively
than the Company would otherwise be able to do; and (viii) lower support and
carrying costs compared with the costs associated with direct sales to a large
number of direct dealers.
6
During 1998, the Company introduced its STARPLUS 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, wireless, and other products
similar to the Company's INFINITE line of products. The authorized dealers must
commit to minimum purchases of Triad or other STARPLUS products and must be
trained and certified through a formal product and sales training program
conducted by the Company. The Company provides the authorized Triad dealers with
order fulfillment, marketing, sales, and product support services.
Distributors that currently resell the Company's products include
Graybar Electric Co., Inc. ("Graybar"), Alltel Supply, Inc., Sprint/North
Supply, Famous Telephone Supply, ADI, Target, Power & Telephone Supply Company,
GTE Supply Co., Catalyst, Anixter Brothers, Inc., and Capitol. Graybar accounted
for 40% and 39% of sales during 1997 and 1998, respectively. The Company's sales
and marketing personnel stimulate demand for its products with the smaller
interconnects and independent telephone companies that purchase the Company's
products from Graybar and other distributors and install these products at the
end users' premises. These interconnects and independent telephone companies
provide the "pull through" demand for the Company's products from Graybar and
other distributors. As a result, the Company believes that a decrease in
purchases by Graybar or other distributors would result in only a temporary
adverse effect on the Company's operations if interconnects and independent
telephone companies would continue to demand the Company's products from other
distributors, which in turn would increase their purchases of the Company's
products.
DIRECT DEALERS
The Company developed its 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 the Company's
products directly to end users. The Company believes that the principal
advantages of this distribution channel include greater visibility of the
Company's product lines and the ability to exert additional control over factors
such as pricing of the Company's products. Sales to direct dealers, however,
generally involve longer credit terms for the Company, the necessity to provide
increased direct marketing and technical support, and additional costs
associated with developing and training the independent commissioned sales staff
of the various direct dealers to enable them to solicit purchases of the
Company's products. The Company has increased the number of direct dealers that
sell its INFINITE products from 15 at December 31, 1992 to approximately 100 at
December 31, 1998 and continues to seek additional direct dealers for its
INFINITE products.
IN-HOUSE SALES STAFF
The Company maintains an in-house sales staff that makes direct sales
of its IVR products. The Company's in-house sales force also develops
relationships with strategic partners, which purchase certain of the Company's
products as a base platform, enhance the platform with specialized software that
they have developed, and then resell the combined systems.
INTERNATIONAL SALES
To date, sales of the Company's products in foreign countries have not
represented a significant portion of the Company's revenue. The Company,
however, believes that sales of its voice processing 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 the Company's sales in foreign countries are denominated
in U.S. dollars.
RESEARCH AND DEVELOPMENT; STRATEGIC ALLIANCES WITH LGIC AND OTHER COMPANIES
The Company believes that the continued development of software that
distinguishes the functions and features of the Company's products from those of
its competitors represents a critical factor in determining the Company's
ongoing success. The Company's engineering staff consists of highly trained and
experienced
7
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 the
Company's facilities in Arizona and Georgia provides the Company 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. The Company utilizes 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.
The Company conducts joint development activities with LGIC for the
design and development of hardware incorporated into certain of the Company's
existing or planned telephone system and commercial grade telephone product
lines. Under its joint development projects with LGIC, the Company provides
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. To the extent that the Company
develops new hardware in conjunction with LGIC or another development partner,
the development partner typically retains ownership rights to the new hardware
and the Company retains the right to sell products incorporating that hardware
throughout North America. See Item 1, "Business - Manufacturing" and Item 1,
"Special Considerations - The Company Relies on LGIC as a Strategic Partner."
The Company has successfully engaged in such projects with LGIC in the past and
believes that it will continue to have access to LGIC's advanced hardware
research and development capabilities as the Company develops new product lines.
The Company also enhances its software development expertise through
acquisitions of or licensing arrangements and other strategic alliances with
independent third-party developers. The Company has active strategic alliance
relationships with other companies that possess expertise in automatic call
distribution, small digital key telephone systems, computer telephony, and
Internet telephony. The Company believes that its strategic alliances with other
companies enables the Company to develop products and bring them to market more
quickly and at a lower cost than it would be able to achieve by developing the
products internally. The Company intends 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
The Company obtains its key telephone systems, full-featured commercial
grade telephones, and certain of its voice processing systems under
manufacturing arrangements with various third-party manufacturers, including
LGIC. The Company owns a significant portion of the tooling used by the
third-party manufacturers to manufacture its products. The Company's agreements
with the third-party manufacturers generally require the manufacturers to
produce the Company's products according to the Company's technical
specifications, to perform quality control functions or otherwise meet the
Company's quality standards for manufacturing, and to test or inspect the
products prior to shipment. Pursuant to the manufacturing agreements, the
manufacturers provide the Company 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. The Company performs final
assembly, systems integration, and testing of certain of its automated call
distribution, voice mail, automated attendant, interactive voice response, and
computer-telephony integration products at its Arizona and Georgia facilities.
The Company obtains certain of its digital telephone systems and
certain of its commercial grade telephones from LGIC, which owns the rights to
produce such equipment. The Company purchases products manufactured by LGIC in
Korea on a purchase order basis. LGIC owns approximately 18.7% of the Company's
outstanding Common Stock. See Item 1, "Special Considerations - The Company
Relies on LGIC as a Strategic
8
Partner" and "Special Considerations - Certain Conflicts of Interest May Arise
as a Result of LGIC's Ownership Interest in the Company."
The Company obtains certain of its analog telephone systems and most of
its commercial grade telephones and replacement parts for such telephones from
LG Srithai, Ltd. ("LGST"), a joint venture between LGIC and Srithai Group, a
Thailand-based entity. Pursuant to an agreement with LGST (the "LGST
Agreement"), LGST granted the Company the right to distribute and sell
throughout the United States and Canada such products manufactured by LGST in
Thailand. The LGST Agreement prohibits the Company from purchasing the products
covered by the LGST Agreement from any other manufacturer during the term of the
agreement. The LGST 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. The
Company makes all purchases pursuant to the LGST Agreement on a purchase order
basis. See Item 1, "Special Considerations - The Company Relies on LGIC as a
Strategic Partner" and "Special Considerations - Certain Conflicts of Interest
May Arise as a Result of LGIC's Ownership Interest in the Company."
The Company currently obtains certain of its digital key telephone
systems and related digital products from Wong's Electronics Co., Ltd.
("Wongs"), a Hong Kong company, pursuant to an agreement with Wong's (the
"Wong's Agreement"). The Wong's Agreement will remain in effect until either
party gives the other party at least three months' advance notice of
termination. The Company makes all purchases pursuant to the Wong's Agreement on
a purchase order basis. Executone Information Systems, Inc. ("Executone") owns
certain rights to the products that the Company purchases pursuant to the Wong's
Agreement and licenses to the Company the right to use Executone's technology
incorporated into such products. See Item 1, "Business - Patents, Trademarks,
and Licenses."
The Company also obtains certain of its digital key telephone systems
from Tecom Co., Ltd., ("Tecom") a Republic of China company. Pursuant to an
agreement with Tecom (the "Tecom Agreement"), Tecom granted the Company the
exclusive right to sell and distribute throughout all of North and South America
such products manufactured by Tecom. The initial term of the Tecom Agreement
expires in June 1999, at which time the agreement will automatically renew and
continue until either party gives the other party not less than 120 days'
advance notice of termination. The Company makes all purchases pursuant to the
Tecom Agreement on a purchase order basis.
The countries in which certain of the Company's products are
manufactured have been subject to natural disasters and civil disturbances in
the past. These circumstances could affect the Company's ability to obtain
certain of its products from its overseas manufacturers. Except for a fire that
interrupted production at one plant in China during late 1993 and the first part
of 1994, the Company has not experienced any significant interruptions of
shipments to date. The termination of any of the agreements with its
manufacturers or the inability of the Company to obtain products pursuant to
such agreements, even for a relatively short period of time, could have a
material adverse effect on the Company's operations. In addition, the countries
in which certain of the Company's products are manufactured have been subject to
economic problems at times in the past. To date, such economic difficulties have
not adversely impacted the Company's ability to obtain its products or the
prices the Company pays for its products. There can be no assurance, however,
that such difficulties will not impact the Company in the future. See Item 1,
"Special Considerations - The Company Depends on Third Parties for
Manufacturing" and Item 1, "Special Considerations - The Company Faces Risks
Associated with International Manufacturing Sources."
QUALITY CONTROL
The Company recognizes that product quality and reliability are
critical factors in distinguishing its products from those of its competitors.
The Company designs its products to include components meeting specified quality
standards in order to ensure reliable performance. The Company also requires its
third-party manufacturers to comply with specified quality standards regarding
materials and assembly methods used in manufacturing the Company's products. See
Item 1, "Business - Manufacturing." In addition, the Company
9
maintains a rigorous quality assurance program designed to ensure that the
manufacture of its products conforms with specified standards and to detect
substandard products before shipment. The Company inspects products as they
arrive at its warehouse in Arizona.
SUPPORT SERVICES
The Company provides limited warranties against defective materials and
workmanship on each of the products that it sells. The Company provides a
complete support service for all of its products by maintaining a 24-hour
toll-free telephone number that system users or their service representatives
can contact for trouble shooting and diagnostic assistance. The Company
maintains an operating set-up of each of its telephone systems, key telephone
units, and peripheral systems at its headquarters facility, supported by a staff
of technicians trained to handle service assistance calls. When a customer calls
with a question relating to performance malfunctions or an operational system
question, the Company's personnel attempt to replicate any problem the customer
is encountering, diagnose the cause, and provide a solution to the customer via
telephone. If the Company's technicians cannot determine the cause of the
malfunction over the telephone, the Company dispatches a service representative
to the customer's place of business in order to locate the source of the problem
and take corrective measures.
