ITEM 1. BUSINESS
Introduction
We design, develop, market, and support a broad range of business telecommunications solutions, including traditional, converged, and IP-based telephone systems and telephony applications, as well as traditional and IP-based commercial grade telephones, that address a wide variety of business applications. Our telephone systems incorporate sophisticated features such as automatic call distribution, scalable networking, Internet Protocol, or IP, as well as wireless solutions. Our telephony applications include Internet messaging, automated attendant, voice and fax mail, and computer-telephony products that enable users to integrate the functionality of their telephone systems with their computer systems. We market our products primarily in the United States as well as in foreign countries through a distribution model consisting primarily of wholesale distributors and direct dealers.
Our goal is to develop, deliver, and support high-quality telecommunications products and services that meet the demands of the markets we serve. Key elements of our strategy to achieve that goal include the following:
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focus on IP telephony product developments that provide more Voice over IP, or VoIP, functionality for our legacy products and our IP local area network, or LAN, telephony system;
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continued expansion of our core business of supplying telephone systems, telephony applications, and commercial grade telephones;
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develop marketing strategies and applications for vertical markets;
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emphasize sales of larger and more advanced systems through our dealers;
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expand our product lines and distribution to participate in the emerging Hosted IP Services Market;
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expand our strategic relationship with LG-Nortel Co. LTD., or LGN, which is a joint venture between the multi-billion dollar, Korean-based LG Group and Nortel Networks Corporation;
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enhance our existing products and expand our product lines by expanding our technological expertise and distribution channels through
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internal research and development efforts, and
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business acquisitions, license arrangements, and other strategic relationships.
Our corporate offices are located at 4717 East Hilton Avenue, Suite 400, Phoenix, Arizona, and our telephone number is (480) 443-6000. All references to our business operations in this report include the operations of Vodavi Technology, Inc. and our subsidiaries. Our website is located at www.vodavi.com. Through our website, we make available free of charge our annual report on Form 10-K, our proxy statement, our quarterly reports on Form 10-Q, our current reports on Form 8-K, amendments to reports filed under the Securities Exchange Act of 1934, and earnings press releases. These filings are available as soon as reasonably practical after we electronically file them with the Securities and Exchange Commission. We also post on our website the charters of our Audit, Compensation, and Nomination and Corporate Governance Committees; our Corporate Governance Guidelines, Code of Conduct, Code of Ethics for the CEO and Senior Financial Officers, and any amendments and waivers thereto; and any other corporate governance materials contemplated by SEC or Nasdaq regulations. These documents are also available in print to any stockholder requesting a copy from our corporate secretary at our principal executive offices.
Industry Overview
The telecommunications industry encompasses a broad range of equipment and service providers. We focus our efforts in the customer premise equipment, or CPE, segment of the industry. Within the CPE segment, we provide business telephone systems, telephony applications, and commercial grade telephones that help small to medium sized businesses streamline operations, reduce costs, and communicate more effectively.
Many factors have influenced the telecommunications industry over the years, including the following:
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broadband connectivity;
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successive technological developments that have resulted in enhanced features and services;
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optical networking technologies;
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wireless and mobile communications;
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emphasis on the use of communications systems to provide cost-effective customer service; and
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regulatory changes.
Perhaps the most significant technological advancement in recent years has been the evolution and acceptance of the Internet and other packet-switched networks to carry voice and data traffic. This evolution is transforming the way businesses communicate and allows equipment providers to develop sophisticated systems that offer a wide variety of applications in addition to traditional call switching functions. While utilizing packet-switched networks to carry voice and data traffic can offer more efficiencies and value to businesses, the traditional telephone network utilizing analog and digital time-division-multiplexing, or TDM, technologies remains the standard for voice communications today. Nevertheless, businesses of all sizes will increasingly demand affordable telecommunications systems that provide the capacity for the following:
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IP-enabled telephone systems, which represent products based on TDM technology that have been blended with IP technology, to create IP capable business communications systems that retain certain TDM functionality while taking advantage of newer IP technology for certain applications;
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IP telephony, which represents products based exclusively on IP technology for voice and data communications. These products take advantage of a common infrastructure, provide scalability, and integrate with data networks to simplify administration;
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Voice processing applications that automate call answering, provide voice mail and automated call distribution functions, provide the capacity to manage facsimile messages, and unified messaging applications, which allow users to receive all message types (voice, e-mail, fax) to be managed from their e-mail program;
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Computer-telephony applications, which greatly enhances efficiency and productivity by integrating businesses’ voice and data networks; and
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Contact Center applications, wireless offerings, and remote worker applications to further increase employee mobility and efficiency.
Our Products
We currently design, develop, market, and support a broad range of products that can be categorized as follows:
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telephone systems, which include traditional digital and IP-based key telephone systems;
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telephony applications, which include voice messaging, automated attendant, automatic call distribution, as well as advanced messaging products that include fax mail, and unified messaging systems, and computer-telephony products, including Windows-based application products such as PC telephones and attendant consoles, local area network to PBX connection packages, IP gateways, and Internet messaging systems; and
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commercial grade telephones, which include single-line and multi-line traditional and IP-based telephones.
Telephony Systems
Sales of telephone systems represented approximately 87% of our revenue during 2005, 83% in 2004, and 81% in 2003. A 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 and modems, located at individual “stations.” We supply various models of telephone sets with progressive features for use in conjunction with each of our telephone systems.
We currently market various lines of telephone systems under our STARPLUS and Vodavi brand names for businesses requiring as few as eight stations up to 492 stations (a 600-port system). Our flagship digital telephone systems are the XTS (eXpandable Telephone System) for larger applications and the STS for smaller businesses and residences. These systems employ a digital architecture in order to provide digital voice transmission and system control. Most of our digital telephone systems feature flexible software combined with modular hardware and card slot design, which allow cost-effective system customization and expansion to meet the needs of individual users. Our digital telephone systems are fully compatible with industry-standard commercial grade telephones and contain an extensive array of standard features that add sophistication generally found only in larger telephone systems. We design our telephone systems to permit expansion or customization for specific business applications by the installation of a variety of voice processing or computer-telephony integration applications.
In addition, our XTS system can be IP-enabled with the addition of a VoIP Gateway, or LAN card. An IP-enabled XTS, together with our IP networking software package allows up to 32 XTS systems to communicate as one large system using an IP infrastructure. This configuration allows companies with multiple locations or remote workers to communicate more efficiently and to reduce costs by utilizing a common network to connect multiple locations together.
Our digital systems enable customers to upgrade their telephone systems as their businesses grow and as technology advances by adding or replacing components in stages without replacing their entire systems. As a result, it is generally more economical for the end users to expand our systems than to switch to a competitor’s system. We believe that the cost savings and flexibility we provide our customers through this migration strategy provides us with a competitive advantage.
Our flagship IP-based telephone system, the Telenium, is based exclusively on IP technology, which allows a business’ local area network or wide area network to be utilized as the communication medium. The Telenium system provides an extensive array of standard features that operate in much the same manner as a traditional system. The Telenium system also offers web-based administration, which simplifies administration locally or from a remote location. The Telenium system accommodates IP telephones, software-based phones for personal computers and PDA’s, Wi-Fi phones, commercial grade telephones, and a variety of incoming lines including traditional as well as ISDN types.
Telephony Applications
Telephony applications include a combination of various software and hardware solutions designed to improve customer service and reduce labor costs while providing faster, more efficient routing of incoming calls as well as speeding up and simplifying message delivery and storage. Some of our telephony applications may be integrated with telephone systems sold by competing manufacturers while other applications only integrate with our telephone systems to differentiate them from our competitors’ products and to provide a value-added basis for
increased sales and profit margins. Sales of telephony applications accounted for approximately 7% of our revenue during 2005, 11% during 2004, and 13% during 2003.
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 locations. Each voice mailbox can be customized to the individual user’s needs. Voice messages can be stored, replayed, saved, or erased as desired by the user. The menu routing functions included in some of our voice mail systems enable business users to program the systems to create custom, multi-level menus that permit callers to automatically access organizational departments or product, service, or event information by dialing menu choices.
In addition to our larger voice processing systems, we market a line of self-contained, competitively priced voice processing systems designed for small- to medium-sized organizations. These systems, which work in conjunction with telephone systems sold by us as well as other manufacturers, can be expanded from two ports up to eight ports, feature a full range of automated attendant and voice mail functions, and include a serial port for administration via the user’s personal computer.
Advanced Messaging Platform
Our Pathfinder Microsoft® Windows based messaging systems, which provide virtually unlimited port capacities, combine voice mail functions with facsimile messaging capabilities (known as fax mail) as well as the ability to share messages with other voice messaging systems over the Internet. Fax mail provides the ability to receive, store, retrieve, and forward facsimile messages in the same manner that voice mail handles voice messages. Our fax mail system digitizes and stores facsimile messages and notifies the user that messages have been received. The user can retrieve and print the facsimiles from his or her office or remote locations (such as a hotel room) and can also instruct the system to forward facsimiles to other recipients. “Fax-on-demand” enables callers to access information stored by a business, such as sales and marketing brochures, technical specifications, and pricing data, and request the system to transmit the desired information to the caller’s facsimile machine.
Our Pathfinder system also uses Internet e-mail protocols to enable voice messages to be transported over the Internet or other electronic fields for efficient, low-cost information exchange between remote systems. In addition, our Pathfinder Internet fax delivery systems connect the user’s telephone and computer to enable the user to transmit facsimile messages or documents to conventional facsimile machines via the Internet. These systems provide ease of use and avoid problems associated with e-mail attachments, mismatched data encryption techniques, or private or switched network costs. Our Internet fax delivery systems provide spoken prompts that guide the user through the transmission process and also transmit delivery confirmations to the user’s mailbox. As a result, a business with multiple offices can extend its voice messaging system so as to permit employees in different locations to create, receive, answer, or forward voice and facsimile messages via the Internet more quickly, efficiently, and economically than traditional long-distance telephone calls.
Our Pathfinder system also uses Microsoft® 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.
Automatic Call Distribution
We market our automatic call distribution, or ACD, software systems and ACD reporting packages for use with our telephone systems. The automatic call distribution functions enable businesses that receive customer calls to manage incoming calls efficiently by directly routing them to the proper person or group. Our ACD systems reduce the number of abandoned calls by reducing the number of calls placed on hold and by minimizing the length of time that calls are kept on hold. When all group member telephones are busy, ACD plays a custom “hold” message for the caller and connects the call to the first available person or sales agent. ACD saves employee time by eliminating the necessity of continually answering and transferring calls to the same groups. ACD enables agents
with display telephones to see the number of calls waiting in queue as well as the length of the longest waiting call in order to speed call handling at times of heavy calling activity.
Our ACD reporting package provides real-time statistics and comprehensive reports on calling activity for review by the user’s management. These statistics allow users to analyze and make informed decisions regarding their business operations.
Computer-Telephony Integration Products
We market CTI products that use an open architecture to integrate computer and telephone systems into a user-friendly information processing and storage system. Our CTI products allow a user:
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to use the Internet to access voice, facsimile, and e-mail messages via personal computers;
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to incorporate telephone functions with computer software to speed call handling and permit the user to personalize telephone functions;
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to identify incoming callers and immediately access computer files relating to the caller;
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to connect Windows-based local area networks to the user’s telephone system; and
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to access and analyze call accounting information quickly and inexpensively.
Commercial Grade Telephones
We market several models of commercial grade telephones for use with IP-based, analog or digital telephone systems, PBX systems, or telephone company central office, or Centrex, switching systems and software-based “soft switch” systems used in the hosted IP services market. Businesses, the hospitality industry, and school districts represent the principal purchasers of our commercial grade telephones. All of our commercial grade telephones meet industry standards for commercial telephone units and may be used with telephone systems sold by us or by competing manufacturers.
Our commercial grade telephones offer a myriad of features, functions, and designs ranging from simple, traditionally styled desk and wall-mounted telephones to programmable telephones with contemporary styling. Our more advanced commercial grade telephones contain a central processing unit, built-in memory, built-in data jacks, built-in speakerphones, built-in Caller ID, and the capability to use custom calling features provided by local telephone companies. Sales of commercial grade telephones represented approximately 4% of our revenue during 2005, 5% of our revenue during 2004, and 5% during 2003.
New Product Development
We engage in an ongoing program to develop enhancements to our existing product lines and to develop new products that address the increasing demands of business organizations for productivity enhancing communication solutions. We believe that continuous development of new products and features will be necessary to enable us to continue to offer telephony systems, voice processing products, computer-telephony products, and related business communications products that will be in greatest demand and that will provide the best opportunities for our growth and profitability on an ongoing basis. We are currently focusing our product development efforts on new products and enhancements that will address broader market applications, sophistication, and value to our current product offerings. In addition, through new developments, we are targeting specific market segments that we do not currently serve. Examples of our current developments include the following:
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the fourth phase of our IP telephone system, the Telenium, providing advance audio and video conferencing capabilities;
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a more economical, second generation WiFi phone;
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enhancing our XTS IP telephone system to include IP trunking capabilities;
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a next generation, router-based data and voice appliance, or gateway, providing wired and wireless data and voice services for small businesses; and
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a software-based administration tool that provides advanced management interfaces into our telephone systems that reduce installation times and maintenance.
We are expanding our strategic alliances with LGN and other third parties related to the development of new products, product lines, or product features, including new features on our Telenium IP system. We will continue to seek additional strategic alliances for new product development in the future.
Sales, Marketing, and Distribution
We currently market our products in all 50 states and, to a limited extent, internationally through a distribution network consisting primarily of Authorized Dealers and wholesale distributors, who resell our products to general sales and installation companies and to Authorized Vodavi Dealers that do not buy directly from our company. We also distribute our products and services directly to end-users in the Phoenix metropolitan area. We have in the past and may in the future market our products on a private label basis to original equipment manufacturers, or OEMs.