The Company also performs repairs on certain of its products. The
Company believes that operating its own repair center provides it with savings
on repair expenses as well as increased customer satisfaction as a result of
faster turn-around time, improved quality of repairs, and reduced need for
repeat repairs.
COMPETITION
Markets for communications products are extremely competitive. The
Company currently competes principally on the basis of the technical innovation
and performance of its telephone systems, commercial grade telephones, and other
products, including their ease of installation and use, reliability, cost, and
the technical support both before and after sales to end users. The Company's
competitors in the sale of telephone systems and telephones include Lucent
Technologies, Inc., Nortel, Toshiba Information Systems, Inc., Comdial
Corporation, Panasonic Communications & Systems Co., Nitsuko, and NEC Corp.
Competitors in the supply of 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., Periphonics, Syntellect, and Brite Voice Systems. In the computer
telephony market, the Company competes with many of the same companies indicated
above. Most of the Company's competitors are large companies that have greater
name recognition and greater financial, technical, marketing, manufacturing,
distribution, and personnel resources than the Company. Certain of the Company's
product lines compete with products and services provided by the regional Bell
operating companies ("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.
The revenue, profitability, and success of the Company depends substantially
upon its ability to compete with other providers of telephone systems and other
telephony products. The Company cannot provide assurance that it will continue
to be able to successfully compete with such organizations.
PATENTS, TRADEMARKS, AND LICENSES
As of December 31, 1998, the Company owned six United States patents
expiring on various dates beginning in 2000 and ending in 2008. The Company
intends to continue to seek patents on its inventions used in its products. The
process of seeking patent protection can be expensive and can consume
significant management resources. The Company believes that its patents
strengthen its negotiating position with respect to future disputes that may
arise regarding its technology. However, the Company believes that its continued
success depends primarily on such factors as the technological skills and
innovative abilities of its personnel rather than on its
10
patents. There can be no assurance that patents will issue from pending or
future applications or that any patents that are issued will provide meaningful
protection or other commercial advantage to the Company.
The Company owns a number of registered and unregistered trademarks
that it considers to be an important factor in marketing its products. The
Company's ability to compete may be enhanced by its ability to protect its
proprietary information, including the issuance of patents, copyrights, and
trademarks. The Company also has taken steps to protect its proprietary
information through a "trade secrets" program that includes copy protection of
its software programs and obtaining confidentiality agreements with its
employees. There can be no assurance, however, that such efforts will be
effective to prevent misappropriation, reverse engineering, or independent
development of the Company's proprietary information by its competitors. While
no intellectual property right of the Company has been invalidated or declared
unenforceable, there can be no assurance that such rights will be upheld in the
future. Accordingly, the Company believes that, due to the rapid pace of
technological change in the telecommunications industry, the technical and
creative skills of its engineers and other personnel will be extremely important
in determining the Company's future technological success.
Pursuant to an agreement with Executone (the "License Agreement"), the
Company possesses a non-exclusive license to use Executone's technology related
to certain of the Company's digital telephone systems. The License Agreement
prohibits the Company from modifying the technology so that the Company's
telephone systems can be used with Executone's products. The License Agreement
requires Executone to provide certain technical support necessary for the
Company to utilize the technology covered by the agreement. Pursuant to the
License Agreement, the Company purchases all of the proprietary components for
its digital telephone systems at Executone's cost plus 5%, and the Company pays
Executone a royalty fee of 5.3% of the manufactured cost of all of its products
that utilize the technology covered by the agreement. The License Agreement
expires in 2014.
The telecommunications industry is characterized by rapid technological
development and frequent introduction of new products and features. In order to
remain competitive, the Company 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, the Company receives notices from time
to time alleging possible infringement of patents and other intellectual
property rights of others. To date, the Company has been able to successfully
defend such claims or to negotiate settlements to such claims on terms that it
believes to be favorable. In the future, however, the defense of such claims,
fees paid in settlement of such claims, or costs associated with licensing
rights to use the intellectual property of others or to develop alternative
technology may have a material adverse impact on the Company's operations.
GOVERNMENT REGULATION
The United States government from time to time has imposed anti-dumping
duties on certain telephone products manufactured in certain of the countries in
which the Company's products are manufactured. There can be no assurance that
similar duties will not be imposed in the future on telephone products,
including the Company's products, manufactured in these or other foreign
countries. The imposition of such additional duties on the Company's products
could have a material adverse effect on the Company's operating results.
Legislation enacted in the United States during 1997 will phase out duties that
the Company pays for products manufactured in certain other of the countries in
which the Company's products are manufactured. Provided that those countries
remain qualified under the legislation, duties on products manufactured in those
countries will be phased out through 2000. There can be no assurance, however,
that the countries that currently qualify for the phase-out of duties will
remain qualified or that duties will not be levied on products manufactured in
those countries in the future.
EMPLOYEES
As of March 26, 1999, the Company employed a total of 164 persons,
consisting of 160 full-time employees and four part-time employees at its
facilities in Scottsdale, Arizona and Norcross, Georgia. This number includes 33
persons in engineering and product development, 79 in sales, marketing and
technical
11
support, 18 in warehouse and distribution functions, 15 in equipment repair, and
19 in administration, including executive personnel. The Company considers its
relationship with its employees to be good, and none of its employees currently
are represented by a union in collective bargaining with the Company.
Various third-party manufacturers provide the personnel engaged in the
manufacture and assembly of the Company's products in South Korea, Thailand,
Taiwan, and the People's Republic of China pursuant to the agreements between
the Company and the respective manufacturers.
EXECUTIVE OFFICERS
The following table sets forth information concerning each of the
executive officers of the Company:
NAME AGE POSITION
---- --- --------
William J. Hinz.......... 53 Chairman of the Board
Gregory K. Roeper........ 38 President, Chief Operating Officer, Chief
Financial Officer, Secretary, and Treasurer
WILLIAM J. HINZ has served as Chairman of the Board of the Company
since October 1997 and as a director of the Company since April 1997. Since
March 1996, Mr. Hinz has served as Executive Vice President of Operations and a
director of Stolper-Fabralloy Company, a precision aerospace engine component
manufacturer that is a subsidiary of Triumph Group, Inc., a publicly held
company. 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 the Company's President since December
1998; as Chief Operating Officer since June 1998; as Secretary of the Company
since October 1997; and as Chief Financial Officer and Treasurer of the Company
since November 1994. Mr. Roeper served as the Company's Executive Vice President
- - Finance, Administration, and Operations from December 1997 until December 1998
and as Vice President - Finance from November 1994 until December 1997. From
1982 to 1994, Mr. Roeper was employed by Arthur Andersen LLP, most recently as a
Senior Manager. Mr. Roeper is a Certified Public Accountant in the state of
Arizona.
THE COMPANY
The Company was incorporated in Delaware on March 10, 1994. On April
11, 1994, the Company 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 July 1995, the Company acquired from an affiliate of LGIC certain of the
assets and liabilities of a telecommunications equipment repair business located
in Scottsdale, Arizona. In October 1995, Vodavi-CT, Inc. (formerly Enhanced
Systems, Inc.) ("Vodavi-CT") merged with a wholly owned subsidiary of the
Company. 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.
12
SPECIAL CONSIDERATIONS
INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING FACTORS, IN ADDITION
TO THOSE DISCUSSED ELSEWHERE IN THIS REPORT, IN EVALUATING THE COMPANY AND ITS
BUSINESS.
A VARIETY OF FACTORS MAY AFFECT OPERATING RESULTS
A wide variety of factors affect the Company's operating results and
could adversely impact its net sales and profitability. These factors, many of
which are beyond the control of the Company, include
+ the Company's ability to identify market segments that have
significant growth potential and to successfully market its
products and services to those market segments;
+ the Company's ability to maintain the product design and
production capabilities necessary to design and produce innovative
and desirable product lines on a timely and cost-effective basis;
+ the Company's success in maintaining customer satisfaction with
its products;
+ market acceptance of new products or technological innovations;
+ the Company's ability to establish and maintain strong and
long-lasting relationships with the wholesale distributors and
direct dealers that distribute its products;
+ the Company's success in encouraging its distributors and dealers
to promote the Company's products ahead of those of its
competitors;
+ the level and timing of orders placed by customers that the
Company can complete in a quarter;
+ customer order patterns and seasonality;
+ changes in product mix;
+ the performance and reliability of the telephone systems, voice
processing systems, and computer-telephony products designed and
marketed by the Company;
+ the life cycles of its products;
+ the ability of the Company and its third-party manufacturers to
produce the Company's products and product components in an
efficient, timely, and high-quality manner;
+ the availability and cost of raw materials, equipment, and
supplies;
+ the availability and terms of adequate financing;
+ the timing of expenditures in anticipation of orders;
+ the cyclical nature of the businesses, industries, and markets
served by the Company;
+ technological changes;
+ the introduction of new products by competitors; and
+ competition and competitive pressures on prices which, among other
things, may decrease gross margins.
The Company's ability to increase its design capacity and enter into
manufacturing arrangements in order to meet customer demand and maintain
satisfactory delivery schedules will be an important factor in its long-term
prospects. A slowdown in demand for the Company's products as a result of
economic or other conditions in markets served by the Company or other
broad-based factors would adversely affect the Company's operating results.
13
THE COMPANY DEPENDS ON THIRD PARTIES FOR MANUFACTURING
The Company depends upon third parties to manufacture its products.
Although the Company owns most of the equipment, tools, dies, and molds utilized
in the manufacturing process, the Company has limited control over the
manufacturing processes. As a result, certain difficulties could have a material
adverse effect on the Company, 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.