Authorized Vodavi Dealers
We have approximately 430 Authorized Dealers that sell our products. Approximately 160 Authorized Dealers buy our products directly from our company and approximately 270 Authorized Dealers buy our products through our wholesale distributors. Our Authorized Dealers generally must commit to minimum purchases of our products and must be trained and certified through our formal product and sales training program. Our goal is to encourage Authorized Dealers to promote our products to their customers as the preferred line of telecommunications equipment. We provide Authorized Dealers with marketing, sales, and product support services as well as incentive programs to encourage the sale of our products.
We maintain a program to focus on selling to fewer, but larger and better-established, dealers. We secure arrangements with large-volume, well-qualified dealers and have discontinued sales to dealers that have not provided a sufficient level of sales or support for our products. We strive to secure dealers that maintain large customer bases and possess the resources needed to provide quality sales presentations and support to their customers.
We believe that the principal advantages of having an authorized dealer program include greater control over the application and installation of our products and the ability to obtain market feedback on product pricing, quality, and technology. Purchases from our Authorized Dealers represented approximately 60% of our total revenue in 2005, 2004 and 2003, whether those purchases were made directly from our company or through our wholesale distributors.
Wholesale Distributors
We have a select number of wholesale distributors that resell our full line of products to Authorized Dealers and our STARPLUS line and non IP-based, or traditional, commercial grade telephones to general telephone sales and installation companies and independent telephone companies. Our STARPLUS line of products consists of our STS and STSe telephone systems. We provide ongoing support and training to enable our wholesale distributors to sell more effectively our products and to provide their customers with technical assistance in installation, maintenance, and customer support. We believe that sales through wholesale distributors offer several advantages, including the following:
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established distribution systems and access to a large number of dealer and national customer accounts;
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maintenance of customer credit facilities and an established inventory of our products;
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availability of products in over 600 locations throughout the United States;
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security of receivables;
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reduced needs for direct training;
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effective promotion of our products at trade shows;
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geographically dispersed sales forces that can reach customers more effectively than we would otherwise be able to do; and
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lower support and carrying costs compared with the costs associated with direct sales to a large number of dealers.
Wholesale distributors that currently resell our products include Graybar Electric Co., Inc., Alltel Supply, Inc., Sprint/North Supply, Famous Telephone Supply, ADI, and Target Distributing, Inc. Graybar accounted for 23% of our revenue during 2005, 26% in 2004 and 27% in 2003. Target, our second largest distributor, accounted for 21% of our revenue during 2005, 17% in 2004 and 14% in 2003.
Vodavi Direct
We have a direct sales office that sells our products and provides pre- and post-sales support services directly to end-users in the Phoenix metropolitan area. Our direct sales office also serves as a conduit for the beta testing of our new product developments, which greatly enhances the product development life cycle. We acquired this operation during March 2002 through our acquisition of Dataspeak Systems, Inc.
International Sales
To date, sales of our products in foreign countries have not represented a significant portion of our revenue. We believe, however, that sales of our products in international markets may increase in the future as demand for features, such as voice mail, advanced messaging, and automatic call distribution increases, as communications infrastructures are improved, and as regulatory differences between countries are eliminated. All of our sales in foreign countries are denominated in U.S. dollars.
In-house Sales Support Staff
We have an in-house sales support staff who provide Authorized Dealers and wholesale distributors with order fulfillment, marketing, sales, and pre-sales support. We believe that our commitment to support dealers that sell our products on a pre-sale and post-sale basis provides us with a competitive advantage.
Research and Development; Strategic Alliances with LGN and Other Companies
We believe that the continued development of software that distinguishes the functions and features of our products from those of our competitors represents a critical factor in determining our ongoing success. Our engineering staff consists of highly trained and experienced software professionals who focus on providing and supporting high-quality, user-friendly business communications systems and related products. The availability of in-house software and systems development expertise at our facilities in Arizona and Georgia provides us with product control, permits faster turnaround and reaction time to changing market conditions, and provides a solid base of maintenance and support services to end users. We use product and market development groups that interact with customers in order to anticipate and respond to customer needs through development of new product programs and enhancement of existing product lines.
We conduct joint development activities with LGN for the design and development of hardware incorporated into some of our existing and planned telephone systems and commercial grade telephone product lines. Other products are completely developed by LGN. In connection with the products jointly developed with LGN, we provide market analysis, product management, functional and performance standards, software development, quality control program development, sales and distribution, and customer service and support, while LGN provides hardware research, design, and development, development of components such as integrated circuits and semiconductor chips, and manufacturing and production engineering. Generally, LGN contributes the ongoing research and development costs for the product hardware in return for an arrangement under which LGN produces the finished goods developed under the alliance. As a result of this arrangement, we have been able to obtain access to LGN’s research and development expertise and resources while controlling our capital expenditures for much of our product development efforts. In addition, our arrangement with LGN enables us to minimize the risks inherent in making significant investments in research and development infrastructure or personnel. To the extent that we develop new hardware in conjunction with LGN or another development partner, the development partner typically retains ownership rights to the new hardware and we retain the right to sell products incorporating that hardware throughout North America and the Caribbean. See Item 1, “Business - - Manufacturing” and Item 1, “Business - - Risk Factors - We rely on LGN as a strategic partner.” We have successfully engaged in such projects with LGN in the past and believe that we will continue to have access to LGN’s advanced hardware research and development capabilities as we develop new product lines.
We enhance our software development expertise through acquisitions of or licensing arrangements and other strategic alliances with independent third-party developers. We have active strategic alliance relationships with other companies that possess expertise in automatic call distribution, computer telephony, Internet telephony, and certain voice mail applications. We believe that our strategic alliances with other companies enable us to develop products and bring them to market more quickly and at a lower cost than we would be able to achieve by developing the products internally. We intend to pursue additional opportunities to enter into strategic alliances with other companies that possess established expertise in specific technologies in order to co-develop proprietary products, or to acquire such companies in order to develop new products internally.
Manufacturing
We obtain our telephone systems, some of our telephony applications, and our commercial grade telephones under supply arrangements with various third-party manufacturers, including LGN. We also purchase certain voice processing products from third parties on an OEM basis. Our agreements with the third-party manufacturers generally require the manufacturers to produce our products according to our technical specifications, to perform quality control functions or otherwise meet our quality standards for manufacturing, and to test or inspect the products prior to shipment. Under the manufacturing and supply agreements, the manufacturers provide us with warranties that the products are free of defects in material and workmanship. The agreements also require the manufacturers to repair or replace, at their expense, products that fail to conform to the warranties within specified periods. All of the equipment and most of the tools and molds used in the manufacturing process are owned by the third-party manufacturers.
We obtain a majority of our telephone systems, voice mail products and IP-based commercial grade telephones from LGN, which owns the rights to produce this equipment. Under an agreement with our Company, LGN granted us the exclusive right to distribute and sell throughout North America and the Caribbean the products that LGN manufacturers for us. The agreement expires in December 2009. We purchase products manufactured by LGN in Korea on a purchase order basis. We purchased $20.3 million, $20.8 million, and $20.0 million of product from LGN in 2005, 2004, and 2003, which represented 80%, 82%, and 82%, of our total purchases, respectively. LGN currently owns approximately 23% of our outstanding common stock. See Item 1A, “ Risk Factors - We rely on LGN as a strategic partner” and “ Risk Factors - Certain conflicts of interest may arise as a result of LGN’s ownership interest in our company.”
We obtain all of our traditional commercial grade telephones and replacement parts for such telephones from LG Sritahi InfoComm (Thailand) Co., Ltd., or LGICTH, a joint venture between LGN and Srithai Group, a Thailand-based entity. Under an agreement with our company, LGICTH granted us the right to distribute and sell throughout the United States and Canada the products that LGICTH manufactures for us in Thailand. Our agreement with LGICTH prohibits us from purchasing the products covered by the agreement from any other
manufacturer during the term of the agreement. The initial term of the agreement expires in December 2007; however, the agreement automatically renews for successive one-year terms unless either party provides notice to the other of its intent to cancel the agreement at least six months prior to the end of the then-current term. We make all purchases pursuant to the agreement on a purchase order basis. We purchased $1.0 million, $1.4 million, and $1.1 million of product from LGICTH in 2005, 2004, and 2003, which represented 4%, 6%, and 5% of our total purchases, respectively. See Item 1, “Business - Risk Factors - We rely on LGN as a strategic partner” and “Business - Risk Factors - Certain conflicts of interest may arise as a result of LGN’s ownership interest in our company.”
We currently maintain a $5.0 million insurance policy to cover lost revenue in the event of significant interruptions in purchases from our overseas manufacturers. See Item 1, “Business - Risk Factors - We depend on third parties for manufacturing” and Item 1, “Business - Risk Factors - We face risks associated with international manufacturing sources.”
Quality Control
We recognize that product quality and reliability are critical factors in distinguishing our products from those of our competitors. We design our products to include components meeting specified quality standards in order to assure reliable performance. We also require our third-party manufacturers to comply with specified quality standards regarding materials and assembly methods used in manufacturing our products. In addition, we maintain a rigorous quality assurance program designed to assure that the manufacture of our products conforms to specified standards and to detect substandard products before shipment. We have an inspection program in which we examine varying numbers of our products as they arrive at our warehouse in Arizona, depending upon the manufacturer and the type of product.
Support Services
We provide limited warranties against defective materials and workmanship on each of the products that we sell. We provide a complete support service for all of our products by maintaining a 24-hour toll-free telephone number and e-mail support that our resellers can contact for trouble shooting and diagnostic assistance. We also maintain a technical support page on our Web site that includes frequently asked questions, technical tips, and product-related notifications. We maintain an operating set-up of each of our telephone systems, key telephone units, and peripheral systems at our headquarters facility, supported by a staff of technicians trained to handle service assistance calls. When a dealer or interconnect calls with a question relating to performance malfunctions or an operational system question, our personnel attempt to replicate any problem the user is encountering, diagnose the cause, and provide a solution via telephone. If our technicians cannot determine the cause of the malfunction over the telephone, we dispatch a service representative to the user’s place of business in order to locate the source of the problem and take corrective measures.
We currently outsource the repair and refurbishment of our products. We believe that this arrangement enables us to continue to provide fast turn-around time and consistent quality of repairs without the overhead and other expenses associated with operating a repair facility.
Competition
Markets for communications products are extremely competitive. We currently compete principally on the basis of the technical innovation and performance of our products, including their ease of installation and use, reliability, price, and the technical support both before and after sales to end users. Our competitors include Avaya, Inc., Inter-Tel, Inc., Iwatsu, NEC Corporation, Nortel Networks Corporation, Panasonic Technologies, Inc., 3Com Corporation, AltiGen Communications, Inc., Artisoft, Inc., and Cisco Systems, Inc. and Toshiba Information Systems.
Some of our product lines compete with products and services provided by the regional Bell operating companies, or RBOCs, which offer telephone systems and commercial grade telephones produced by several of the competitors named above as well as Centrex systems and Hosted IP Services that provide automatic call distribution facilities and features through equipment located in the telephone company’s central switching offices. Many
competitors listed above are larger than our company and therefore may have greater financial resources at their disposal.
Patents, Trademarks, and Licenses
We own various U.S. patents. We intend to continue to seek patents on our inventions used in our products. The process of seeking patent protection can be expensive and can consume significant management resources. We believe that our patents strengthen our negotiating position with respect to future disputes that may arise regarding our technology. However, we believe that our continued success depends primarily on such factors as the technological skills and innovative abilities of our personnel rather than on our patents. We cannot assure you that patents will issue from our pending or future applications or that any patents that are issued will provide meaningful protection or other commercial advantage.
We own a number of registered and unregistered trademarks that we consider to be an important factor in marketing our products. Our ability to compete may be enhanced by our ability to protect our proprietary information, including the issuance of patents, copyrights, and trademarks. We also have taken steps to protect our proprietary information through a “trade secrets” program that includes copy protection of our software programs and obtaining confidentiality agreements with our employees and resellers. We cannot assure you, however, that these efforts will be effective in preventing misappropriation, reverse engineering or independent development of our proprietary information by our competitors. While none of our intellectual property rights have been invalidated or declared unenforceable, we cannot assure you that our rights will be upheld in the future. Accordingly, we believe that, due to the rapid pace of technological change in the telecommunications industry, the technical and creative skills of our engineers and other personnel will be extremely important in determining our future technological success.
We license from third parties the rights to the software included in certain of our products, including certain CTI and ACD products. These licenses generally give us a non-exclusive right to use and sell the licensed software included in our products during the term of the applicable agreement. We pay the licensors fees based on the number of units that we purchase from them.
The telecommunications industry is characterized by rapid technological development and frequent introduction of new products and features. In order to remain competitive, we and other telecommunications manufacturers continually find it necessary to develop products and features that provide functions similar to those of other industry participants, often with incomplete knowledge of whether patent or copyright protection may have been applied for or obtained by other parties. As a result, we receive notices from time to time alleging possible infringement of patents and other intellectual property rights of others. To date, we have been able to successfully defend ourselves against these claims or to negotiate settlements to these claims on terms we believe to be favorable. In the future, however, the defense of such claims, fees paid in settlement of such claims, or costs associated with licensing rights to use the intellectual property of others or to develop alternative technology may have a material adverse impact on our operations.
Government Regulation
The U.S. government from time to time has imposed anti-dumping duties on some telephone products manufactured in some of the countries where our products are manufactured. Most recently, duties on certain of our products were phased out between 1997 and 2000. We cannot assure you that similar duties will not be imposed in the future on telephone products, including our products, manufactured in these or other foreign countries. The imposition of such additional duties on our products could have a material adverse effect our operating results.
Employees
As of December 31, 2005, we employed a total of 110 people, all of which were full-time employees at our facilities in Phoenix, Arizona, and Lawrenceville, Georgia. Our current number of full-time employees includes 28 people in engineering and product development; 57 in sales, marketing, and technical support; 10 in warehouse and distribution functions; and 15 in administration, including executive personnel. We consider our relationship with our employees to be good, and none of our employees currently are represented by a union.
ITEM 1A.
ITEM 1A. RISK FACTORS
You should carefully consider the following factors, in addition to those discussed elsewhere in this report, in evaluating our company and our business. Some of the statements and information contained in this report that are not historical facts are forward-looking statements, as such term is defined in the securities laws. These include statements concerning future, proposed, and anticipated activities of our company; certain trends with respect to our revenue, operating results, capital resources, and liquidity; and certain trends with respect to the markets where we compete or the telecommunications industry in general. Forward-looking statements, by their very nature, include risks and uncertainties, many of which are beyond our control. Accordingly, actual results may differ, perhaps materially, from those expressed in or implied by such forward-looking statements. Factors that could cause actual results to differ materially include those discussed under this Item 1A, “Risk Factors.”
We rely upon LGN as a strategic partner
We rely on LGN to supply most of our telephone systems and voice mail products and all of our commercial grade telephones. We also rely on LGN’s engineering, hardware and circuit development, and manufacturing capabilities. We purchased approximately $21.2 million, $22.2 million, and $21.1 million of product LGN and LGITCH, constituting approximately 84%, 88%, and 87% of our total purchases in 2005, 2004, and 2003, respectively.
Additionally, we consider Nortel Networks Corporation, the controlling joint venture partner in LGN, to be a direct competitor with our company in North America. Although, we have a long-term manufacturing and supply agreement with LGN that expires in December 2009, we cannot be assured that LGN will continue to support our business or operations.
Certain conflicts of interest may arise as a result of LGN’s ownership interest in our company.
LGN currently owns approximately 23% of our outstanding common stock. We obtain most of our telephone systems, IP-based products, and voice mail products from LGN and obtain all of our commercial grade telephones and replacement parts for such telephones from LGICTH, an affiliate of LGN. See Item 1, “Business - Manufacturing” and Item 1A. “Risk Factors - We rely on LGN as a strategic partner.” As a result of LGN’s direct ownership interest in us, an inherent conflict of interest exists in establishing the volume and terms and conditions of our purchases from LGN and LGICTH. In order to mitigate such conflicts, all decisions with respect to such purchases are made by our officers and reviewed by directors who have no relationship with LGN.
Our relationship with LGN may have the effect of making more difficult or delaying attempts by others to obtain control of us, even when these attempts may be in the best interests of stockholders. Through LGN’s stockholder interest and business interests in our company, LGN may have significant influence over our business.
Our stock price may be volatile.
The trading price of our common stock in the public securities market could be subject to a variety of factors, including the following:
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wide fluctuations in response to quarterly variations in our operating results or the operating results of our competitors;
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actual or anticipated announcements of technological innovations or new product developments by us or our competitors;
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significant actual or anticipated expenditures for property or equipment, research and development, sales and marketing activities, or other planned or unanticipated events;
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changes in analysts’ estimates of our financial performance;
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limited trading activity and a relatively small public float;
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developments or disputes concerning proprietary rights;
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regulatory developments;
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general industry conditions; and
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worldwide economic and financial conditions.
The trading volume of our common stock in the past has been limited, which may increase the volatility of the market price for our stock and reduce the liquidity of an investment in shares of our common stock. During certain periods, the stock markets have experienced extreme price and volume fluctuations. In particular, prices for many technology stocks often fluctuate widely, frequently for reasons unrelated to the operating performance of such companies. These broad market fluctuations and other factors may adversely affect the market price of our common stock.
Our reliance on our independent distribution network affects our inventory levels, the timing and predictability of our revenue, and our overall operating results.
We currently market our products through a distribution network consisting primarily of large wholesale distributors and telephone sales and installation companies known as “direct dealers.” Distributors generally maintain inventories in amounts that they consider sufficient to fill anticipated orders. A decline in the volume of sales made by distributors could result in their inventory levels exceeding their anticipated sales, which could delay purchases of additional products from us until the distributors’ inventories reach re-ordering levels. Direct dealers generally stock inventories only in quantities they deem sufficient to fill anticipated short-term orders, including orders related to support and maintenance. As a result, distributors and direct dealers may cancel orders and delay or change volume levels on short notice to us. Because the sale of telephone systems, voice processing and related products typically involves a long sales cycle, we may not be able to accurately forecast our own inventory levels. Our reliance on third-party distributors and dealers to sell our products could further exaggerate any inventory shortages or excesses that we might experience, particularly if our distributors or dealers are not able to give us adequate notice of anticipated changes in demand for our products.
Additionally, we offer our distributors price protection on their inventory of our products. If we reduce the list price of our products, we will compensate our distributors for the respective products that remain in their inventory on the date the price adjustment becomes effective. If we do not have sufficient cash resources to compensate distributors on terms satisfactory to them or us, our price protection obligations may prevent us from reacting quickly to competitive market conditions.
We depend upon independent distributors and direct dealers to sell our products to end users, to perform installation services, and to perform service and support functions after the sale. Other telephone system manufacturers compete intensely for the attention of the same distributors and direct dealers, most of which carry products that compete directly with our products. We may not be able to maintain favorable relationships with the distributors and direct dealers that currently carry our product lines in order to encourage them to promote and sell our products instead of those of our competitors. In addition, we may not be able to develop such relationships with additional distributors and dealers in the future.
Graybar accounted for 23% of our sales during 2005, 26% of our sales during 2004 and 27% during 2003. Accounts receivable from Graybar comprised approximately 29% of total accounts receivable at December 31, 2005. Our second largest distributor in each of the respective years accounted for 21% of our sales during 2005, 17% of our sales during 2004 and 14% during 2003. Accounts receivable from our second largest distributor comprised approximately 28% of total accounts receivable at December 31, 2005.
We face risks associated with international manufacturing sources.
We currently obtain a substantial majority of our products under various manufacturing arrangements with third-party manufacturers in South Korea and Thailand. We believe that production of our product lines overseas enables us to obtain these items on a cost basis that enhances our ability to market them profitably. Our reliance on third-party manufacturers to provide personnel and facilities in these countries and the potential imposition of quota limitations on imported goods from certain Far East countries expose us to certain economic and political risks, including the following:
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political instability in Asia, and in particular on the Korean Peninsula;
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the business and financial condition of our third-party manufacturers;
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the possibility of expropriation, supply disruption, currency controls, and currency exchange fluctuations;
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changes in tax laws, tariffs, and freight rates; and
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strikes, work slow downs, or lockouts at any ports where our products arrive in the United States.
The countries in which most of our products are manufactured also have been subject to economic problems in the past. Although the economic situation in Asia in recent years has not resulted in any adverse changes in our ability to obtain products or the prices that we pay for our products, an extended period of financial pressure on overseas markets or currency devaluations that result in a financial setback to our overseas manufacturers could have an adverse impact on our operations.
Protectionist trade legislation in either the United States or foreign countries, such as a change in the current tariff structures, export compliance laws, or other trade policies, could adversely affect our ability to purchase our products from foreign suppliers or the price at which we can obtain those products.
We depend on new products and technologies.
We operate in an industry that is characterized by fast-changing technology. As a result, we will be required to expend substantial funds for and commit significant resources to the conduct of continuing product development, including research and development activities and the engagement of additional engineering and other technical personnel. Any failure on our part to anticipate or respond adequately to technological developments, customer requirements, or new design and production techniques, or any significant delays in product development or introduction, could have a material adverse effect on our operations.
Our future operating results will depend to a significant extent on our ability to identify, develop, and market enhancements or improvements to existing product lines as well as to introduce new product lines that compare favorably on the basis of time to market, price, and performance with the product lines offered by our competitors, many of which have greater financial, technical, marketing distribution, and other resources than we posses. The success of new product lines depends on various factors, including proper market segment selection, utilization of advances in technology, innovative development of new product concepts, timely completion and delivery of new product lines, efficient and cost-effective features, and market acceptance of our products. Because of the complexity of the design and manufacturing processes required by our products, we may experience delays from time to time in completing the design and manufacture of improvements to existing product lines or the introduction of new product lines. In addition, customers or markets may not accept new product lines. Our failure to design and implement enhancements to existing product lines or failure to introduce new products on a timely and cost-effective basis would adversely affect our future operating results.
Complex software programs, such as those we develop or those developed by other software sources and incorporated into our products, occasionally contain errors that are discovered only after the product has been installed and used by many different customers in a variety of business operations. Although we conduct extensive
testing of the software programs included in our products, we may not successfully detect and eliminate all such errors in our products prior to shipment. Significant programming errors in product software could require substantial design modifications that may create delays in product introduction and shipment and that could result in an adverse impact on our reputation as well as on our operating results.
The telecommunications industry is cyclical.
The telecommunications industry has experienced economic downturns at various times, characterized by diminished product demand, accelerated erosion of average selling prices, and production overcapacity. We have sought to reduce our exposure to industry downturns by targeting our product lines towards small- and medium-sized businesses, which we believe will sustain continued growth in the near and long-term, resulting in a steadily increasing demand for enhanced and upgraded telephone systems and voice processing products. However, we may experience substantial period-to-period fluctuations in future operating results because of general industry conditions or events occurring in the general economy. In addition, the size and timing of sales of our new voice processing, IP systems, and computer-telephony products may vary from quarter to quarter to a greater extent in future periods. The expanding importance of these new products could result in significant variations in our overall operating results on a quarterly basis.
We must finance the maintenance and expansion of our business and the development of new products.
To remain competitive, we must continue to make significant investments in research and development, equipment, and facilities. As a result of the increase in fixed costs and operating expenses related to these expenditures, our failure to increase net sales sufficiently to offset the increased costs may adversely affect our operating results. From time to time, we may seek additional equity or debt financing to provide for the expenditures required to maintain or expand our business. We cannot predict the timing and amount of any such capital requirements. Such financing may not be available or, if available, may not be available on terms satisfactory to us. If such financing is not available on satisfactory terms, we may be unable to maintain or expand our business or develop new products at the rate desired and our operating results may be adversely affected. Debt financing increases expenses and must be repaid regardless of our operating results. Equity financing could result in additional dilution to existing stockholders. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”
We depend on third parties for manufacturing.
We depend upon third parties to manufacture our products. We do not own most of the equipment, tools, and molds used in the manufacturing process, and we have only limited control over the manufacturing processes. As a result, certain difficulties could have a material adverse effect on our business, including any difficulties encountered by the third-party manufacturers that result in
Our operations would be adversely affected if we were to lose our relationship with any of our suppliers, if any of our suppliers’ operations were interrupted or terminated, or if overseas or air transportation services were disrupted even for a relatively short period of time. We do not maintain an inventory of sufficient size to provide protection for any significant period against an interruption of supply, particularly if we were required to locate and use alternative sources of supply.
Markets for our products are intensely competitive, and we cannot assure you that we will be able to compete successfully in the future.
We engage in an intensely competitive business that has been characterized by price erosion, rapid technological change, and foreign competition. We compete with major domestic and international companies.
Many of our competitors have greater market recognition and substantially greater financial, technical, marketing, distribution, and other resources than we possess. Emerging companies also may increase their participation in the telephone systems and peripherals markets. Our ability to compete successfully depends on a number of factors both within and outside our control, including the following:
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the quality, performance, reliability, features, ease of use, pricing, and diversity of our product lines;
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the performance of our distributors and dealers;
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the quality of our customer services;
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our ability to address the needs of our customers;
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our success in designing and manufacturing new products, including those implementing new technologies;
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the availability of adequate sources of raw materials, finished components, and other supplies at acceptable prices;
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our suppliers’ efficiency of production;
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the rate at which end users upgrade or expand their existing telephone systems, applications, and services;
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new product introductions by our competitors;
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the number, nature, and success of our competitors in a given market; and
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general market and economic conditions.
We currently compete principally on the basis of the technical innovation and performance of our products, including their ease of use and reliability, as well as price, timely delivery, and after-sale service and technical support. We may not continue to be able to compete successfully in the future.
We face risks associated with patents, licenses, and intellectual property.
Our success depends in part upon our ability to protect our proprietary technology. We rely on a combination of copyright, trademark, and trade secret laws, nondisclosure and other contractual agreements, and technical measures to protect our proprietary technology. We have acquired certain patents and patent licenses, and we intend to continue to seek patents on our inventions. We face risks associated with our intellectual property, including the following:
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the steps we have taken to protect our proprietary rights may be inadequate to protect misappropriation of such rights;
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third parties may independently develop equivalent or superior technology;
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the process of seeking patent protection can be long and expensive, and patents may not issue from future applications;
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existing patents or any new patents that are issued may not be of sufficient scope or strength to provide us meaningful protection or any commercial advantage;
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we may be subject to or may initiate interference proceedings in the U.S. Patent and Trademark Office, which can demand significant financial and management resources; and
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we may commence litigation to enforce patents or other intellectual property rights, or to defend us against claimed infringement of the rights of others, which could result in substantial cost to us and diversion of our management’s attention.
As is typical in the telecommunications industry, we have received from time to time, and in the future may receive, allegations of possible infringement of patents or other intellectual property rights of others. Based on industry practice, we believe that in most cases we could obtain any necessary licenses or other rights on commercially reasonable terms. In the event that a third party alleges that we are infringing its rights, we may not be able to obtain licenses on commercially reasonable terms from the third party, if at all, or the third party may commence litigation against us. The failure to obtain necessary licenses or other rights or the occurrence of litigation arising out of such claims could materially and adversely affect us, our result of operations, or prospects.
Our third-party manufacturers may experience shortages of raw materials and supplies.
The principal raw materials and components used in producing our products consist of
The third-party manufacturers of our products acquire these raw materials primarily from Asian sources, which indirectly subjects us to certain risks, including supply interruptions and currency price fluctuations. We and our third-party manufacturers from time to time experience difficulties in obtaining these materials. The suppliers of these materials currently are adequately meeting our requirements and those of our third-party manufacturers. We also believe that there are alternate suppliers for most of these materials.
We depend on management and other key personnel.