The Company's operations would be adversely affected if the Company were to lose
its relationship with any of its suppliers, if any of its suppliers' operations
were interrupted or terminated, or if overseas or air transportation services
were disrupted even for a relatively short period of time. The Company does not
maintain an inventory of sufficient size to provide protection for any
significant period against an interruption of supply, particularly if it were
required to locate and utilize alternative sources of supply. The Company
currently maintains a $5.2 million insurance policy to cover lost revenue in the
event of certain interruptions in purchases from its overseas manufacturers.
THE COMPANY FACES RISKS ASSOCIATED WITH INTERNATIONAL MANUFACTURING SOURCES
The Company currently obtains certain of its products under various
manufacturing arrangements with third-party manufacturers in South Korea,
Thailand, Taiwan, and the People's Republic of China. See Item 1, "Business -
Manufacturing" for a description of the material terms of certain of these
arrangements. The Company believes that production of its product lines overseas
enables the Company to obtain these items on a cost basis that enhances the
ability of the Company to market them profitably. The Company's reliance on the
third-party manufacturers to provide personnel and facilities in these
countries, the Company's maintenance of equipment and inventories abroad, and
the potential imposition of quota limitations on imported goods from certain Far
East countries expose it to certain economic and political risks, including the
following:
+ the business and financial condition of the third-party
manufacturers;
+ 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.
Although the economic situation in Asia in recent years has not resulted in any
adverse changes in the prices that the Company pays for its products, an
extended period of financial pressure on overseas markets or currency
devaluations that result in a financial setback to the Company's overseas
manufacturers could have an adverse impact on the Company's operations. Except
for a fire that interrupted production at one plant in China during late 1993
and the first part of 1994, the Company has not experienced any significant
interruptions to date in obtaining its products from third-party manufacturers.
THE COMPANY RELIES ON LGIC AS A STRATEGIC PARTNER
During 1998, LG Electrontics, Inc. ("LGE") transferred certain of its
assets related to business communications systems to LGIC. The Company now
relies on LGIC to supply certain key telephone systems and commercial grade
telephones as well as on LGIC's engineering, hardware and circuit development,
and manufacturing capabilities. The Company now purchases a significant portion
of its key telephone systems and commercial grade telephones from LGIC and LGST,
an affiliate of LGIC. During 1997, the Company purchased $18.8 million of such
products from LGE and LGST, constituting approximately 63.5% of total purchases
during 1997. During 1998, the Company purchased $16.3 million of product from
LGIC, LGE, and LGST, constituting
14
approximately 60% of total purchases of such products during 1998. See Item 1,
"Business - Manufacturing" and Item 1, "Special Considerations - Certain
Conflicts of Interest May Arise as a Result of LGIC's Ownership Interest in the
Company." The Company currently obtains products from LGIC on a purchase order
basis and cannot provide assurance that it will be able to secure long-term
manufacturing arrangements for the products it currently obtains from LGIC. LGIC
has no formal commitments to support the business or operations of the Company.
THE COMPANY FACES RISKS ASSOCIATED WITH COMPETITION
The Company engages in an intensely competitive business that has been
characterized by price erosion, rapid technological change, and foreign
competition. The Company competes with major domestic and international
companies. Many of the Company's competitors have greater market recognition and
substantially greater financial, technical, marketing, distribution, and other
resources than the Company possesses. Emerging companies also may increase their
participation in the telephone systems and peripherals markets. Principal
competitors include
+ Lucent Technologies, Inc. + Active Voice Corporation
+ Nortel + Applied Voice Technology
+ Toshiba Information Systems, Inc. + Intervoice Communications, Inc.
+ Comdial Corporation + Edify Corp.
+ Panasonic Communications & Systems Co. + Periphonics
+ Nitsuko + Syntellect
+ NEC Corp. + Brite Voice Systems
The ability of the Company to compete successfully depends on a number
of factors both within and outside its control, including the following:
+ the quality, performance, reliability, features, ease of use,
pricing, and diversity of its product lines;
+ the quality of its customer services;
+ its ability to address the needs of its customers;
+ its 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;
+ its efficiency of production;
+ the rate at which end users upgrade or expand their existing
telephone systems, applications, and services;
+ new product introductions by the Company's competitors;
+ the number, nature, and success of its competitors in a given
market; and
+ general market and economic conditions.
The Company currently competes principally on the basis of the technical
innovation and performance of its telephone systems, commercial grade
telephones, voice processing products, and computer-telephony products,
including their ease of use, reliability, cost, timely introduction, delivery
schedules, and after-sale service and technical support. The Company may not
continue to be able to compete successfully in the future.
THE COMPANY DEPENDS ON NEW PRODUCTS AND TECHNOLOGIES
The Company operates in an industry that is increasingly characterized
by fast-changing technology. As a result, the Company will be required to expend
substantial funds for and commit significant resources to the
15
conduct of continuing product development, including research and development
activities and the engagement of additional engineering and other technical
personnel. Any failure by the Company 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 the Company's operations.
The Company's future operating results will depend to a significant
extent on its 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 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 its products. Because of
the complexity of the design and manufacturing processes required by the
Company's products, the Company 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. The failure of the Company to design and implement
enhancements to existing product lines or the failure of the Company to
introduce new products on a timely and cost-effective basis would adversely
affect the Company's future operating results.
Complex software programs, such as those developed by the Company or
other software sources and incorporated into the Company's 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 the Company conducts extensive testing of the software
programs included in its products, the Company may not successfully detect and
eliminate all such errors in its 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 the Company's goodwill as well as on
its operating results.
THE COMPANY RELIES ON AN INDEPENDENT DISTRIBUTION NETWORK
The Company currently markets its 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 period of time. A decline in the
volume of sales made by distributors, however, could result in inventory levels
that exceed anticipated sales, which could delay purchases of additional
products from the Company until the distributors' inventories reach re-ordering
levels. Direct dealers generally stock inventories only in quantities deemed
sufficient to fill anticipated short-term orders. As a result, distributors and
direct dealers generally cancel orders and delay or change volume levels on
short notice to the Company.
The Company depends upon independent distributors and direct dealers to
sell its 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 the
Company's products. The Company may not be able to maintain favorable
relationships with the distributors and direct dealers that currently carry its
product lines in order to encourage them to promote and sell its products
instead of those of its competitors. In addition, the Company may not be able to
develop such relationships with additional distributors and dealers in the
future. See Item 1, "Business - Sales, Marketing, and Distribution."
Graybar accounted for 40% of sales during 1997 and 39% of sales during
1998. Accounts receivable from Graybar comprised approximately 32% of total
accounts receivable at December 31, 1998.
THE COMPANY FACES RISKS ASSOCIATED WITH PATENTS, LICENSES, AND INTELLECTUAL
PROPERTY
The Company's success depends in part upon its ability to protect its
proprietary technology. The Company relies on a combination of copyright,
trademark, and trade secret laws, nondisclosure and other
16
contractual agreements, and technical measures to protect its proprietary
technology. The Company has acquired certain patents and patent licenses and
intends to continue to seek patents on its inventions and manufacturing
processes. The Company faces risks associated with its intellectual property,
including the following:
+ the steps taken by the Company to protect its 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 meaningful protection or
any commercial advantage to the Company;
+ the Company 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;
+ the Company may commence litigation to enforce patents or other
intellectual property rights, or to defend the Company against
claimed infringement of the rights of others, which could result
in substantial cost to and diversion of effort by the Company.
As is typical in the telecommunications industry, the Company from time
to time has received, and in the future may receive, allegations of possible
infringement of patents or other intellectual property rights of others. Based
on industry practice, the Company believes that in most cases it could obtain
any necessary licenses or other rights on commercially reasonable terms. In the
event that a third party alleges that the Company is infringing its rights, the
Company 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
the Company. The failure to obtain necessary licenses or other rights or the
occurrence of litigation arising out of such claims could materially and
adversely affect the Company, its result of operations, or prospects.
THE COMPANY MUST BE ABLE TO MANAGE ITS GROWTH
The failure of the Company to manage its growth in an effective manner
could have a material adverse effect on the Company's operations. The Company's
ability to manage its growth effectively in the future will require it to
+ enhance its operational, financial, and management systems;
+ expand its facilities and equipment;
+ successfully hire, train, and motivate additional employees,
including the technical personnel necessary to design the software
used in the Company's telephone systems, voice processing
products, and computer-telephony products; and
+ integrate new software systems with evolving hardware
technologies.
The Company may be required to increase staffing and other expenses as
well as its capital expenditures in order to meet the demand for its products
and services. Customers, however, generally do not commit to firm purchase
orders for more than a short time in advance. Any increase in the Company's
expenditures in anticipation of future orders would adversely affect the
Company's 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 place excessive short-term burdens on the
Company's 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. The
17
Company has sought to reduce its exposure to industry downturns by targeting its
product lines towards small to medium-sized businesses, which the Company
believes 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, the Company 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 the Company has not experienced significant quarterly sales
fluctuations in the past, the size and timing of sales of its 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 the Company's overall operating
results on a quarterly basis.
THE COMPANY MUST FINANCE THE EXPANSION OF ITS BUSINESS AND THE DEVELOPMENT OF
NEW PRODUCTS
To remain competitive, the Company 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, any failure of the Company to increase net sales sufficiently to
offset the increased costs may adversely affect the Company's operating results.
The Company from time to time may seek additional equity or debt financing to
provide for the capital expenditures required to maintain or expand the
Company's design and production facilities and equipment. The Company 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 the Company. If such financing is not available on satisfactory
terms, the Company may be unable to expand its business or develop new products
at the rate desired and its operating results may be adversely affected. Debt
financing increases expenses and must be repaid regardless of 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."
SHORTAGE OF RAW MATERIALS AND SUPPLIES
The principal raw materials and components used in producing the
Company's products consist of
+ semiconductor components,
+ unfinished printed circuit boards,
+ molded plastic parts,
+ metals, and
+ packaging materials.