Our development and operations to date have been, and our proposed operations will be, substantially dependent upon the efforts and abilities of our senior management and technical personnel. We have employment agreements with Gregory K. Roeper, our President and Chief Executive Officer; and David A. Husband, our Vice-President - Finance and Chief Financial Officer. We maintain agreements with each of our officers and employees that prohibit them from disclosing confidential information obtained while employed with us. The loss of existing key personnel or the failure to recruit and retain necessary additional personnel would adversely affect our business prospects. We cannot provide assurance that we will be able to retain our current personnel or that we will be able to attract and retain necessary additional personnel. Our internal growth and the expansion of our product lines will require additional expertise in such areas as software development, operational management, and sales and marketing. Such growth and expansion activities will increase further the demand on our resources and require the addition of new personnel and the development of additional expertise by existing personnel. Our failure to attract and retain personnel with the requisite expertise or to develop internally such expertise could adversely affect the prospects for our success.
Rights to acquire our common stock could result in dilution to other holders of our common stock.
As of March 29, 2006, we had outstanding options to acquire 663,490 shares of our common stock at a weighted average exercise price of $3.08 per share. An additional 447,500 shares remain available for grant under our 2003 Incentive Compensation Plan. During the terms of these options, the holders thereof will have the opportunity to profit from an increase in the market price of the common stock. The existence of these options may adversely affect the terms on which we can obtain additional financing, and the holders of these options can be expected to exercise such options at a time when we, in all likelihood, would be able to obtain additional capital by
offering shares of our common stock on terms more favorable to us than those provided by the exercise of these options.
Sales of additional shares of our common stock could have a negative effect on the market price of our common stock.
Sales of substantial amounts of our common stock in the public market could adversely affect prevailing market prices and could impair our ability to raise capital through the sale of our equity securities. Most shares of common stock currently outstanding are eligible for sale in the public market, subject in certain cases to compliance with the requirements of Rule 144 under the securities laws. Shares issued upon the exercise of stock options granted under our stock option plan generally will be eligible for sale in the public market. We also have the authority to issue additional shares of common stock and shares of one or more series of preferred stock. The issuance of such shares could dilute the voting power of the currently outstanding shares of our common stock and could dilute earnings per share.
It may be difficult for a third party to acquire us, even if the acquisition would be in the best interest of stockholders.
We are subject to provisions under Delaware corporate law that would require us to obtain certain approvals from our board of directors or stockholders in order to engage in a business combination with an interested stockholder under certain circumstances. Our Amended Certificate of Incorporation and Bylaws also contain a number of other provisions relating to corporate governance and to the rights of stockholders. These provisions
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authorize our board of directors to fill vacancies on our board of directors;
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authorize our board of directors to issue preferred stock in series with such voting rights and other powers as our board of directors may determine; and
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require the affirmative vote of two-thirds of the directors then in office to approve:
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a public offering of our capital stock;
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the merger with or the acquisition of another business or the acquisition of a significant amount of the assets of another business;
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the sale of a significant amount of our assets;
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our entering into contracts with our stockholders or directors;
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our assumption or acquisition of debt in excess of $1.0 million; and
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any amendment of our Amended Certificate of Incorporation and Bylaws of our wholly owned subsidiary Vodavi Communications Systems, Inc.
These provisions in our Amended Certificate of Incorporation and Bylaws and Delaware corporate law may have the effect of making more difficult or delaying attempts by others to obtain control of us, even when these attempts may be in the best interests of stockholders.
We do not pay cash dividends.
We have never paid any cash dividends on our common stock. Our board of directors reviews our dividend policy from time to time and may elect to pay dividends on our common stock in the future. However, the terms of the revolving line of credit facility between our wholly owned subsidiary Vodavi Communications Systems, Inc. and Comerica Bank prohibit our subsidiary from paying dividends to us without the consent of Comerica. This restriction could limit our ability to pay dividends in the future.
ITEM 1B.
ITEM 1B.UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
We sublease, for a ten-year term expiring in December 2011, approximately 55,000 square feet of space in Phoenix, Arizona, where we maintain engineering and design laboratories, a sound engineering laboratory, software development facilities, testing laboratories, product development facilities, customer service support facilities, an employee training facility, warehouse and distribution areas, sales and marketing offices, and administrative and executive offices.
We also lease approximately 3,000 square feet of space in Lawrenceville, Georgia, for a term expiring in August 2006. We maintain software development facilities, engineering and design laboratories, product development facilities, product assembly and testing facilities.
We believe our facilities are adequate for our reasonably anticipated needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time we are subject to certain asserted and unasserted claims encountered in the normal course of business. We believe that the resolution of these matters will not have a material adverse effect on our financial position or results of operations. We cannot provide assurance, however, that damages that result in a material adverse effect on our financial position or results of operations will not be imposed in these matters.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our Annual meeting of Stockholders on October 20, 2005. The following nominees were elected to our Board of Directors to serve until the next annual meeting of stockholders, until their successors are elected or have been qualified, or until their earlier resignation or removal:
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed on the NASDAQ SmallCap Market under the symbol “VTEK.” The following table sets forth the high and low sales prices of our common stock on the NASDAQ SmallCap Market for the periods indicated.
On March 29, 2006, the closing sales price of our common stock was $7.17 per share. As of March 29, 2006, there were approximately 40 holders of record of our common stock.
Issuer Purchases of Equity Securities
On April 27, 2005, we announced that our Board of Directors approved a stock repurchase program under which we may purchase up to $1.0 million of our common stock in the open market or through privately negotiated transactions through March 31, 2006. The following table sets forth the activity under the stock repurchase program during fiscal 2005.
Dividend Policy
We have never paid any cash dividends on our common stock. Our board of directors reviews our dividend policy from time to time and may elect to pay dividends on our common stock in the future. However, the terms of the revolving line of credit facility between our wholly owned subsidiary Vodavi Communications Systems, Inc. and Comerica Bank prohibit our subsidiary from paying dividends to us without the consent of Comerica. This restriction could limit our ability to pay dividends in the future.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data presented below as of and for the years ended December 31, 2005, 2004, and 2003 are derived from our consolidated financial statements (included herein), which have been audited by Mayer Hoffman McCann P.C., independent registered public accounting firm. The selected consolidated financial data presented below as of December 31, 2002 and 2001 and for each of the years in the two-year period ended December 31, 2002 are derived from our consolidated financial statements (not included herein), which have been audited by Deloitte & Touche LLP, independent auditors. The selected consolidated financial information provided below should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of our company and related notes thereto. No dividends were paid during the periods presented.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We design, develop, market, and support a broad range of business telecommunications solutions, including traditional, converged, and IP-based telephone systems and telephony applications, as well as traditional and IP-based commercial grade telephones, that address a wide variety of business applications. Our telephone systems incorporate sophisticated features such as automatic call distribution, scalable networking, Internet Protocol, or IP, as well as wireless solutions. Our telephony applications include Internet messaging, automated attendant, voice and fax mail, and computer-telephony products that enable users to integrate the functionality of their telephone systems with their computer systems. We market our products primarily in the United States as well as in foreign countries through a distribution model consisting primarily of wholesale distributors and direct dealers.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and judgments, including those related to customer incentives, bad debts, sales returns, excess and obsolete inventory, and contingencies and litigation. We base our estimates and judgments on historical experience and on various other factors that are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Customer Incentives
We record reductions to revenue for customer incentive programs, including special pricing agreements, price protection for our distributors, promotions, and other volume-related rebate programs. Such reductions to revenue are estimates, which are based on a number of factors, including our assumptions related to historical and projected customer redemption rates, sales volumes, and inventory levels at our distributors. If actual results differ from our original assumptions, revisions are made to our estimates that could result in additional reductions to our reported revenue in the period the revisions are made. Additionally, if market conditions were to decline, we may take actions to increase the level of customer incentive offerings that could result in an incremental reduction of revenue in the period in which we offer the incentive.
Accounts Receivable
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Additionally, we have a significant concentration of accounts receivable with our two largest distributors, Graybar Electric Company, Inc. and Target Distributing, Inc. As of December 31, 2005, Graybar accounted for 29% and Target accounted for 28% of our total accounts receivable. If either Graybar or Target’s financial condition were to deteriorate, resulting in their inability to make payments to us, it could have a material adverse impact on our financial condition and results of operations.
Sales Returns
We maintain allowances for estimated sales returns. While we have distribution agreements with our largest distributors that limit the amount of sales returns on active products, we generally allow unlimited returns of products that we discontinue. Accordingly, the timing and amount of revisions to our estimates for sales returns is largely influenced by our decisions to discontinue product lines and our ability to predict the inventory levels of such products at our largest distributors. Revisions to these estimates have the effect of increasing or decreasing the reported amount of revenue in the period in which the revisions are made. We generally do not accept product returns from our direct dealers unless the product is damaged.
Excess and Obsolete Inventory
We record our inventory at the lower of cost or market value. Our assessment of market value is determined by, among other things, historical and forecasted sales activity, the condition of specific inventory items, and competitive pricing considerations. When the assessed market value is less than the historical cost, provision is made in the financial statements to write-down the carrying amount of the respective inventory items to market value. If actual results are less favorable than our original assumptions for determining market value, additional inventory write-downs may be required.
The above listing is not intended to be a comprehensive list of our accounting policies. See our audited consolidated financial statements and notes thereto, beginning on page of this Annual Report on Form 10-K, which contain accounting policies and other disclosures required by generally accepted accounting principles in the United States.
Results of Operations
The following table sets forth, for the periods indicated, the percentage of total revenue represented by certain revenue and expense items. The table and the discussion below should be read in conjunction with the consolidated financial statements and notes thereto that appear elsewhere in this report.
Year Ended December 31, 2005 Compared with Year Ended December 31, 2004
Revenue
Revenue for the year ended December 31, 2005 totaled $43.7 million, a decline of 0.3%, from revenue of $43.8 million for the same period of 2004. Sales of our telephone systems increased 4.9% to $38.1 million during
fiscal 2005, compared to $36.4 million in fiscal 2004. The increase in telephone system sales is attributed to an increase in the sale of larger and more advanced systems, including a significant increase in the number of systems that contain VoIP cards, or LAN cards, and “in-skin” voice mail cards, within the XTS product line. Sales of commercial grade telephones declined 8.6% to $1.9 million during 2005 compared to $2.1 million in 2004. Unit shipments of commercial grade telephones during 2005 increased by approximately 35% from 2004; however, the average selling prices of our traditional commercial grade telephones declined significantly when we introduced the 2800 Series phones during the third quarter of 2004. We expect sales of commercial grade telephones to improve in fiscal 2006 as we begin selling more IP-based phones into the Hosted IP Services Market. Sales of telephony applications, including voice processing, computer telephony integration, and unified messaging decreased to $3.1 million from $4.8 million between the respective years of 2005 and 2004. The decline in telephony applications is a direct result of selling more embedded voice mail applications, which are reported in telephone system sales.
Sales through our direct sales office in the Phoenix Metropolitan area totaled $1.6 million during fiscal 2005 compared with $2.1 million during fiscal 2004. The decrease in sales through our direct sales office is attributable to a high level of employee turnover, a focus on developing vertical marketing sales tools to benefit our core business, and an increase in the number of field trial, or beta testing, installations, which typically sell for a reduced price.
Our reported revenue includes shipping and handling charges and is recorded net of reserves for sales returns, discounts, and customer incentive programs. These items resulted in a net reduction to revenue of $1.1 million in 2005 compared with a net reduction of $1.4 million in 2004.
Gross Margin
Our gross margin was approximately $15.8 million during 2005 compared with $15.4 million during 2004. Our gross margin as a percentage of total revenue increased to 36.1% during 2005 from 35.2% during 2004. The increase in our gross margin percentage during 2005 is a direct result of the mix of product sales.
Engineering and Product Development
Engineering and product development expenditures increased to $2.0 million during 2005 from $1.9 million in 2004. As a percentage of revenue, engineering and product development expenditures increased slightly to 4.5% of total revenue during fiscal 2005 from 4.3% during fiscal 2004.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses increased to $11.2 million in 2005 compared to $10.6 million in 2004. Factors that increased our expenses include increased employee compensation and health benefits and additional marketing and promotional activity. As a percentage of revenue, selling, general, and administrative expenses increased to 25.6% during 2005 compared with 24.1% during 2004.
Goodwill Impairment
We have one reporting unit for which goodwill was tested for impairment in accordance with the provisions of SFAS 142 on December 31, 2005. We used a combination of valuation techniques, which included consideration of market-based approaches and an income approach, in determining the fair value of our applicable reporting unit in the annual impairment test of goodwill.
The initial impairment test indicated that the carrying value of our reporting unit exceeded the corresponding fair value. The implied fair value of goodwill in this reporting unit was then determined through the allocation of the fair value to the underlying assets and liabilities. As of December 31, 2005, the carrying value of the goodwill in this reporting unit exceeded its implied fair value by approximately $725,000. The corresponding write-down of goodwill to its fair value was reported as a component of operating income during the fourth quarter of 2005.
Interest (Income) Expense
Interest (income) expense, net was $(107,000) in 2005 compared with $6,000 in 2004. The change in interest (income) expense is a direct result of the elimination of interest-bearing debt during the first half of 2004 and additional interest income earned on our short-term investments as a result of higher cash balances and greater yields on our investments.
Provision for Income Taxes
We provided for federal and state income taxes using an effective rate of 37.9% in 2005 compared with 38.5% for the same period in 2004. The change in our effective rate is due to the impact of research and development credits and certain non-deductible expenses between years.
Year Ended December 31, 2004 Compared with Year Ended December 31, 2003
Revenue
Revenue for the year ended December 31, 2004 totaled $43.8 million, an increase of 6.1%, from revenue of $41.3 million for the same period of 2003. Sales of our telephone systems increased 8.8% to $36.4 million during fiscal 2004 compared to $33.4 million in fiscal 2003. The increase in telephone system sales is attributed to an increase in unit sales of our STS product line and the sale of larger systems within the XTS product line. Sales of commercial grade telephones declined 8.1% to $2.1 million during 2004 compared to $2.2 million in 2003. During the third quarter of 2004, we discontinued our 2700 Series of single line telephones and in June 2004 we introduced the 2800 Series. We expect unit sales of commercial grade telephones to accelerate in 2005. Sales of telephony applications, including voice processing, computer telephony integration, and unified messaging decreased to $4.8 million from $5.2 million between the respective years of 2004 and 2003. The decline in telephony applications is a direct result of selling more embedded voice mail applications, which are reported in telephone system sales.