The third-party manufacturers of the Company's products acquire these raw
materials primarily from Asian sources, which indirectly subjects the Company to
certain risks, including supply interruptions and currency price fluctuations.
Purchasers of these materials, including the Company and its third-party
manufacturers, from time to time experience difficulties in obtaining such
materials. The suppliers of these materials currently are adequately meeting the
requirements of the Company. The Company also believes that there are alternate
suppliers for most of these materials.
Voice processing boards that are used in certain of the Company's voice
processing and interactive voice response products currently are available from
a limited number of sources. The Company currently purchases most of its
requirements for voice processing boards from Dialogic on a purchase order
basis. The failure of the Company to obtain voice processing boards from
Dialogic at any time that alternative sources of similar components are not
readily available could adversely affect the Company's ability to deliver
certain of its product lines.
THE COMPANY DEPENDS ON MANAGEMENT AND OTHER KEY PERSONNEL
The Company's development and operations to date have been, and its
proposed operations will be, substantially dependent upon the efforts and
abilities of its senior management and technical personnel. The
18
Company does not have employment agreements with any of its executive officers.
The Company, however, maintains agreements with each of its officers and
employees that prohibit such persons from disclosing confidential information
obtained while employed with the Company. The loss of existing key personnel or
the failure to recruit and retain necessary additional personnel would adversely
affect the Company's business prospects. The Company cannot provide assurance
that it will be able to retain its current personnel or that it will be able to
attract and retain necessary additional personnel. The Company's internal growth
and the expansion of its product lines will require additional expertise in such
areas as software development, operational management, and marketing. Such
growth and expansion activities will increase further the demand on the
Company's resources and require the addition of new personnel and the
development of additional expertise by existing personnel. The failure of the
Company to attract and retain personnel with the requisite expertise or to
develop internally such expertise could adversely affect the prospects for the
Company's success.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products may not
function properly when processing transactions that include dates on and after
January 1, 2000. The Company has completed its assessment of its existing
products and has modified or upgraded those products to be Year 2000 compliant.
The Company believes that it will be able to pass along to its customers the
cost of upgrading installed products that are no longer covered by the Company's
product warranties. The Company currently is evaluating its entire internal
computer system with respect to a proposed program to upgrade its existing
hardware and software or to install new hardware and software systems intended
to improve the content, quality, and flow of information within the Company as
well as to address any Year 2000 issues that may exist. Although the Company has
not completed the evaluation of its Year 2000 compliance issues and is not able
to quantify the costs that it may incur in order to eliminate any Year 2000
issues that may exist, the Company currently does not believe that the total
cost to the Company of addressing its Year 2000 compliance issues will have a
material adverse effect on the Company's financial condition or results of
operations. The Company currently is evaluating the Year 2000 issue as it
relates to computer systems operated by third parties, including suppliers and
financial institutions, with which the Company's systems interface. Any failure
of the Company's computer system or the systems of third parties to timely
achieve Year 2000 compliance could have a material adverse effect on the
Company's business, financial condition, and operating results. See Item 7,
"Management's Discussion and Analysis of Financial Conditions and Results of
Operations - Year 2000 Compliance."
CERTAIN CONFLICTS OF INTEREST MAY ARISE AS A RESULT OF LGIC'S OWNERSHIP INTEREST
IN THE COMPANY
LGIC owns approximately 18.7% of the Company's outstanding Common
Stock. The Company obtains certain of its digital telephone systems and certain
of its commercial grade telephones from LGIC and obtains certain of its analog
telephone systems and most of its commercial grade telephone and replacement
parts for such telephones from LGST, an affiliate of LGIC. See Item 1, "Business
- - Manufacturing" and "Special Considerations - The Company Relies on LGIC as a
Strategic Partner." As a result of LGIC's indirect ownership interest in the
Company, an inherent conflict of interest exists in establishing the volume and
terms and conditions of such purchases. In order to mitigate such conflicts, all
decisions with respect to such purchases will be made by officers of the Company
and reviewed by directors of the Company who have no relationship with LGIC.
The Company, LGIC, and certain other stockholders of the Company are
parties to a stockholders' agreement. At any time that the Company issues shares
of its Common Stock in an amount representing 1% or more of its outstanding
Common Stock, the stockholders' agreement gives LGIC the right to purchase from
the Company a sufficient number of shares as may be required to enable LGIC to
maintain the percentage of ownership of Common Stock that existed immediately
prior to such issuance. The stockholders' agreement also requires Glenn R.
Fitchet and Steven A. Sherman, former officers and directors of the Company, to
vote their shares of Common Stock to elect as directors of the Company that
number of persons designated by LGIC that comprises a percentage of the Board of
Directors equal to LGIC's then percentage of ownership of the Company's Common
Stock, provided that so long as LGIC owns 8% or more of the Company's
outstanding Common Stock, Messrs. Fitchet and Sherman will vote their shares to
the elect at least one designee of LGIC as a director.
19
THE COMPANY'S STOCK PRICE MAY BE VOLATILE
The trading price of the Company's Common Stock in the public
securities market could be subject to
+ wide fluctuations in response to quarterly variations in operating
results of the Company or its competitors,
+ actual or anticipated announcements of technological innovations
or new product developments by the Company or its competitors,
+ changes in analysts' estimates of the Company's financial
performance,
+ developments or disputes concerning proprietary rights,
+ regulatory developments,
+ general industry conditions,
+ worldwide economic and financial conditions, and
+ other events and factors.
The trading volume of the Company's Common Stock has been limited, which may
increase the volatility of the market price for such stock or reduce the
liquidity of an investment in shares of the Company's 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 the Company's Common Stock.
RIGHTS TO ACQUIRE SHARES
A total of 850,000 shares of Common Stock have been reserved for
issuance upon exercise of options granted or that may be granted under the
Company's stock option plan and other options granted to consultants. Options to
acquire 197,200 shares of Common Stock at a weighted average exercise price of
$4.85 per share currently are outstanding under the stock option plan. In
addition, the Company sold to the underwriter of its 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, the Company issued to an investor relations firm warrants to
acquire an aggregate of 122,500 shares of Common Stock. Those warrants have
exercise prices ranging from $4.00 to $6.50 per share and are exercisable until
February 2004. During the terms of such 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 such options and warrants may adversely
affect the terms on which the Company can obtain additional financing, and the
holders of such options and warrants can be expected to exercise such options or
warrants at a time when the Company, in all likelihood, would be able to obtain
additional capital by offering shares of its Common Stock on terms more
favorable to the Company than those provided by the exercise of such options or
warrants.
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of Common Stock in the public market could
adversely affect prevailing market prices and could impair the Company's ability
to raise capital through the sale of its equity securities. Approximately
1,715,000 shares of Common Stock, including 1,360,030 shares held by the
Company's directors, executive officers, and LGIC, 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 the Company's stock option plan generally will be eligible for
sale in the public market. The Company also has 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 Common Stock and could dilute earnings per
share.
20
CHANGE IN CONTROL PROVISIONS
The Company is subject to provisions under Delaware corporate law that
would require the Company to obtain certain approvals from the Board of
Directors or stockholders in order to engage in a business combination with an
interested stockholder under certain circumstances. The Company's Amended
Certificate of Incorporation and Bylaws also 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 the capital stock of the Company;
-- 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 the assets of the Company;
-- the Company entering into contracts with stockholders or
directors of the Company;
-- the assumption or acquisition by the Company of debt in excess
of $1.0 million; and
-- any amendment of the Amended Certificate of Incorporation and
Bylaws of the Company or its wholly owned subsidiary Vodavi
Communications Systems, Inc.
These provisions in the Company's 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 the Company, even when these
attempts may be in the best interests of stockholders.
THE COMPANY DOES NOT PAY CASH DIVIDENDS
The Company has never paid any cash dividends on its Common Stock and
does not anticipate that it will pay dividends in the foreseeable future.
Instead, the Company intends to retain any earnings to provide funds for use in
its business. Furthermore, the terms of the revolving line of credit facility
between Vodavi Communications Systems, Inc., a wholly owned subsidiary of the
Company ("VCS") and General Electric Capital Corporation ("GE Capital") prohibit
VCS from paying dividends to the Company without the consent of GE Capital. This
restriction could limit the Company's ability to pay dividends in the future.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements and information contained in this Report concerning
future, proposed, and anticipated activities of the Company; certain trends with
respect to the Company's revenue, operating results, capital resources, and
liquidity or with respect to the markets in which the Company competes or the
telecommunications industry in general; and other statements contained in this
Report regarding matters that are not historical facts are forward-looking
statements, as such term is defined in the securities laws. Forward-looking
statements, by their very nature, include risks and uncertainties, many of which
are beyond the Company's 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
The Company leases, for a term expiring in December 2001, approximately
60,000 square feet of space in Scottsdale, Arizona, where it maintains
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. The Company also leases approximately 16,200 square feet of
space in
21
Norcross, Georgia, for a term expiring in August 2002. The Company maintains
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. The Company leases, for a term ending in December 2004, approximately
19,500 square feet of space in Scottsdale, Arizona, for its telecommunications
equipment repair operations. The Company believes its facilities are adequate
for its reasonably anticipated needs.
ITEM 3. LEGAL PROCEEDINGS
On September 20, 1996, the Company and Vodavi-CT filed a lawsuit
against Michael Mittel and Fereydoun Taslimi, former officers and directors of
Vodavi-CT, in the United States District Court for the District of Arizona. The
lawsuit subsequently was transferred to the Northern District of Georgia,
Atlanta Division (No. 1-98-CV-18-CAM). The lawsuit alleges, among other things,
that Messrs. Mittel and Taslimi violated federal and Arizona securities laws and
engaged in fraudulent activities in connection with the Company's 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. The Company and Vodavi-CT are
seeking compensatory and punitive damages against Messrs. Mittel and Taslimi. On
September 24, 1996, Messrs. Mittel and Taslimi filed a lawsuit in the United
States District Court for the Northern District of Georgia, Atlanta Division
(No. 196-CV-2563), against the Company and Vodavi-CT. The lawsuit alleges that
Vodavi-CT breached Messrs. Mittel's and Taslimi's respective employment
agreements by terminating their employment. Messrs. Mittel and Taslimi are
seeking damages in an amount to be determined at trial, plus costs and attorneys
fees. The parties have commenced discovery in the lawsuits. In January 1999, the
parties filed motions for summary judgment with respect to portions of their
respective claims. The Company intends to proceed with its lawsuit against
Messrs. Mittel and Taslimi and is vigorously defending the lawsuit filed by them
against the Company and Vodavi-CT.