Sales through our direct sales office in the Phoenix Metropolitan area totaled $2.1 million during fiscal 2004 compared with $1.3 million in fiscal 2003. The increase in sales through our direct sales office is attributable to the expansion of our sales force and the positive impact of a focused sales and marketing program.
Our reported revenue includes shipping and handling charges and is recorded net of reserves for sales returns, discounts and customer incentive programs. These items resulted in a net reduction to revenue of $1.4 million in 2004 compared with a net reduction of $905,000 in 2003.
Gross Margin
Our gross margin was approximately $15.4 million in 2004 compared with $14.3 million in 2003. Our gross margin as a percentage of total revenue increased to 35.2% during 2004 from 34.6% during 2003. The increase in our gross margin percentage during 2004 is a direct result of the mix of product sales, a higher volume of sales to cover the fixed component of cost of sales, and increased sales at our direct sales office.
Engineering and Product Development
Engineering and product development expenditures decreased to $1.9 million during 2004 from $2.1 million in 2003. As a percentage of revenue, engineering and product development expenditures decreased to 4.3% of total revenue during fiscal 2004 from 5.0% during fiscal 2003. This reduction reflects a slight decrease in headcount and outsourced development costs primarily related to a specific development that was completed in 2003.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses increased to $10.6 million in 2004 compared to $10.0 million in 2003. Factors that increased our expenses include increased compensation and additional marketing and
promotional activity. As a percentage of revenue, selling, general, and administrative expenses declined to 24.1% compared with 24.3% in 2003.
Interest Expense
Interest expense decreased to $6,000 during 2004 compared with $128,000 during 2003. The reduction in interest expense is a direct result of the elimination of interest-bearing debt in the first half of 2004.
Provisions for Income Taxes
We provided for federal and state income taxes using an effective rate of 38.5% in 2004 compared with 38.7% for the same period in 2003.
Liquidity and Capital Resources
Our net working capital position was approximately $12.2 million at December 31, 2005 compared with $10.2 million at December 31, 2004. We had a cash balance of $6.5 million at December 31, 2005 compared with a cash balance of $4.0 million at December 31, 2004. Sources of cash included positive income from operations, when considering non-cash items of $469,000 of depreciation and amortization and $735,000 of goodwill impairment, a reduction in inventories of $1.0 million, and $213,000 from the exercise of stock options. Uses of cash during 2005 included the payment of accrued liabilities of $596,000 $348,000 for the purchase of property and equipment, and $236,000 to repurchase 44,339 shares of our common stock.
Our accounts receivable days sales outstanding, calculated on a quarterly basis, were approximately 60 days in 2005 compared to 59 days as of December 31, 2004. The timing of payments received from our largest distributors greatly influence our days sales outstanding. Our two largest distributors comprised 57% of our total accounts receivable as of December 31, 2005 and 2004.
Our inventory days on-hand, measured in terms of days outstanding on a quarterly basis, was 46 days as of December 31, 2005 compared to 59 days as of December 31, 2004. The decrease in inventory days on-hand is a direct result of our efforts to change our inventory mix to more fast-moving products.
Trade payables and accrued liabilities, including payables to third-party and related-party manufacturers, were approximately $5.9 million as of December 31, 2005 compared with $6.5 million as of December 31, 2004. The level of our trade payables and accrued liabilities between periods is largely influenced by the timing of payments we make to our largest suppliers for inventory items and payments to cover payroll, income taxes, and customer rebates. We generally pay trade payables within 45 days from the invoice date, except for payments to our largest supplier, which are 60 days from the invoice date.
During April 2003, we entered into a credit agreement with Comerica Bank (Comerica) of a size that is reflective of the operational requirements of our business. The credit agreement established a $5.0 million revolving line of credit and a $1.0 million term loan. Advances under the credit facility are based upon eligible accounts receivable and inventory of our wholly owned subsidiary, Vodavi Communications Systems, Inc., and are secured by substantially all of our assets. The credit facility contains covenants that are customary for similar credit facilities and also prohibits our operating subsidiaries from paying dividends to us without the consent of Comerica. As of December 31, 2005, we had no outstanding borrowings on our line of credit and $5.0 million available for future advances.
The $5.0 million revolving line of credit bears interest at Comerica’s prime rate, or 7.25% at December 31, 2005, and requires monthly payments of interest only with all unpaid principal and accrued interest due at its expiration in April 2006. We plan to either renew or replace the existing credit facility with a similar credit facility in April 2006.
The $1.0 million term loan was available to us only for the purpose of acquiring our common stock. Borrowings on the term loan bore interest at Comerica’s prime rate plus 0.5%. In April 2004, we repaid the amount outstanding on our term loan.
We have no special purpose entities or off balance sheet financing arrangements, commitments, or guarantees other than certain long-term operating lease agreements for our office and warehouse facilities and short-term purchase commitments to our third-party suppliers. The following table sets forth all known commitments as of December 31, 2005 and the year in which those commitments become due or are expected to be settled (in thousands):
From time to time we are subject to certain asserted and unasserted claims encountered in the normal course of business. We believe that the resolution of these matters will not have a material adverse effect on our financial position or results of operations. However, we cannot provide assurance that damages resulting from the resolution of these matters, if any, will not have a material adverse effect on our financial position or results of operations.
We believe that our cash flows from operations, working capital, and credit facilities are sufficient to fund our capital needs during the next 12 months. We intend to continue to explore business acquisition opportunities as they arise and may be required to seek additional financing in the future to meet such opportunities.
International Manufacturing Sources
We currently obtain a substantial majority of our products under various manufacturing arrangements with third-party manufacturers in South Korea and Thailand, including LGN who owns approximately 23% of our outstanding common stock. We face risks associated with international manufacturing sources. For a more detailed discussion of these risks, please see Item 1A, “Risk Factors - We face risks associated with international manufacturing sources.”
Impact of Recently Issued Accounting Standards
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R). This Statement replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123R requires companies to recognize the grant date fair value of stock options and other equity-based compensation issued to employees in the income statement. The statement, as amended by the Securities and Exchange Commission, becomes effective for annual periods beginning after June 15, 2005. The adoption of SFAS No. 123R will not have any impact on our consolidated financial statements unless and until share-based payments are issued to employees after the effective date of this statement.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections - A Replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 requires retrospective application to prior periods’ financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle, such as a change in non-discretionary profit-sharing payments resulting from an accounting change, should be recognized in the period of the accounting change. SFAS No. 154 also requires that a change in depreciation, amortization, or depletion method for long-lived non-financial assets be accounted for as a
change in accounting estimate affected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date this Statement is issued. We are required to adopt the provisions of SFAS No. 154, as applicable, beginning in fiscal 2006.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not participate in any activities involving derivative financial instruments or other financial and commodity instruments. We do not hold investment securities that would require disclosure of market risk. Our market risk exposure is limited to interest rate risk associated with our credit facility. We incur interest at a variable rate of prime on advances made under our revolving line of credit and prime plus 0.5% on our term loan. At December 31, 2005 we had no outstanding borrowings on the line of credit or term loan.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
Reference is made to the consolidated financial statements, the report thereon, and the notes thereto commencing at page of this Report, which consolidated financial statements, report, and notes are incorporated herein by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
We have evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of December 31, 2005. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have each concluded that our disclosure controls and procedures are effective to ensure that we record, process, summarize, and report information required to be disclosed by us in our quarterly reports filed under the Securities Exchange Act within the time periods specified by the Securities and Exchange Commission’s rules and forms. During the quarterly period covered by this report, there have not been any changes in our internal controls over financial reporting that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Subsequent to the date of their evaluation, there have not been any significant changes in our internal controls or in other factors that could significantly affect these controls, including any corrective action with regard to significant deficiencies and material weaknesses.
ITEM 9B.
ITEM 9B.OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding our directors and executive officers:
(1)
Member of the Compensation Committee
(2)
Member of the Audit Committee
(3)
Member of the Nominating and Corporate Governance Committee
William J. Hinz has served as Chairman of the Board of our company since October 1997 and as a director of our company since April 1997. From October 1999 until March 2004, Mr. Hinz served as Group President for the Triumph Components Group, which is a group of seven divisional companies within Triumph Group, Inc., a publicly held company. Mr. Hinz served as President of Stolper-Fabralloy Company, a precision aerospace engine component manufacturer that is a subsidiary of Triumph Group, Inc., from September 1997 until October 1999 and as Executive Vice President of Operations of Stolper-Fabralloy from March 1996 until September 1997. Mr. Hinz served as 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.
Gregory K. Roeper has served as President of our company since December 1998 and as Chief Executive Officer and a director of our company since December 1999. Mr. Roeper served as our Chief Operating Officer from June 1998 until December 1999. Between November 1994 and June 1998, Mr. Roeper held a variety of other executive positions with our company, including Chief Financial Officer; Executive Vice President - Finance, Administration, and Operations; Secretary; and Treasurer. From 1982 until 1994, Mr. Roeper was employed with Arthur Andersen LLP.
David A. Husband has served as our Vice President - Finance, Chief Financial Officer, Secretary, and Treasurer since March 2001. Prior to joining our company, Mr. Husband served in various capacities with Action Performance Companies, Inc., a publicly held company engaged in the motorsports merchandising business, from May 1998 until December 2000, most recently as Executive Vice President and Chief Operating Officer. Mr. Husband was employed as an accountant with Arthur Andersen LLP from July 1992 to May 1998, where he was primarily engaged in auditing publicly held companies. Mr. Husband is a Certified Public Accountant in the state of Arizona.
Jong Dae An has served as a director of our company since August 2004. Mr. An has served as a group leader of the export business within the Network Division of LG Electronics Inc. where his career began in 1986. During most of this tenure with LGN, Mr. An managed the export of telecommunications equipment, establishing considerable market share in North America and Europe through relationships with leading distributors and world-class telecom service providers. Mr. An received a Master of Business Administration degree from the Helsinki School of Economy.
Donald A. Bliss has served as a director of our company since October 20, 2005. Mr. Bliss served as a Vice President and Chief Executive Officer of U.S. West Communications, a U.S. West company, until his
retirement in December 1994. Mr. Bliss served as Chairman of the Western Region Advisory Board of AON Risk Services of Arizona, Inc. from October 2001 to February 2005. Mr. Bliss currently serves on the board of directors of Knight Transportation, Inc., a public company, and is a director of Western and Southern Life Insurance Company, Continental General Insurance Company, and the Biltmore Bank of Arizona.
Jack A. Henry has served as a director of our company since November 2001. Mr. Henry began his career in 1966 with Arthur Andersen LLP and held positions in Detroit, Michigan, San Jose, California, Seattle, Washington and Phoenix, Arizona. In 2000, Mr. Henry retired as Managing Partner of the Phoenix office and formed Sierra Blanca Ventures LLC, a private advisory and investment firm. Mr. Henry currently serves on the board of directors of White Electronic Designs Corporation, Vista Care, Inc., and two private companies. Mr. Henry previously served on the boards of directors of Simula, Inc., and SOS Staffing Services, Inc., both public companies. Mr. Henry holds both a Bachelors and Masters of Business Administration from the University of Michigan.
Emmett E. Mitchell has served as a director of our company since February 1999. Mr. Mitchell has been employed with MS Howell & Co., a NASD broker dealer and investment banking firm, as the Executive Vice President since December 2000. Mr. Mitchell has also served as the Chief Financial Officer of ICESoft Technologies, Inc., a privately held software company since December 2001. Prior to this, Mr. Mitchell was employed with Paradise Valley Securities, Inc., since October 1991, most recently as the Chairman and Chief Executive Officer.
Paul D. Sonkin has served as a director of our company since February 2004. Mr. Sonkin has served as the portfolio manager of the Hummingbird Value Fund, The Hummingbird Microcap Value Fund, and The Hummingbird Concentrated Fund since June 1999. He also serves as an adjunct professor at Columbia University Graduate School of Business, where he teaches courses on security analysis and value investing. From May 1998 to June 1999, Mr. Sonkin served as a senior analyst and portfolio manager at First Manhattan & Co., a firm that specialized in mid- and large-cap value investing. Prior to that, from April 1995 to May 1998, Mr. Sonkin served as an analyst and portfolio manager at Royce & Associates, the investment advisor to the Royce Funds. Prior to receiving an MBA from Columbia University, he worked at Goldman Sachs & Co. and at the U.S. Securities and Exchange Commission. Mr. Sonkin is co-author of “Value Investing: From Graham to Buffet and Beyond.”
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our directors, officers, and persons who own more than 10% of a registered class of our equity securities to file reports of ownership and changes in ownership with the SEC. Officers, directors, and greater than 10% stockholders are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. Based solely upon our review of the copies of such forms we received during the fiscal year ended December 31, 2005, and written representations that no other reports were required, we believe that each person who, at any time during such fiscal year, was a director, officer, or beneficial owner of more than 10% of our common stock complied with all Section 16(a) filing requirements during such fiscal year, except as follows: (1) Mr. Bliss filed a late Form 3 regarding his initial beneficial ownership and a late Form 4 covering a grant of options upon becoming a director of our company; (2) Mr. Mitchell filed a late Form 4 regarding the exercise of stock options and subsequent sale of such shares; and (3) each of LG-Nortel Co. Ltd. and Nortel Networks Ltd. filed a late Form 3 regarding its initial beneficial ownership following the transfer of shares of our common stock from LGE to LG-Nortel Co. Ltd.
Code of Ethics and Committee Charters
Our Board of Directors has adopted Corporate Governance Guidelines, a Code of Conduct, a Code of Ethics for the CEO and Senior Financial Officers, an Audit Committee Charter, a Compensation Committee Charter, a Nominating/Corporate Governance Charter, and any other corporate governance materials contemplated by SEC or NASDAQ regulations. We post on our website at www.vodavi.com these corporate governance materials. These documents are also available in print to any stockholder who requests by contacting our corporate secretary at our executive offices.