On November 9, 1998, Paradygm Communications, Inc. ("Paradygm") and
R.C. Patel ("Patel") filed a lawsuit against 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 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. The Company intends to vigorously
defend this lawsuit.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
22
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's 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 the Company's Common Stock on the
Nasdaq National Market for the periods indicated.
HIGH LOW
---- ---
1996:
First quarter................................... $7.38 $5.25
Second quarter.................................. 8.88 5.88
Third quarter................................... 8.13 5.25
Fourth quarter.................................. 5.88 2.88
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 (through March 26, 1999).......... $3.63 $2.38
On March 26, 1999, the closing sales price of the Common Stock was
$2.75 per share. As of March 26, 1999, there were 31 holders of record and
approximately 640 beneficial owners of the Company's Common Stock.
The Company has not declared or paid any cash dividends on its Common
Stock and does not intend to declare or pay any cash dividends in the
foreseeable future. In addition, the Company's credit facility with GE Capital
restricts the Company's ability to pay cash dividends.
23
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table summarizes certain selected consolidated financial
data of the Company and its predecessor, the Vodavi Division. The results of
operations for the three months ended March 31, 1994 are not necessarily
indicative of the results of operations for a full fiscal year. The selected
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 the Company and related
notes thereto. No dividends were paid during the periods presented.
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
VODAVI
DIVISION(1)
----------- THE COMPANY
THREE MONTHS -----------------------------------------------------
ENDED MARCH 31, YEAR ENDED DECEMBER 31,
-------------- -------------------------------------------------------
OPERATING DATA: 1994 1994(2) 1995 1996 1997 1998
---- ------- ---- ---- ---- ----
Revenue....................... $8,587 $29,140 $39,601 $46,154 $47,675 $47,983
Gross margin.................. 2,418 8,613 12,404 15,312 15,667 15,858
Operating expenses............ 1,872 6,291 10,399 13,749 13,828 14,414
Asset impairment and
restructuring charges...... -- -- -- 4,805 819 --
Operating income (loss)....... 546 2,322 2,055 (3,242) 1,020 1,444
Interest & other expenses..... -- 576 1,130 840 663 791
Pretax income (loss).......... 546 1,746 875 (4,082) 357 653
Income taxes.................. -- 693 417 327 142 (331)
Net income (loss)............. 546 1,053 458 (4,409) 215 984
Net income (loss) per share,
diluted.................... N/A $0.55 $0.17 $(1.02) $0.05 $0.23
Weighted average shares
outstanding, diluted....... N/A 1,917,346 2,769,434 4,342,238 4,342,238 4,342,238
AS OF MARCH 31, AS OF DECEMBER 31,
-------------- -----------------------------------------------
BALANCE SHEET DATA: 1994 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ----
Assets:
Current assets................ $12,034 $14,122 $17,719 $16,591 $19,507 $16,766
Property and equipment........ 452 635 1,731 2,465 2,616 2,663
Goodwill...................... -- 2,833 7,089 2,547 2,395 2,244
Other......................... -- 357 931 815 1,146 1,169
------- ------- ------- ------- ------- -------
$12,486 $17,947 $27,470 $22,418 $25,664 $22,842
======= ======= ======= ======= ======= =======
Liabilities:
Current liabilities........... $3,128 $5,316 $5,706 $7,292 $7,115 $4,333
Long-term debt................ -- 8,574 7,884 5,588 8,752 7,711
Other long-term obligations... -- -- 69 137 182 199
Due to parent................. 2,705 -- -- -- -- --
------- ------- ------- ------- ------- -------
Total liabilities.............. 5,833 13,890 13,660 13,017 16,049 12,243
Stockholders' equity........... 6,653 4,057 13,810 9,401 9,615 10,599
------- ------- ------- ------- ------- -------
$12,486 $17,947 $27,470 $22,418 $25,664 $22,842
======= ======= ======= ======= ======= =======
- ----------
(1) Prior to the acquisition by the Company, the Vodavi Division operated as a
separate division within a publicly held company. See Item 1, "Business --
History of the Company." As a result, share information is not applicable.
(2) Excludes the results of operations of the Vodavi Division prior to April 1,
1994, the effective date of the acquisition.
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
ANNUAL RESULTS
The following table summarizes the operating results of the Company for
the periods indicated. 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,
-----------------------------------------------------------
1996 1997 1998
---------------- ---------------- ----------------
(DOLLAR AMOUNTS IN THOUSANDS)
$ % $ % $ %
------- ----- ------- ----- ------- -----
Revenue .................... $46,154 100.0% $47,675 100.0% $47,983 100.0%
Cost of goods sold ......... 30,842 66.8% 32,008 67.1% 32,125 67.0%
------- ----- ------- ----- ------- -----
Gross margin ............ 15,312 33.2% 15,667 32.9% 15,858 33.0%
Operating expenses:
Engineering and product
development ............. 2,161 4.7% 2,101 4.4% 1,616 3.4%
Selling, general, and
administrative .......... 11,588 25.1% 11,727 24.6% 12,798 26.7%
Asset impairment and
restructuring charges.. 4,805 10.4% 819 1.7% -- 0%
------- ----- ------- ----- ------- -----
Operating income (loss) .... (3,242) (7.0)% 1,020 2.2% 1,444 2.9%
Other income (expense), net (840) 1.8% (663) (1.4)% (791) (1.6)%
------- ----- ------- ----- ------- -----
Pretax income (loss) ....... (4,082) (8.8)% 357 0.8% 653 1.3%
Income tax expense (benefit) 327 0.7% 142 0.3% (331) (0.7)%
------- ----- ------- ----- ------- -----
Net income (loss) .......... $(4,409) (9.5)% $ 215 0.5% $ 984 2.0%
======= ===== ======= ===== ======= =====
REVENUE
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 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. The Company intends to continue emphasizing
sales of its newer product lines, such as its new voice mail systems, which were
well-received in 1998. The Company also is taking steps to slow the decrease in
sales of its current line of commercial grade telephones and plans to introduce
a new line of commercial grade telephones in 1999.
Revenue in 1997 was approximately $47.7 million, an increase of $1.5
million, or 3.2%, over 1996 revenue of approximately $46.2 million. The increase
in 1997 can be attributed to the addition of two OEM accounts, which accounted
for approximately $1.7 million of the increased revenue. Revenue from the
Company's other channels declined approximately $200,000. The Company attributes
this decline to delays in the introduction of new products in 1997 as a result
of an emphasis on securing the OEM contracts. In an effort to reverse this
trend, the Company began adding to its outside sales force in the fourth quarter
of 1997 and began a series of programs late in the year designed to stimulate
growth.
25
COST OF GOODS SOLD
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 provided primarily to wholesale
distributors and the interconnects to which those distributors sell the
Company's products. The Company provided the increased rebates in order to
stimulate "pull through" demand for its products.
Gross margins decreased to approximately 32.9% of revenue in 1997 as
compared with 33.2% in 1996. The decline can be attributed to the lower margins
earned on the Company's OEM contracts as well as the impact of certain discounts
included in the programs discussed above, which are designed to stimulate
growth. The Company expects that margins will continue to be lower in the near
term while these programs continue.
ENGINEERING AND PRODUCT DEVELOPMENT
Expenditures related to engineering and product development decreased
to approximately $1.6 million in 1998 as compared with $2.1 million and $2.2
million in 1997 and 1996, respectively. This decrease is due to the elimination
of several engineering and products development positions within the Company.
The Company believes the elimination of these positions will have no effect on
new product development.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative ("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 as compared with
24.6% in 1997. This increase can be attributed primarily to an increase in
personnel in sales and marketing functions.
SG&A expenses were approximately $11.7 million in 1997, an increase of
approximately $100,000, or 1.0%, over SG&A expenses in 1996 of approximately
$11.6 million. As a percentage of revenue, SG&A expenses declined to 24.6% in
1997 as compared with 25.1% in 1996. The recognition of the impairment loss
related to Vodavi-CT in the fourth quarter of 1996, as described below, resulted
in the elimination of goodwill amortization of approximately $460,000 annually.
After considering the impact of this, SG&A expenses increased approximately
$480,000 in 1997, primarily as a result of additional personnel in sales and
marketing functions.
ASSET IMPAIRMENT AND RESTRUCTURING CHARGES
In 1996, the Company recorded a $4.2 million write-down of the goodwill
associated with the acquisition of Vodavi-CT in accordance with Statement of
Financial Accounting Standard No. 121, ACCOUNTING FOR THE IMPAIRMENT OF
LONG-LIVED ASSETS AND FOR ASSETS TO BE DISPOSED OF. The Company determined that
the write-down was appropriate after evaluating the impact of several events
that occurred in the latter part of 1996, including communications from a
customer that purchase levels to which the customer had previously committed
would not be met. The write-down of the goodwill of Vodavi-CT resulted in a
reduction of goodwill amortization of approximately $460,000 annually. In 1996,
the Company also accrued approximately $600,000 in restructuring reserves
related to the operations of Vodavi-CT. These reserves included the costs of
relocating new management to Atlanta, Georgia; costs related to the Company's
lawsuit against the former owners of Vodavi-CT; costs related to the settlement
of an outstanding legal matter; and other expenses related to the management
change.
In the fourth quarter of 1997, the Company began implementing a
restructuring plan designed to increase the Company's focus and competitive
position in the industry. As part of this plan, the Company determined to
implement certain personnel reductions as well as to cancel certain product
lines. The Company has recorded a charge of $820,000 in the fourth quarter
related to severance charges for the personnel reductions as well as the costs
associated with the abandonment of the various products. At December 31, 1997,
approximately $700,000 was included in accrued liabilities as restructuring
reserves on the Company's balance sheet.
26
During 1998, approximately $412,000 and $196,000 was charged against
the reserve for severance payments and legal fees, respectively. The remaining
restructuring reserve balance included in accrued liabilities at December 31,
1998, was approximately $92,000, which relates to legal fees.
OTHER INCOME (EXPENSE), NET
Other income (expense), net consists primarily of interest expense.
Interest expense was approximately $791,000, $663,000, and $840,000, in 1998,
1997, and 1996, respectively. 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. The $177,000 reduction in interest expense in 1997
is attributable to the lower interest rate obtained in connection with the
renewal of the Company's operating line of credit with GE Capital. See Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
INCOME TAXES
The effective rate of the Company's income tax provision was (50.7)%,
31.6%, and (8.0)%, in 1998, 1997, and 1996 respectively. The Company utilized
research and development tax credits of approximately $509,000 in 1998 and
approximately $100,000 in 1997, which favorably impacted the effective tax rate
in each of those years. The Company's effective tax rate in 1996 was impacted by
the asset impairment and restructuring charges taken in 1996, as described
above. The write-down of the goodwill associated with the acquisition of
Vodavi-CT was not deductible, which also impacted the effective rate for 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company had approximately $796,000 in cash at December 31, 1998.
The Company's cash accounts are swept regularly and applied against the
Company's operating line of credit, as described below. The Company's borrowings
against its available operating line of credit at December 31, 1998 were
approximately $7.7 million, which represents a $900,000 decrease from its
borrowings of $8.6 million at December 31, 1997. The decrease is attributed to
the increase in current assets of approximately $2.7 million over the same
period. At December 31, 1998, the Company had total availability under its
operating line of credit of approximately $2.0 million, with $200,000 reserved
for standby letters of credit and $1.25 million reserved for maintaining the
minimum availability covenant, resulting in net availability of $550,000.
The Company has a $12.0 million revolving line of credit with GE
Capital that extends through April 2000. Borrowings under the line of credit
bear interest at 2.5% over the 30-day commercial paper rate, which resulted in a
borrowing rate of 7.8% at December 31, 1998. Available borrowings under the line
of credit depend upon the accounts receivable and inventories of VCS and are
secured by substantially all of the Company's assets. The line of credit
contains certain financial covenants that are customary for similar credit
facilities and also prohibits VCS from paying dividends to the Company without
the consent of GE Capital. At December 31, 1998, the Company was in compliance
with all of the covenants.
The Company has several capital lease agreements with interest rates
ranging from 9% to 13%. These agreements generally have terms of 24 months and
provide the Company with the option to purchase the leased equipment for a
nominal amount at the end of the lease term.
The Company has no significant outstanding commitments other than its
existing lease agreements and commitments under a royalty agreement, as
described in the Notes to the Consolidated Financial Statements.
The Company believes that its working capital and credit facilities
will be sufficient to finance its internal growth for the foreseeable future.
Although the Company currently has no acquisition targets, it may explore
acquisition opportunities as they arise and may be required to seek additional
financing in the future to meet such opportunities.
27
INTERNATIONAL MANUFACTURING SOURCES
The Company currently obtains certain of its products under various
manufacturing arrangements with third-party manufacturers in Asia. As of the
date of this Report, the Company does not believe that the current economic
situation in Asia will have any adverse impact on the Company's operations.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are
coded to accept only two-digit entries to represent years in the date code
field. Computer systems and products that do not accept four-digit year entries
will need to be upgraded or replaced to accept four-digit entries to distinguish
years beginning with 2000 from prior years. The Company has initiated but has
not yet completed an internal system assessment to determine whether its
existing computer hardware and software systems are "Year 2000" compliant.
The Company currently is evaluating its entire internal computer system
and has engaged a third-party consultant in connection with the upgrade of
certain of its existing financial and accounting systems, including software
related to order entry, inventory management, materials planning, and accounts
payable and receivable. These upgrades are intended to improve the content,
quality, and flow of information within the Company, as well as to address any
Year 2000 issues that may exist. As of the filing date of this Report, these
projects are approximately 75 to 85% complete. The Company currently plans to
test the upgrades to this system in May 1999. The Company estimates that the
cost of these upgrades will be approximately $25,000.
The Company has been advised that certain of the computer processing
platforms and networks and certain software systems used in connection with its
operations, other than the financial and accounting systems described above, may
not be Year 2000 compliant. The Company currently is assessing the extent of
such non-compliance and intends to develop a program to brings those systems
into Year 2000 compliance during calendar 1999. A failure of its computer
systems as a result of Year 2000 issues could have a material adverse effect on
the Company's operations.
A significant portion of the Company's business communications systems
products is manufactured by third parties in Asia. The Company has initiated but
has not yet completed an assessment of the Year 2000 risks associated with the
inability of those manufacturers to bring their production processes and other
computer-based systems into Year 2000 compliance. Because the manufacturing
processes utilized do not rely upon date-related information, the Company
currently believes that a failure on the part of its overseas manufacturers to
bring their processes and equipment into Year 2000 compliance does not represent
a material risk to the Company's ability to obtain its products on a timely
basis.
Certain of the Company's products contain software and hardware that
perform functions based upon date-related information. The Company has
identified those of its existing products that are not Year 2000 compliant and
has completed development of upgrades or modifications to those products that
will enable them to process Year 2000 dates without malfunctioning. The Company
believes that it will be able to pass along to its customers costs related to
upgrading installed products that are no longer covered by the Company's product
warranties. The Company also believes that the costs related to upgrading
installed products that remain under the Company's product warranties would be
relatively insignificant. To date, the Company has incurred approximately
$15,000 in costs associated with the development of Year 2000 compliance
upgrades. The inability of the Company to develop and provide on a timely basis
product modifications that may be required could result in a material adverse
effect on the Company, including increased warranty costs, customer satisfaction
issues, and potential litigation.
The Company is unable to fully assess the impact of the Year 2000 issue
as of the filing date of this Report. The Company currently is evaluating the
Year 2000 issue as it relates to computer systems operated by all of the third
parties, including manufacturers, suppliers, customers, and financial
institutions, with which the Company's systems interface. The failure of the
Company's computer system or the systems of third parties to timely achieve Year
2000 compliance could have a material adverse effect on the Company's business,
financial
28
condition, and operating results. As of the filing date of this Report, the
Company has not formulated a contingency plan with respect to the Year 2000
compliance issues described above.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
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 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 directors of the
Company 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 (the "Exchange Act") for the Company's 1999 Annual Meeting of
Stockholders. The information required by this Item relating to executive
officers of the Company 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 the Company's 1999 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 the Company's 1999 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 the Company's 1999 Annual Meeting of Stockholders.
29
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) No Financial Statement Schedules are included because such
schedules are not applicable, are not required, or because
required information is included in the consolidated financial
statements or notes thereto.
(b) REPORTS ON FORM 8-K.
Not applicable.
(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)
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)
10.11 Escrow Agreement dated as of March 28, 1994 between the Registrant,
GoldStar Telecommunication Co., Ltd., Steven Sherman, Glenn R. Fitchet
and STKK Service Company, as Escrow Agent(l)
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)
10.14 License Agreement dated as of March 31, 1994 between Executone
Information Systems, Inc. and V Technology Acquisition Corp.(l)
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)
10.20 Agreement dated June 14, 1995 between Wong's Electronics Co., Ltd. and
Vodavi Communications Systems, Inc.(3)
30
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)
10.30 Strategic Alliance Agreement dated May 22, 1997 between Vodavi
Communications Systems, Inc. and Paradygm Communications, Inc.(2)
10.31 OEM Agreement dated August 15, 1997 between Vodavi Communications
Systems, Inc. and Fujitsu Business Communication Systems, Inc.(6)
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)
21 List of Subsidiaries
23.1 Consent of Arthur Andersen LLP
27.1 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.
31
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 30, 1998 By: /s/ William J. Hinz
----------------------------------
William J. Hinz
Chairman of the Board
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 (Principal March 30, 1999
- --------------------------- Executive Officer)
William J. Hinz
/s/ Gregory K. Roeper President, Chief Operating March 30, 1999
- --------------------------- Officer, Chief Financial Officer,
Gregory K. Roeper Secretary, and Treasurer
(Principal Accounting Officer)
/s/ Nam K. Woo Director March 30, 1999
- ---------------------------
Nam K. Woo
Director March __, 1999
- ---------------------------
Gilbert H. Engels
/s/ Stephen A Mcconnell Director March 30, 1999
- ---------------------------
Stephen A McConnell
/s/ Emmett E. Mitchell Director March 30, 1999
- ---------------------------
Emmett E. Mitchell
32
VODAVI TECHNOLOGY, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Public Accountants ............................... F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998 ........... F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1997, and 1998 ................................... F-4
Consolidated Statements of Changes in Stockholders' Equity for
the Years Ended December 31, 1996, 1997, and 1998 ................... F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1997, and 1998 ................................... F-6
Notes to Consolidated Financial Statements ............................. F-7
F-1
ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Vodavi Technology, Inc.:
We have audited the accompanying consolidated balance sheets of VODAVI
TECHNOLOGY, INC. (a Delaware corporation) and subsidiaries as of December 31,
1997 and 1998, 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, 1998. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes 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 Vodavi Technology, Inc. and
subsidiaries as of December 31, 1997 and 1998 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
Phoenix, Arizona,
January 29, 1999.