Information Relating to Our Audit Committee of the Board of Directors
The purpose of the Audit Committee is to assist our board of directors in the oversight of the integrity of the consolidated financial statements of our company, our company’s compliance with legal and regulatory matters, the independent auditor’s qualifications and independence, and the performance of our company’s independent auditors. The primary responsibilities of the Audit Committee are set forth in its charter, and include various matters with respect to the oversight of our company’s accounting and financial reporting process and audits of the consolidated financial statements of our company on behalf of our Board of Directors. The Audit Committee also selects the independent certified public accountants to conduct the annual audit of the consolidated financial statements of our company; reviews the proposed scope of such audit; reviews accounting and financial controls of our company with the independent public accountants and our financial accounting staff; and reviews and approves transactions between us and our directors, officers, and their affiliates.
The Audit Committee currently consists of Messrs. Bliss, Henry, and Mitchell. Each member of our Audit Committee is an independent director of our company under applicable NASDAQ rules as well as under rules adopted by the Securities and Exchange Commission pursuant to the Sarbanes-Oxley Act of 2002. The board of directors has determined that each of Messrs. Henry and Mitchell qualify as an “audit committee financial expert” in accordance with applicable rules and regulations of the SEC.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Summary of Cash and Other Compensation
The following table sets forth certain information with respect to the compensation we paid to our Chief Executive Officer and one other executive officer who received cash compensation in excess of $100,000 during fiscal 2005. The table also sets forth certain information regarding one former executive officer of our company.
SUMMARY COMPENSATION TABLE
(1)
We consider Messrs. Roeper and Husband to be our executive officers. Mr. Borcich , our former Vice President - Distribution Sales, resigned from our company during October 2005.
(2)
The exercise price of all stock options granted were equal to the fair market value of our common stock on the date of grant.
Option Grants
The following table sets forth certain information with respect to stock options granted to the officers listed during the fiscal year ended December 31, 2005.
OPTION GRANTS IN LAST FISCAL YEAR
(1)
Each of the options granted vested on October 20, 2005.
(2)
Potential gains are net of the exercise price, but before taxes associated with the exercise. Amounts represent hypothetical gains that could be achieved for the respective options if exercised at the end of the option term. The assumed 5% and 10% rates of stock price appreciation are provided in accordance with SEC rules and do not represent our estimate or projection of the future price of our common stock. Actual gains, if any, on stock option exercises will depend upon the future market prices of our common stock.
Aggregate Option Exercises and Fiscal Year-End Option Holdings
The following table provides information on options exercised during fiscal 2005 by the officers listed and the value of each such officer’s unexercised options of December 31, 2005.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
Employment Agreements
Gregory K. Roeper
We have an employment agreement with Mr. Roeper for a term expiring on December 31, 2006. The agreement automatically renews for successive one-year terms unless either party terminates by giving the other party at least 30 days’ written notice. The employment agreement provides for Mr. Roeper to serve as our President and Chief Executive Officer. The employment agreement provides for Mr. Roeper to receive a base salary of $220,000 during fiscal 2006.
The agreement provides for Mr. Roeper to receive his fixed compensation to the date of termination of his employment by reason of resignation, death, or as a result of termination of employment “for cause,” as defined in the agreement. If we terminate his employment, or if his employment is terminated by reason of disability, the agreement provides for the payment of his base salary and benefits for a period of one year, payable in a lump sum within ten days of the date of termination. In addition, Mr. Roeper’s vested options as of the date of termination will remain outstanding through the 120-day period following the then-current term of the agreement. All unvested options as of the date of termination will be cancelled.
In the event of a “change of control” of our company, as defined in the agreement, Mr. Roeper will receive a minimum bonus of $150,000. In addition, any options that were granted to Mr. Roeper that remain unvested as of the date of the change of control will become fully vested and exercisable on the effective date of the change of control. If Mr. Roeper’s employment is terminated as a result of a change of control, we will be required to pay him, within ten days of the date of termination, his annual base salary and benefits for a period of one year following the date of termination plus any earned bonus through the date of termination.
David A. Husband
We have an employment agreement with Mr. Husband for a term expiring on December 31, 2006. The agreement automatically renews for successive one-year terms unless either party terminates by giving the other party at least 30 days’ written notice. The employment agreement provides for Mr. Husband to serve as our Vice President - Finance and Chief Financial Officer. The employment agreement provides for Mr. Husband to receive a base salary of $175,000 during fiscal 2006.
The agreement provides for Mr. Husband to receive his fixed compensation to the date of termination of his employment by reason of resignation, death, or as a result of termination of employment “for cause,” as defined the agreement. If we terminate Mr. Husband’s employment, or if his employment is terminated by reason of disability, we will pay Mr. Husband his base salary and benefits for a period of one year. In addition, Mr. Husband’s vested options as of the date of termination will remain outstanding through the 120-day period following the then-current term of the agreement. All unvested options as of the date of termination will be cancelled.
In the event of a “change of control” of our company, as defined in the employment agreement, Mr. Husband will receive a minimum bonus of $100,000. In addition, any options that were granted to Mr. Husband that remain unvested as of the date of the change of control will become fully vested and exercisable on the effective date of the change of control. If Mr. Husband’s employment is terminated as a result of a change of control, we will be required to pay him his base salary and benefits for a period of one year following the date of termination plus any earned bonus through the date of termination.
Each employment agreement described above provides that the executive will be eligible to receive discretionary bonuses in amounts determined by our Board of Directors. In addition, each employment agreement generally requires us to
•
reimburse each executive for all travel, entertainment, and other ordinary and necessary expenses incurred in connection with our business and their duties under their respective employment agreements; and
•
provide such other fringe benefits that we make generally available to all of our employees on a non-discriminatory basis.
Each employment agreement also contains provisions that prohibit the executive from
•
competing with us for a period of 12 months after the termination of the executive’s employment with our company,
•
taking certain actions intended to solicit other persons to terminate their business relationship with us or to terminate his or her employment relationship with us, and
•
making unauthorized use or disclosure of our trade names, fictitious names, or confidential information.
Other Arrangements
We maintain agreements with each of our other officers and employees that prohibit such persons from disclosing confidential information obtained while employed by us. We offer our employees medical, life, and disability insurance benefits. Our executive officers and other key personnel (including directors who also are employees of our company) are eligible to receive stock options under our stock option plan.
401(k) Profit Sharing Plan
In April 1994, we adopted a profit sharing plan pursuant to Section 401(k) of the Internal Revenue Code of 1986. Pursuant to the 401(k) Plan, all eligible employees may make elective contributions through payroll deductions. In addition, we may make matching and discretionary contributions in such amounts as may be determined by our Board of Directors. During fiscal 2005, we expensed matching contributions pursuant to the 401(k) Plan to all executive officers as a group in the amount of $2,000.
The 1994 Stock Option Plan, as amended, provided for
•
the granting of incentive stock options or nonqualified options to acquire our common stock;
•
the granting of stock appreciation rights;
•
the direct granting of shares of our common stock; and
•
the granting of other cash awards to key employees of our company and to consultants or independent contractors who provide valuable services to us.
The plan also provided for automatic grants of stock options to non-employee directors of our company under an automatic program. Under the automatic program, each newly elected non-employee member of our Board of Directors received an automatic initial grant of options to acquire 5,000 shares of common stock on the date of his or her first appointment or election to our Board of Directors. In addition, options to acquire 5,000 shares of common stock were automatically granted to each non-employee director at the meeting of our Board of Directors held immediately after each annual meeting of stockholders.
We were authorized to issue 1,600,000 shares of Common Stock under the 1994 Plan. As of March 29, 2006, 489,260 shares of common stock have been issued upon exercise of options granted under the plan, and there were outstanding options to acquire 510,990 shares of our common stock under the plan. The 1994 Plan expired in April 2004 and all remaining options available for grant were cancelled. We may not grant additional awards under the 1994 Plan. Any awards outstanding on the expiration date were not affected by virtue of the expiration of the 1994 Plan. In approving the 2003 Plan discussed below, the Board considered that the remaining shares available under the 1994 Plan would be cancelled in favor of the new shares available under the 2003 Plan.
To exercise an option, the option holder will be required to deliver to us full payment of the exercise price for the shares as to which the option is being exercised. Generally, options may be exercised by delivery of cash, bank cashier’s check, or shares of our common stock.
2003 Incentive Compensation Plan
Our Board of Directors approved the Vodavi 2003 Incentive Compensation Plan in August 2003, and our stockholders approved the 2003 Plan during October 2003.
The purpose of the 2003 Plan is to assist us in attracting, motivating, retaining, and rewarding high-quality executives and other employees, officers, directors, and consultants by enabling such persons to acquire or increase a proprietary interest in our company in order to strengthen the mutuality of interests between such persons and our stockholders, and providing such persons with annual and long-term performance incentives to expend their maximum efforts in the creation of stockholder value.
General Terms of the 2003 Plan; Shares Available for Issuance
The 2003 Plan provides for the granting of awards in the form of incentive stock options, nonqualified stock options, stock appreciation rights, shares of restricted common stock, bonus stock in lieu of obligations, or other stock-based awards to employees, directors, and independent contractors who provide valuable services to our company. The 2003 Plan authorizes the issuance of 600,000 shares of stock, and no more than 500,000 shares may be issued pursuant to incentive stock options. As of March 29, 2006, no shares of common stock have been issued upon exercise of options granted under the 2003 Plan, and there were outstanding options to acquire 152,500 shares of our common stock under the 2003 Plan. As of March 29, 2006, an additional 447,500 shares of common stock were available for grant under the 2003 Plan. The maximum number of shares of common stock covered by awards granted to any individual in any year may not exceed 200,000. If any award previously granted under the 2003 Plan is forfeited, terminated, canceled, surrendered, does not vest, or expires without having been exercised in full, stock not issued under such award will again be available for grant for purposes of the 2003 Plan. If any change is made in the stock subject to the 2003 Plan, or subject to any award granted under the 2003 Plan (through consolidation, spin-off, recapitalization, stock dividend, split-up, combination of shares, exchange of shares, or otherwise), the 2003 Plan provides that appropriate adjustments will be made as to the aggregate number and type of shares available for awards, the maximum number and type of shares that may be subject to awards to any individual, the number and type of shares covered by each outstanding award, the exercise price grant price, or purchase price relating to any award, and any other aspect of any award that the Board of Directors or Committee determines appropriate.
The 2003 Plan provides that it is not intended to be the exclusive means by which we may issue options to acquire our common stock or any other type of award. To the extent permitted by applicable law and the rules and regulations of the NASDAQ SmallCap Market, we may issue other options, warrants, or awards other than pursuant to the 2003 Plan without stockholder approval.
Eligibility and Administration
Employees, executive officers, directors, and independent contractors of our company will be eligible to receive awards under the 2003 Plan. Options that are incentive stock options may be granted only to employees of our company.
A committee designated by the Board of Directors will administer the 2003 Plan, however, the Board may exercise any power or authority granted to the committee under the 2003 Plan. The Board may designate more than one committee to administer the 2003 Plan as to various categories of eligible persons. The committee will consist of at least two directors, and each member of which will be (a) a “non-employee director” within the meaning of Rule 16b-3 under the Exchange Act, unless administration of the 2003 Plan by “non-employee directors” is not then required in order for exemptions under Rule 16b-3 to apply to transactions under the 2003 Plan, and (b) an “outside director” within the meaning of Section 162(m) of the Internal Revenue Code, unless administration of the 2003 Plan by “outside directors” is not then required in order to qualify for tax deductibility under Section 162(m) of the Internal Revenue Code. The Board and/or any committee that has been delegated the authority to administer the
2003 Plan is referred to as the “Plan Administrator.” Where appropriate, the Plan Administrator will satisfy the then requirements of any stock exchange or automated quotation system upon which our stock is listed or quoted.
The Plan Administrator will have the authority, in its discretion, to determine all matters relating to awards, including the selection of the individuals to be granted awards, the type of awards, the number of shares of common stock subject to an award, vesting conditions, and any and all other terms, conditions, restrictions, and limitations, if any, of an award. The Plan Administrator will also have the authority to construe and interpret the 2003 Plan, and to make all decisions and determinations as the Plan Administrator may deem necessary or advisable for administration of the 2003 Plan. The Plan Administrator may delegate to officers or managers of our company certain functions, in each case to the extent permitted by the Board, under the 2003 Plan, and applicable law.
Terms of Awards
General
Awards granted under the 2003 Plan may be granted either alone or in addition to, in tandem with, or in substitution or exchange for, any other award or any award granted under another plan of our company. Such additional, tandem, and substitute or exchange award may be granted at any time. The term of each award will be for such period as may be determined by the Plan Administrator, provided that in no event will the term of any option or stock appreciation right exceed a period of 10 years, or such shorter period as may be required in the case of an incentive stock option.
Options
Options granted under the 2003 Plan may be either incentive stock options, as defined under the Internal Revenue Code, or nonqualified options. The expiration date, maximum number of shares purchasable, vesting provisions, type of consideration to be paid upon exercise, and any other provisions of options granted under the 2003 Plan will be established at the time of grant. The Plan Administrator will set the term of each option, and in the case of incentive stock options, such terms will be subject to compliance in all respects with the Internal Revenue Code and the 2003 Plan. Options will vest and become exercisable in whole or in one or more installments at such time as may be determined by the Plan Administrator, including based on achievement of performance goals or future service requirements.
The exercise prices of options will be determined by the Plan Administrator, provided that the exercise price of all options granted under the 2003 Plan may not be less than 100% of the fair market value of the common stock on the date of the grant (110% of the fair market value if the option intended to be an incentive stock options granted to a stockholder who at the time the option is granted owns stock possessing more than 10% of the total combined voting power of all classes of stock of our company or of its subsidiaries).
The Plan Administrator will also have the discretion to grant options that are immediately exercisable for restricted shares of stock that will vest over a period of time or pursuant to certain performance criteria established by the Plan Administrator. Should the optionee’s continuous service cease while holding such unvested shares, we will have the right to repurchase, at the exercise price paid per share, any or all of the unvested shares. The terms upon which such repurchase right will be exercisable will be established by the Plan Administrator and set forth in the document evidencing such repurchase right.