F-2
VODAVI TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
--------------------------
1997 1998
----------- -----------
ASSETS
CURRENT ASSETS:
Cash $ 634,255 $ 795,731
Accounts receivable, net of allowances
of $250,000 in 1997 and $674,000 in 1998 9,681,545 8,887,884
Inventories, net 8,286,173 6,385,460
Prepaid expenses and other 905,451 696,835
----------- -----------
Total current assets 19,507,424 16,765,910
PROPERTY AND EQUIPMENT, net 2,616,320 2,662,979
GOODWILL, net 2,394,990 2,243,514
OTHER LONG-TERM ASSETS, net 1,145,308 1,169,664
----------- -----------
$25,664,042 $22,842,067
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 378,931 $ 124,141
Payable to related parties 1,621,547 34,221
Accounts payable 2,698,362 2,320,844
Accrued liabilities 2,416,218 1,853,921
----------- -----------
Total current liabilities 7,115,058 4,333,127
----------- -----------
LONG-TERM DEBT, net 8,752,367 7,711,471
----------- -----------
OTHER LONG-TERM OBLIGATIONS 181,247 198,685
----------- -----------
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
and outstanding 4,342 4,342
Additional paid-in capital 12,307,739 12,307,739
Accumulated deficit (2,696,711) (1,713,297)
----------- -----------
9,615,370 10,598,784
$25,664,042 $22,842,067
=========== ===========
The accompanying notes are an integral part of these
consolidated balance sheets.
F-3
VODAVI TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
---------------------------------------
1996 1997 1998
----------- ----------- -----------
REVENUE, net $46,154,174 $47,674,751 $47,983,344
COSTS OF GOODS SOLD (including
products acquired from related parties
(LGIC) of $17.8 million, $17.8 million,
and $18.0 million, respectively) 30,842,422 32,007,992 32,124,508
----------- ----------- -----------
Gross margin 15,311,752 15,666,759 15,858,836
OPERATING EXPENSES:
Engineering and product development 2,161,306 2,100,682 1,616,134
Selling, general and administrative 11,587,971 11,726,902 12,798,609
Asset impairment and restructuring
charges (Note 2) 4,804,717 819,389 --
----------- ----------- -----------
OPERATING INCOME (LOSS) (3,242,242) 1,019,786 1,444,093
INTEREST EXPENSE 840,830 662,828 791,362
----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES (4,083,072) 356,958 652,731
PROVISION (BENEFIT) FOR INCOME TAXES 326,691 142,013 (330,683)
----------- ----------- -----------
NET INCOME (LOSS) $(4,409,763) $ 214,945 $ 983,414
=========== =========== ===========
BASIC EARNINGS (LOSS) PER SHARE $ (1.02) $ .05 $ .23
=========== =========== ===========
DILUTED EARNINGS (LOSS) PER SHARE $ (1.02) $ .05 $ .23
=========== =========== ===========
WEIGHTED AVERAGE SHARES
OUTSTANDING - BASIC 4,342,238 4,342,238 4,342,238
=========== =========== ===========
WEIGHTED AVERAGE SHARES
OUTSTANDING - DILUTED 4,342,238 4,342,238 4,342,238
=========== =========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
VODAVI TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Retained
------------------- Additional Earnings
Par Paid-in (Accumulated
Shares Value Capital Deficit) Total
------ ----- ------- -------- -----
BALANCE, December 31, 1995 4,342,238 $4,342 $12,307,739 $ 1,498,107 $13,810,188
Net loss -- -- -- (4,409,763) (4,409,763)
--------- ------ ----------- ----------- -----------
BALANCE, December 31, 1996 4,342,238 4,342 12,307,739 (2,911,656) 9,400,425
Net income -- -- -- 214,945 214,945
--------- ------ ----------- ----------- -----------
BALANCE, December 31, 1997 4,342,238 4,342 12,307,739 (2,696,711) 9,615,370
Net income -- -- -- 983,414 983,414
--------- ------ ----------- ----------- -----------
BALANCE, December 31, 1998 4,342,238 $4,342 $12,307,739 $(1,713,297) $10,598,784
========= ====== =========== =========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
VODAVI TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
---------------------------------------------
1996 1997 1998
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (4,409,763) $ 214,945 $ 983,414
Adjustments to reconcile net income (loss) to net
cash (used in) provided by operating activities:
Depreciation and amortization 903,735 750,400 765,394
Asset impairment 4,174,717 407,776 --
Rent levelization 68,246 44,187 17,441
Loss on retirement of fixed assets 63,081 -- --
Changes in working capital:
Accounts receivable (1,310,669) (1,943,753) 793,661
Inventories 1,302,059 (1,137,315) 1,900,713
Prepaid expenses and other 380,878 (351,853) 208,616
Other long-term assets 36,615 (450,926) (56,134)
Accounts payable and payables to related
parties 838,935 (143,714) (1,964,844)
Accrued liabilities 619,003 227,831 (562,297)
Accrued income taxes (77,223) (426,983) --
------------ ------------ ------------
Net cash flows provided by (used in)
operating activities 2,589,614 (2,809,405) 2,085,964
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Accrued acquisition costs paid (217,894) (36,040) --
Cash paid to acquire property and equipment (556,664) (577,030) (628,802)
------------ ------------ ------------
Net cash flows used in investing
activities (774,558) (613,070) (628,802)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Financing costs paid -- (77,301) --
Payments on capital leases (109,760) (259,282) (378,065)
Borrowings on revolving credit facility 41,369,367 48,488,925 47,712,453
Payments on revolving credit facility (43,867,070) (45,247,325) (48,630,074)
------------ ------------ ------------
Net cash flows (used in) provided by
financing activities (2,607,463) 2,905,017 (1,295,686)
------------ ------------ ------------
CHANGE IN CASH (792,407) (517,458) 161,476
CASH, beginning of period 1,944,120 1,151,713 634,255
------------ ------------ ------------
CASH, end of period $ 1,151,713 $ 634,255 $ 795,731
============ ============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
VODAVI TECHNOLOGY, INC.
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.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries Vodavi Communication Systems, Inc. (VCS), Arizona
Repair Services, Inc. (ARSI) and Vodavi-CT, Inc. (Vodavi-CT), formerly known as
Enhanced Systems, Inc. (together referred to as the Company). ARSI merged with
VCS on December 31, 1998. 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.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or
market.
F-7
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, 1997 and 1998, respectively:
Useful Life
Type of Asset in Years 1997 1998
------------- -------- ---- ----
Office and computer equipment 5 $ 1,030,354 $ 1,443,562
Furniture and fixtures 10 255,089 338,779
Tooling and manufacturing equipment 5-8 1,506,761 1,724,553
Assets under capital lease 5-12 741,226 741,226
Property and equipment in progress -- 128,702 42,814
----------- -----------
3,662,132 4,290,934
Less: Accumulated depreciation (1,045,812) (1,627,955)
----------- -----------
$ 2,616,320 $ 2,662,979
=========== ===========
Property and equipment in progress relates to assets under development that have
not yet been placed in service.
GOODWILL
Goodwill represents the cost in excess of the estimated fair value of tangible
assets acquired in business combinations and is being amortized on the
straight-line method over the estimated life of the asset.
INCOME TAXES
The Company utilizes the liability method of accounting for income taxes as set
forth in Statement of Financial Accounting Standards (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, net of an allowance for product returns, is generally recognized upon
shipment to the customer. When the Company has an installation or other
significant obligation, revenue is recognized upon installation or substantial
completion of the Company's obligation. Revenue from extended maintenance
contracts is recognized over the lives of the respective contracts.
EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128,
EARNINGS PER SHARE, which supersedes Accounting Principles Board (APB) Opinion
No. 15, the previous authoritative guidance. SFAS No. 128 replaces the
calculation of primary and fully diluted earnings per share (EPS) with basic and
diluted EPS. SFAS No. 128 is effective for financial statements for both interim
and annual periods presented after December 15, 1997, and as a
F-8
result, all prior period EPS data presented has been restated. Basic EPS for the
years ended December 31, 1996, 1997 and 1998, were determined by dividing net
income by the weighted average number of common shares outstanding. The weighted
average number of common shares outstanding excludes all common stock
equivalents. Diluted EPS for the years ended December 31, 1996, 1997 and 1998,
were determined by dividing net income by the weighted average number of common
and common equivalent shares outstanding. No common equivalent shares were
included in weighted average common and common equivalent shares for each of the
three years ended December 31, 1998.
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 estimated fair value amounts have been
determined by the Company at December 31, 1998, using available market
information. Considerable judgment is required in interpreting market data to
develop the estimates of fair value. Accordingly, the estimates may not be
indicative of the amounts that the Company could realize in a current market
exchange. The use of different market assumptions and valuation methodologies
could have a material effect on the estimated fair value amounts.
The carrying value of cash, accounts receivable, accounts payable, payable to
related parties, accrued liabilities, and the revolving credit facility
approximate fair values due to the short-term maturities of these instruments.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1998, the Company adopted SFAS No. 131, DISCLOSURES ABOUT
SEGMENTS OF AND 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 has one reportable operating segment. The
Company has three operating segments which are managed based on the Company's
product categories, key telephone systems, voice processing systems, and
computer-telephony products. The Company's voice processing systems and
computer-telephony products categories do not meet the reportable thresholds of
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 in SFAS No. 131.
Accordingly, the Company has not presented separate financial information for
each of its operating segments as the Company's consolidated financial
statements present its one reportable segment.
(2) ASSET IMPAIRMENT AND RESTRUCTURING CHARGES:
The Financial Accounting Standards Board has issued SFAS No. 121, ACCOUNTING FOR
THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF,
which the Company adopted in 1996. SFAS No. 121 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
F-9
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.