Stock Appreciation Rights
The Plan Administrator is authorized to grant stock appreciation rights, which provide the holder the right to receive, upon exercise thereof, the excess of (a) the fair market value of one share of stock on the date of exercise, over (b) the grant price of the stock appreciation right as determined by the Plan Administrator. The grant price of a stock appreciation right will not be less than the fair market value of a share of stock on the date of grant, except under limited circumstances set forth in the 2003 Plan. The Plan Administrator will determine at the date of grant the terms and conditions of the stock appreciation right, including the form of consideration payable in settlement. Stock appreciation rights may be either freestanding or granted in tandem with other awards. The Plan Administrator may grant “limited stock appreciation rights,” which may be exercised only in the event of a “change of control,” as defined in the 2003 Plan.
Restricted Stock
The Plan Administrator is authorized to grant shares of restricted stock, which will be subject to such restrictions on transferability, risk of forfeiture, and other restrictions as the Plan Administrator will determine or as otherwise provided in the 2003 Plan. The restrictions may lapse separately or in combination at such times, under such circumstances, in such installments, or otherwise, as the Plan Administrator may determine at the date of grant or thereafter. A holder granted restricted stock will have all of the rights of a stockholder, including the right to vote and receive dividends. During the applicable restricted period, the shares may not be sold, transferred, pledged, hypothecated, margined, or otherwise encumbered by the holder.
Except as otherwise determined by the Plan Administrator at the time of the award, upon termination of a participant’s service during the applicable restricted period, the participant’s restricted stock that is at that time subject to restrictions will be forfeited and reacquired by us, provided that the Plan Administrator may provide or determine that restrictions or forfeiture conditions will be waived in whole or in part in the event of terminations resulting from specified causes, and the Plan Administrator may in other cases waive in whole or in part the forfeiture of restricted stock.
As a condition to the grant of an award of restricted stock, the Plan Administrator may require that any cash dividends paid on a share of restricted stock be automatically reinvested in additional shares of restricted stock or applied to the purchase of additional awards under the 2003 Plan, which will be subject to restrictions and a risk of forfeiture to the same extent as the restricted stock with respect to which such stock or other property has been distributed.
Bonus Stock and Awards in Lieu of Obligations
The Plan Administrator is authorized to grant stock as a bonus, or to grant stock or other awards in lieu of company obligations to pay cash or deliver other property under the 2003 Plan or under other plans or compensatory arrangements, subject to certain exceptions in the case of participants subject to Section 16 of the Exchange Act or other terms as determined by the Plan Administrator.
Other Stock-Based Awards
The Plan Administrator is authorized to grant participants such other awards that may be denominated or payable in, valued in whole or in part by reference to, or otherwise based on stock as deemed by the Plan Administrator to be consistent with the purposes of the 2003 Plan. Such awards may be convertible or exchangeable debt securities, other rights convertible or exchangeable into stock, purchase rights for stock, awards with value and payment contingent upon performance of our company or any other factors designated by the Plan Administrator. The Plan Administrator will determine the terms and conditions of such awards, including the nature of the right, consideration to be paid upon exercise, vesting conditions, repurchase rights for unvested shares, and the like. Cash awards, as an element of or supplement to any other award under the 2003 Plan, may also be granted under the 2003 Plan.
Automatic Grant Program
The 2003 Plan includes an automatic grant program that automatically grants options to our non-employee directors. Under the automatic grant program, each newly elected non-employee member of the Board will receive an option to purchase 5,000 shares of common stock, if available, on the date of his or her first appointment or election to the board of directors. In addition, an option to acquire 5,000 shares of common stock, if available, will be granted to each non-employee director at the meeting of the board of directors held immediately after each annual meeting of stockholders. A non-employee member of the board of directors will not be eligible to receive this annual grant if the grant date of such annual grant would be within 90 days of the date on which the non-employee member received his or her initial grant. Each initial grant will vest and become exercisable immediately on the date of grant.
The exercise price per share of common stock subject to automatic options granted under the 2003 Plan will be equal to 100% of the fair market value of our common stock on the date such option is granted. Each automatic option will expire on the tenth anniversary of the date of grant. In the event the non-employee director ceases to serve as a member of the board of directors, the option holder may exercise the automatic options until the earlier of (1) 90 days after the cessation of service, or (2) the expiration of the term of the automatic option. If the non-employee director dies while serving as a director or within 90 days after ceasing to serve as a director, the option holder’s estate or the persons to whom the automatic options are transferred under the option holder’s will or the laws of descent and distribution may exercise the automatic options until the earlier of (a) 90 days after the cessation of service, or (b) the expiration of the term of the automatic option.
Other Provisions
In the event of a proposed sale of all or substantially all of our assets or any reorganization, merger, consolidation, or other form of corporate transaction in which our company does not survive, or in which shares of stock are exchanged for or converted into securities issued by another entity, then the successor or acquiring entity may, with the consent of the committee or the Board, assume each outstanding option or substitute an equivalent option or right. If the successor or acquiring entity does not assume or substitute such options, then (a) each option will terminate upon consummation of sale, merger, consolidation, or other corporate transaction, and (b) the committee will have the discretion and authority exercisable at any time to provide for the automatic acceleration of vesting or exercisability of one or more awards granted by it under the 2003 Plan.
Duration and Modification
The Plan will terminate at such time as no shares of stock remain available for issuance under the 2003 Plan and we have no further rights or obligations with respect to outstanding awards under the 2003 Plan. The Board may amend, alter, suspend, discontinue, or terminate the 2003 Plan without the consent of stockholders, except that any amendment or alteration to the 2003 Plan will be subject to stockholder approval no later than the next annual meeting following such Board action if required by applicable law or the rules or any applicable stock exchange or quotation system on which the stock may then be listed or quoted. In addition, without the consent of an affected participant, the Board may not amend or alter the 2003 Plan to affect the rights of any participant under any previously granted and outstanding award.
Despite the foregoing, the Board of Directors, in its sole discretion, may bifurcate the 2003 Plan so as to restrict, limit, or condition the use of any provision of the 2003 Plan to participants who are officers, directors, or stockholders subject to Section 16 of the Exchange Act without so restricting, limiting, or conditioning the 2003 Plan with respect to other participants.
Director Compensation and Other Information
Employees of our company do not receive compensation for serving as members of our Board of Directors. Each independent director receives a quarterly retainer fee of $5,000 payable on the first day of each quarter. Each independent director also receives a $500 fee for each meeting attended by telephone or in person and reimbursement for reasonable expenses incurred in attending meetings of our Board of Directors. Committee members receive a $500 fee for attendance at committee meetings that are held on days other than days on which a
Board of Directors’ meeting is held. Our Chairman, William J. Hinz, receives a quarterly retainer fee of $6,250 payable on the first day of each quarter. Mr. Hinz also receives a $625 fee for each meeting attended by telephone or in person and reimbursement for reasonable expenses incurred in attending board meetings. Non-employees who serve as directors of our company also receive an annual automatic stock option grant to purchase 5,000 shares of stock under our 2003 Incentive Compensation Plan. Each automatic grant under the 2003 Plan shall vest and become exercisable on the earlier of (1) the first anniversary of the date of grant, or (2) the day prior to the next regularly held annual meeting of our stockholders.
Compensation Committee Interlocks and Insider Participation
Performance evaluation and compensation decisions relating to 2005 were made by the Compensation Committee of our Board of Directors, which consisted of Messrs. Henry, Mitchell, and Sonkin. Upon his election to our Board of Directors during October 2005, Mr. Bliss was appointed to serve as a member of the Compensation Committee, and Mr. Henry resigned as a member of the Compensation Committee. None of such persons had any contractual or other relationships with us during fiscal 2005 except as directors. See Item 11, “Executive Compensation-Director Compensation and Other Information.”
Limitation of Directors’ Liability and Indemnification
Our certificate of incorporation provides that no director of our company will be personally liable to our company or our stockholders for monetary damages for breach of fiduciary duty as a director, except to the extent such exemption or limitation of liability is not permitted under the Delaware General Corporation law, or Delaware GCL. Under the Delaware GCL, a director may be held liable
•
for any breach of the director’s duty of loyalty to our company or our stockholders;
•
for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law;
•
in respect of certain unlawful dividend payments or stock purchases; or
•
for any transaction from which the director derived an improper personal benefit.
The effect of this provision in our certificate of incorporation is to eliminate the rights of our company and our stockholders (through stockholders’ derivative suits on behalf of our company) to recover monetary damages from a director for breach of the fiduciary duty of care as a director (including breaches resulting from negligent or grossly negligent behavior) except in the situations described above. In addition, our certificate of incorporation provides that any repeal or modification of this provision by our stockholders will not adversely affect any right or protection of a director of our company existing at the time of such repeal or modification with respect to acts or omissions occurring prior to such repeal or modification. These provisions do not limit or eliminate the rights of our company or any stockholder to seek non-monetary relief such as an injunction or recision in the event of a breach of a directors’ duty of care.
Our certificate of incorporation requires us to indemnify our directors, officers, and certain other representatives of our company against expenses and certain other liabilities arising out of their conduct on behalf of our company to the maximum extent permitted by the Delaware GCL. Indemnification is not available with respect to proceedings or claims initiated or brought voluntarily by an officer, director, or other representative of our company against us unless such proceeding or claim is approved by our Board of Directors.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information with respect to beneficial ownership of our common stock as of December 31, 2005 by (i) each director; (ii) the executive officers set forth in the Summary Compensation Table under Item 11, “Executive Compensation;” (iii) all of our directors and executive officers as a group; and (iv) each other person who is known by us to beneficially own or to exercise voting or dispositive control over more than 5% of our common stock.
(9)
Includes 3,300 shares of common stock and 15,000 shares issuable upon exercise of options.
(10)
Mr. Sonkin is a control person of Humingbird Management, LLC. Amounts listed for Hummingbird represent 505,414 shares of common stock beneficially owned by Hummingbird Management, LLC (f/k/a Morningside Value Investors, LLC), as investment manager to The Hummingbird Value Fund, L.P. The managing member of Hummingbird Management is Paul D. Sonkin, who also serves as the managing member of HVF Capital, the general partner of The Hummingbird Value Fund and The Hummingbird Microcap Value Fund. Hummingbird Management has sole voting and dispositive power over the shares, and Hummingbird Management disclaims any economic interest or beneficial ownership of the shares. The address of Hummingbird Management, LLC is 460 Park Avenue, 12th Floor, New York, New York 10022. In addition to the amounts listed for Hummingbird Management, Mr. Sonkin’s beneficial ownership, for which Mr. Sonkin has sole voting and dispositive power, includes 15,000 shares issuable upon exercise of options, which is not included in the beneficial ownership of Hummingbird Management.
(11)
Represents 862,500 shares of our common stock held by LG-Nortel Co. Ltd., a Korean corporation. LG-Nortel is a joint venture between LG Electronics Inc. and Nortel Networks Limited, a wholly owned subsidiary of Nortel Networks Corporation. LG-Nortel has sole voting and dispositive power over such shares, however, NNL is the majority shareholder of LG-Nortel. NNL and NNC have shared voting and dispositive power over such shares. The principal executive offices of LG-Nortel is 7th, 8th Floor, GS Kangnam Tower 679, Yeoksam-dong, Kangnam-gu, Seoul, 135-985, Korea. The principal executive offices of NNL and NNC is 8200 Dixie Road, Suite 100, Brampton, Ontario, Canada L6T 5P6.
(12)
Represents shares of common stock beneficially owned by Barclays Global Investors, NA. Barclays has sole voting power and sole dispositive power over all of such shares. The address of Barclays is 45 Fremont Street, San Francisco, California 94105.
Equity Compensation Plan Information
The following table sets forth information with respect to our common stock that may be issued upon the exercise of stock options under our 1994 Stock Option Plan and our 2003 Incentive Compensation Plan as of December 31, 2005.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
LG-Nortel Co. LTD., which is a joint venture between Nortel Networks and LG, our principal supplier, beneficially owns approximately 23% of our outstanding common stock. Jong Dae An, a director of our company since August 2004 is an officer of LGN. We purchased approximately $21.2 million of key telephone systems, commercial grade telephones, and voice mail products from LGN and an affiliate of LGN during 2005. We believe that the purchases from LGN and its affiliate approximate terms that would be offered by non-related parties. We owed LGN and its affiliate approximately $4.1 million for product purchases as of December 31, 2005.
We also conduct joint development activities with LGN for the design and development of hardware incorporated into some of our existing and planned telephone systems and commercial grade telephones. Generally, LGN contributes the ongoing research and development costs for the product hardware and produces the finished goods developed under the alliance and we obtain the right to sell such products throughout North America and the Caribbean.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees
Aggregate fees billed to our company for the fiscal years ended December 31, 2005 and 2004 by our principal accounting firm are as follows:
(1)
Represents fees associated with the audit of our annual consolidated financial statements, review of our quarterly consolidated financial statements, and related consents.
(2)
Represents fees associated with the audit of our 401(k) benefit plan.
(3)
Represents fees associated with the preparation of our corporate, federal, and state income tax returns and assistance with our quarterly estimated tax payments.
Audit Committee Pre-Approval Policies
The charter of our Audit Committee provides that the duties and responsibilities of our Audit Committee include the pre-approval of all audit, audit related, tax, and other services permitted by law or applicable SEC regulations (including fee and cost ranges) to be performed by our independent auditor. Any pre-approved services that will involve fees or costs exceeding pre-approved levels will also require specific pre-approval by the Audit Committee. Unless otherwise specified by the Audit Committee in pre-approving a service, the pre-approval will be effective for the 12-month period following pre-approval. The Audit Committee will not approve any non-audit services prohibited by applicable SEC regulations or any services in connection with a transaction initially recommended by the independent auditor, the purpose of which may be tax avoidance and the tax treatment of which may not be supported by the Internal Revenue Code and related regulations.