During 1996, certain events occurred that required the Company to re-evaluate
the realizability of goodwill recorded in connection with the acquisition of
Vodavi-CT. As a result of the impact of these events on the projected cash flows
of Vodavi-CT, the Company concluded that the goodwill was impaired and recorded
a $4.2 million impairment loss.
During 1997, the Company recorded a restructuring charge of approximately
$820,000 that included a reserve for severance payments and the write off of
various assets following a review of product strategies, which resulted in the
discontinuance of certain product lines. At December 31, 1997, approximately
$700,000 in restructuring reserves is included in accrued liabilities on the
accompanying balance sheet.
During 1998, approximately $412,000 and $196,000 was charged against the reserve
for severance payments and legal fees, respectively. The remaining restructuring
reserve balance in accrued liabilities relating to legal fees at December 31,
1998 was approximately $92,000.
(3) LONG-TERM DEBT:
Long-term debt consists of the following as of December 31, 1997 and 1998:
1997 1998
---------- ----------
Revolving credit facility $8,628,227 $7,710,606
Capital lease obligations 503,071 125,006
---------- ----------
9,131,298 7,835,612
Less: Current portion (378,93) (124,141)
---------- ----------
$8,752,367 $7,711,471
========== ==========
The Company maintains a $12.0 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 1/2% (8.03% and 7.80% at December 31, 1997 and 1998,
respectively). The credit facility expires in April 2000 and is secured by
substantially all of the Company's assets.
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, 1998, the Company was in compliance with
all of the covenants.
During 1996 and 1997, the Company entered into several capital lease agreements
with interest rates ranging from 9% to 13%. These agreements generally have
terms of 24 months and provide the Company with an option to purchase the
equipment for a nominal amount at the end of the lease term.
F-10
(4) COMMITMENTS AND CONTINGENCIES:
LEGAL MATTERS
The Company is currently involved in a lawsuit with the former owners of
Vodavi-CT, who were dismissed from their positions as executive management of
Vodavi-CT in the third quarter of 1996. In September 1996, the Company sued the
former owners alleging securities fraud, fraudulent activities, breach of
employment agreements, breach of fiduciary duties, and other charges. The former
owners countersued the Company claiming the Company breached their employment
agreements and owes them approximately $500,000. The Company intends to
vigorously pursue its action and defend against the countersuit. In connection
with the fourth quarter of 1996 charges for the asset impairment and other
restructuring charges, the Company reserved approximately $250,000 for legal
fees to pursue this matter. The reserve balance in accrued liabilities related
to legal fees at December 31, 1998 was approximately $92,000.
The Company is also involved in a lawsuit with a former OEM alleging that VCS
breached a strategic alliance to provide certain key telephone systems to the
OEM. The former OEM is seeking compensatory, punitive, incidental, and
consequential damages related to the lawsuit. The Company has denied the
allegations and is aggressively defending itself. The Company has filed a
counterclaim against the former OEM for breaching the strategic alliance for
failure to pay for services rendered. Although the outcome of this lawsuit is
still uncertain, the Company has increased its allowance for doubtful accounts
to reflect the added uncertainty associated with the collectibility of accounts
receivable related to this OEM.
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:
TOTAL
-----
1999 $1,120,707
2000 1,160,679
2001 1,201,335
2002 311,745
2003 174,720
Thereafter 174,720
Rent expense is recognized on a straight-line basis and was approximately
$1,115,000, $1,107,000, and $1,107,000 for the years ended December 31, 1996,
1997, and 1998, 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. 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 approximately
$502,000, $449,000, and $264,000 in 1996, 1997, and 1998, respectively.
F-11
401(k) PROFIT SHARING PLAN
In April 1994, the Company adopted 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 Company
matching provision. The Company expensed discretionary contributions pursuant to
the 401(k) Plan in the amounts of approximately $67,500, $75,000, and $70,000
for the years ended December 31, 1996, 1997, and 1998, respectively.
(5) STOCKHOLDERS' EQUITY:
WARRANTS
In connection with its 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
from October 12, 1996 to October 12, 2000.
VODAVI TECHNOLOGY, INC. 1994 STOCK OPTION PLAN
The Vodavi Technology, Inc. 1994 Stock Option Plan (the Plan), as amended,
provides for the granting of options to purchase up to 850,000 shares of the
Company's Common Stock. Under the Plan, options may be issued to key personnel
of the Company. The options issued may be incentive stock options or
nonqualified stock options. If any option terminates or expires without having
been exercised in full, stock not issued under such option will again be
available for the purposes of the Plan.
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 with respect to which options 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.
F-12
The following summarizes activity under the Plan for the years ended:
December 31, 1996 December 31, 1997 December 31, 1998
------------------- -------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Number Exercise Number Exercise Number Exercise
of Shares Price of Shares Price of Shares Price
--------- ------- --------- -------- --------- --------
Options outstanding at
beginning of period: 237,500 $4.00 498,500 $5.08 816,900 $4.80
Granted 295,000 6.07 380,600 4.45 157,500 3.90
Canceled (34,000) 6.00 (62,200) 5.13 (382,000) 4.42
Exercised -- -- -- --
-------- ------ -------- ------- --------- ------
Options outstanding
at end of period 498,500 $5.08 816,900 $4.80 592,400 $4.88
======== ===== ======== ===== ========= =====
Options available
for grant 351,500 33,200 257,600
======== ======== =========
Exercisable at end
of period 118,750 $4.00 178,125 $4.00 197,200 $4.85
======== ===== ======== ===== ========= =====
Weighted average fair
value of options
granted $ 2.69 $ 2.93 $ 2.43
======= ======== =========
The Company has elected to account for its stock-based compensation plans under
APB Opinion 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 Opinion 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 1996, 1997, and 1998, using the Black-Scholes option pricing model with
the following weighted average assumptions:
Year Ended December 31,
----------------------------------
1996 1997 1998
---- ---- ----
Risk free interest rate 5.47% 6.16% 5.50%
Expected dividend yield -- -- --
Expected lives in years 5 5 5
Expected volatility 47.86% 62.47% 70.09%
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If the Company had accounted for its stock-based compensation plan using a fair
value based method of accounting, the Company's net loss and earnings per share
would have been reported as follows:
Year Ended December 31,
----------------------------------
1996 1997 1998
---- ---- ----
(in thousands, except per share amounts)
Net income (loss):
Pro forma $(4,607) $(150) $ 798
Earnings (loss) per share:
Pro forma - Basic $ (1.06) $(.03) $ .18
Pro forma - Diluted (1.06) (.03) .18
(6) MAJOR CUSTOMERS:
The Company's sales efforts have been concentrated on major wholesale
distributors as well as a direct dealer network. During 1996, 1997, and 1998,
sales to the Company's largest distributor accounted for 44%, 40%, and 39% of
total revenues, respectively.
Accounts receivable from this distributor comprise 36% and 32% of total accounts
receivable at December 31, 1997 and 1998, respectively. Generally, the Company
does not require collateral from its customers. The Company believes its credit
evaluation procedures substantially reduce its credit risk.
(7) INCOME TAXES:
The Company files a consolidated federal income tax return. The income tax
provision (benefit) is comprised of the following:
1996 1997 1998
---- ---- ----
Current $311,490 $202,753 $(167,449)
Deferred 15,201 (60,740) (163,234)
-------- -------- ---------
$326,691 $142,013 $(330,683)
======== ======== =========
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,
1997 and 1998, were as follows:
1997 1998
--------- ---------
Deferred tax assets:
Inventory and receivable reserves $ 238,902 $ 374,844
UNICAP adjustment 109,629 87,483
Other accruals 463,722 256,153
Research and development credit - 325,632
--------- ----------
$ 812,253 $1,044,112
========= ==========
F-14
1997 1998
--------- ---------
Deferred tax liabilities:
Depreciation differences (179,433) (264,113)
Amortization differences (53,027) (37,100)
--------- ---------
(232,460) (301,213)
--------- ---------
Net long-term deferred tax asset $ 579,793 $ 742,899
========= =========
The net long-term deferred tax asset is included in other long-term assets in
the accompanying consolidated balance sheet.
Reconciliation of the federal income tax rate to the Company's effective income
tax rate is as follows:
1996 1997 1998
---- ---- ----
Federal statutory tax rate 34.0% 34.0% 34.0%
State taxes, net 4.6 4.6 4.6
Research and development tax credits - (10.8) (93.4)
Non-deductible expenses and
other permanent differences (46.6) 3.8 4.1
----- ----- -----
(8.0)% 31.6% (50.7)%
===== ===== =====
In 1996, the Company recognized an asset impairment charge associated with
goodwill recorded in connection with the acquisition of Vodavi-CT. The goodwill
generated by the acquisition was non-deductible, and its impairment impacts the
Company's effective income tax rate in 1996.
In 1997, the Company recorded approximately $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 approximately $509,000 in available tax credits. Approximately
$183,000 in research and development tax credits was utilized through carrybacks
to prior years' and application to the current year's tax returns. In addition,
a deferred tax asset of approximately $326,000 was recorded. The realization of
this deferred tax asset is dependent on future income. The Company believes that
operating income will more likely than not be sufficient to fully realize this
deferred tax asset during the carryforward period.
(8) RELATED PARTIES TRANSACTIONS:
LG Information and Communications, Ltd. (LGIC), the Company's principal
supplier, owned approximately 18.7% of the Company's outstanding Common Stock at
December 31, 1998. The Company purchased approximately $17.9 million, $18.8
million, and $16.3 million of key telephone systems and commercial grade
telephones from LGIC and an affiliate of LGIC during 1996, 1997, and 1998,
respectively.
F-15
(9) SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest and income taxes for the years ended December 31, 1996,
1997, and 1998 were approximately as follows:
1996 1997 1998
---- ---- ----
Interest paid $840,000 $663,000 $791,000
Income taxes paid $ 22,000 $630,000 $ 58,000
F-16