To the extent deemed appropriate, the Audit Committee may delegate pre-approval authority to the Chairman of the Board or any one or more other members of the Audit Committee provided that any member of the Audit Committee who has exercised any such delegation must report any such pre-approval decision to the Audit Committee at its next scheduled meeting. The Audit Committee will not delegate the pre-approval of services to be performed by the independent audit to management.
Our Audit Committee requires that our independent auditor, in conjunction with our Chief Financial Officer, be responsible for seeking pre-approval for providing services to us and that any request for pre-approval must inform the Audit Committee about each service to be provided and must provide detail as to the particular service to be provided.
All of the services provided by our principal accounting firm described above under the captions “Audit-Related Fees” and “Tax Fees” were approved by our Audit Committee.
PART IV
ITEM 15.
ITEM 15. EXHIBIT AND FINANCIAL STATEMENT SCHEDULES.
(a) Financial Statements and Financial Statement Schedules
(1)
Financial Statements are listed in the Index to Consolidated Financial Statements on page of this report.
(2)
Financial Statement Schedules: Schedule II, Valuation and Qualifying Accounts is set forth on page S-2 of this report.
(b) Exhibits
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.
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 capacity and on the dates indicated.
VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements and Schedule
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders of
VODAVI TECHNOLOGY, INC.
We have audited the accompanying consolidated balance sheets of Vodavi Technology, Inc. and subsidiaries as of December 31, 2005 and 2004, 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, 2005. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vodavi Technology, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with U.S. generally accepted accounting principles.
/s/ Mayer Hoffman McCann P.C.
MAYER HOFFMAN MCCANN P.C.
Phoenix, Arizona
February 9, 2006
VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
In thousands except share and per share amounts
The accompanying notes are an integral part of these consolidated financial statements.
VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
In thousands except per share amounts
The accompanying notes are an integral part of these consolidated financial statements.
VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders’ Equity
In thousands except share amounts
The accompanying notes are an integral part of these consolidated financial statements.
VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
In thousands
The accompanying notes are an integral part of these consolidated financial statements.
VODAVI TECHNOLOGY, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
1. Nature of Business and Summary of Significant Accounting Policies
a. Nature of Business
Vodavi Technology, Inc., a Delaware corporation, and subsidiaries (the Company), designs, develops, markets, and supports a broad range of business telecommunications solutions, including digital and IP-based telephone systems, voice processing systems, and computer-telephony products for a wide variety of business applications. The Company markets its products primarily in the United States through a distribution network consisting of wholesale distributors, direct dealers, and its own sales personnel.
The Company currently obtains most of its products from manufacturers located in South Korea and Thailand. While the Company believes that production of its product lines overseas enhances its profitability, these arrangements expose the Company to certain economic and political risks. The Company does not own most of the equipment, tools, and molds used in the manufacturing process and has only limited control over the manufacturing of its products. A majority of these purchases are made from a stockholder (see Note 6).
b. Concentrations
Sales to the Company’s largest distributor, Graybar Electric Company, Inc., accounted for 23% of total revenue in 2005 and 26% of total revenue in 2004 and 27% of total revenue in 2003. During the same periods, sales to the Company’s second largest distributor accounted for an additional 21%, 17%, and 14% of total revenue, respectively. Accounts receivable from the two largest distributors comprise 57% of total accounts receivable as of December 31, 2005 and 2004. No other customers accounted for more than 10% of the Company’s revenue or receivables.
Other financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash deposits in bank accounts. Deposits in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) of $100,000 are exposed to loss in the event of nonperformance by the institution. At times during the year, the Company has had cash deposits in excess of the FDIC insurance coverage.
c. Principles of Consolidation
The consolidated financial statements include the accounts of Vodavi Technology, Inc. and its wholly owned subsidiaries Vodavi Communications Systems, Inc. and Vodavi Direct, Inc. All material intercompany transactions have been eliminated in consolidation.
d. Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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.
Estimates are used in accounting for, among other things, customer incentive programs, allowances for doubtful accounts and sales returns, price protection, reserves for excess inventory and obsolescence, asset impairments, and contingencies and litigation. Estimates and assumptions are reviewed periodically and
the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.
e. Inventories
Inventories consist of finished products purchased from a stockholder and other third-party manufacturers and are stated at the lower of cost, including in-bound shipping and handling costs, (first-in, first-out method) or market. The Company’s assessment of market value is determined by, among other things, historical and forecasted sales activity, the condition of specific inventory items, and competitive pricing considerations. When the assessed market value is less than the purchased cost, provision is made in the financial statements to reduce the carrying amount of the respective inventory items to market value.
The Company generally takes title to inventory upon shipment from the manufacturer for international purchases and upon receipt for domestic purchases.
f. Property and Equipment
Property and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets. Leasehold improvements are amortized on the straight-line method over the shorter of the estimated useful lives of the assets or the term of the lease. When property or equipment is sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in operations for the period.
Property and equipment and the related useful lives consist of the following as of December 31, 2005 and 2004, respectively.
Depreciation expense was $464,000, $471,000, and $448,000 for the years ended December 31, 2005, 2004, and 2003, respectively.
g. Goodwill
Goodwill represents the cost in excess of the estimated fair values of assets and liabilities acquired. Under Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” goodwill is subject to at least an annual assessment for impairment by applying a fair value-based test. The Company has one reporting unit for which goodwill was tested for impairment in accordance with the provisions of SFAS 142 as of December 31, 2005. The Company used a combination of valuation techniques, which included consideration of market-based approaches and an income approach, in determining the fair value of the Company’s applicable reporting unit in the annual impairment test of goodwill.
The initial impairment test indicated that the carrying value of the Company’s reporting unit exceeded the corresponding fair value. The implied fair value of goodwill in this reporting unit was then determined through the allocation of the fair value to the underlying assets and liabilities. As of December 31, 2005,
the carrying value of the goodwill in this reporting unit exceeded its implied fair value by approximately $725,000. As a result, the corresponding write-down of goodwill was recorded in 2005 and reported as a component of operations in the accompanying consolidated statements of operations for the year ended December 31, 2005.
h. Other Long-Term Assets
Other long-term assets consist principally of bank commitment fees and the cash surrender value of key man life insurance. Amortization of bank commitment fees is recognized as a component of interest expense and totaled $5,000, $21,000, and $19,000 in 2005, 2004, and 2003, respectively.
i. Impairment of Long-Lived Assets
Long-lived assets, excluding goodwill and other intangible assets with indefinite lives, are reviewed for impairment whenever events or circumstances indicate that the carrying amount of the assets may not be recoverable. If events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable, the Company compares the carrying value of the assets to the sum of the expected future cash flows (undiscounted and without interest charges) to be generated by the assets and their ultimate disposition. If the sum of the undiscounted cash flows is less then the carrying value, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed are valued at the lower of carrying value or fair value, less estimated costs to sell.
j. Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R). This Statement replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123R requires companies to recognize the grant date fair value of stock options and other equity-based compensation issued to employees in the income statement. The statement, as amended by the Securities and Exchange Commission, becomes effective for annual periods beginning after June 15, 2005. The adoption of SFAS No. 123R will not have any impact on the Company’s consolidated financial statements unless and until share-based payments are issued to employees after the effective date of this statement. See Note 1 (n).
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections - A Replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 requires retrospective application to prior periods’ financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle, such as a change in non-discretionary profit-sharing payments resulting from an accounting change, should be recognized in the period of the accounting change. SFAS No. 154 also requires that a change in depreciation, amortization, or depletion method for long-lived non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date this Statement is issued. The Company is required to adopt the provisions of SFAS No. 154, as applicable, beginning in fiscal 2006.
k. Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, and operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded against deferred tax assets if it is unlikely that some or all of the deferred tax assets will be realized.
l. Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and determinable and collectibility is probable. Generally, all of these conditions are met at the time the Company ships products to customers. Revenue includes shipping and handling charges and is recorded net of discounts, allowances for sales returns, and volume rebates, many of which are based on estimates. See Note 1(d).
m. Engineering and Product Development
All costs associated with internal engineering and product development activities are expensed as incurred.
n. Stock Option Plans
SFAS No. 123, “Accounting for Stock-Based Compensation”, encourages entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows entities to continue to apply the provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and provide pro forma earnings per share disclosures for employee stock option grants as if the fair-value-based method as defined in SFAS No. 123 had been applied. The Company applies the intrinsic value method under APB No. 25 and provides the pro forma disclosure provisions of SFAS No. 123.
On October 20, 2005, the Company’s Board of Directors approved the acceleration of vesting of 69,375 outstanding unvested options awarded to officers and employees of the Company. Of the 69,375 stock options for which vesting was accelerated, 11,250 were “out of the money” on the modification date having an exercise price of $5.86. The remaining 58,125 stock options have exercise prices ranging from $1.40 to $1.57 and have original vesting periods ranging from February 2006 to February 2007. Based upon the October 20, 2005 closing price of the Company’s common stock of $4.99 per share, the potential compensation costs associated with the acceleration of vesting would be approximately $200,000. Pursuant to FASB Interpretation No. 44 “Accounting for Certain Transactions Involving Stock Compensation”, the Company has determined that no compensation cost should be recognized in the current period financial statements as the underlying officers and employees are expected to provide services to the Company through the original vesting dates. Should one or more of the underlying officers or employees cease providing services to the Company prior to the original vesting dates, compensation costs will be recognized, on a pro rata basis, in the current period financial statements.
If the Company had accounted for its stock-based compensation plans using a fair value based method of accounting as prescribed in SFAS No. 123, the Company’s net income and earnings per share would have been reported as follows:
(1)
The fair value of options granted was determined by using the Black-Scholes option pricing model using the following assumptions:
o. Earnings Per Share
In accordance with SFAS No. 128, “Earnings Per Share”, the Company displays basic and diluted earnings per share (EPS). Basic EPS is determined by dividing net income by the weighted average number of common shares outstanding. The basic weighted average number of common shares outstanding excludes all dilutive securities. Diluted EPS is determined by dividing net income by the weighted average number of common shares and dilutive securities outstanding.
A reconciliation of the numerator and denominator (weighted average number of shares outstanding) of the basic and diluted EPS computation is as follows:
p. Fair Value of Financial Instruments
The carrying values of cash, accounts receivable, accounts payable, trade accounts payable to stockholder, and accrued liabilities approximate their respective fair values due to the short-term maturities of these instruments. As the revolving credit facility and term loan bear a variable interest rate based on the prime rate, the carrying value approximates its fair value.
q. Segments
The Company operates in one reportable segment, the distribution of business telecommunications equipment. Accordingly, the Company has only presented financial information for its one reportable segment.
2. Revolving Credit Facility
In April 2003, the Company entered into a credit agreement with Comerica Bank (“Comerica”), which established a $5.0 million revolving line of credit facility and a $1.0 million term loan (the “Credit Facility”). Advances under the Credit Facility are based upon eligible accounts receivable and inventory of the Company’s wholly owned subsidiary Vodavi Communications Systems, Inc. and are secured by substantially all of the Company’s assets. The Credit Facility contains 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 Comerica. As of December 31, 2005 and 2004, the Company had no outstanding borrowings on its line of credit and $5.0 million available for future advances.
The $5.0 million revolving line of credit bears interest at Comerica’s prime rate (7.25% as of December 31, 2005) and requires monthly payments of interest only with all unpaid principal and accrued interest due at its expiration in April 2005. In March 2005, the Company entered into a modification agreement with Comerica extending the expiration of the credit agreement to April 2006. The company intends to either renew or replace its existing credit facility with a similar credit facility in April 2006.
The $1.0 million term loan was available to the Company only for the purpose of acquiring its common stock. Borrowings on the term loan bore interest at Comerica’s prime rate plus 0.5%. The term loan was repaid in 2004.
3. Commitments and Contingencies
a. Legal Matters
From time to time the Company is subject to certain asserted and unasserted claims encountered in the normal course of business. It is the Company’s belief that the resolution of these matters will not have a material adverse effect on our financial position or results of operations; however, we cannot provide assurance that damages that result in a material adverse effect on our financial position or results of operations will not be imposed in these matters.
b. Operating Leases
The Company has entered into long-term operating lease agreements for all of its office and warehouse facilities and certain vehicles. Minimum payments under the Company’s lease agreements are as follows (in thousands):
Rent expense totaled approximately $1.0 million during 2005 and $1.1 million during each of 2004 and 2003.
c. 401(k) Profit Sharing Plan
The Company sponsors a profit sharing plan (the 401(k) Plan) pursuant to Section 401(k) of the Internal Revenue Code. 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 $81,000, $72,000 and $58,000 for the years ended December 31, 2005, 2004, and 2003, respectively.
4. Stockholders’ Equity
a. Treasury Stock
The Company has a stock repurchase program under which the Company may purchase up to $1.0 million of its common stock through March 31, 2006. As of December 31, 2005, the Company had purchased 76,741 shares of common stock for $388,000. All purchases were made at the market price on the date of purchase.
b. Vodavi Technology, Inc. 1994 Stock Option Plan (the 1994 Plan)
The 1994 Plan, as amended, provided for the granting of (a) options to purchase shares of the Company’s common stock, (b) stock appreciation rights, (c) shares of the Company’s common stock, or (d) other cash awards related to the value of the Company’s common stock. Under the 1994 Plan, options and other awards were issued to key personnel of the Company. The options issued were incentive stock options and nonqualified stock options. The 1994 Plan also included an automatic program under which nonqualified options were automatically granted to the Company’s non-employee directors. The 1994 Plan expired in April 2004. All outstanding options granted under the 1994 Plan prior to its expiration shall remain outstanding until the expiration date of the individual option grants and all remaining options available for grant at the expiration date were cancelled.
c. Vodavi Technology, Inc. 2003 Incentive Compensation Plan (the 2003 Plan)
The 2003 Plan provides for the granting of awards in the form of incentive stock options, nonqualified stock options, stock appreciation rights, shares of restricted common stock, bonus stock in lieu of obligations, or other stock-based awards to employees, directors, and independent contractors who provide valuable services to our Company. The 2003 Plan authorizes the issuance of 600,000 shares of stock, and no more than 500,000 shares may be issued pursuant to incentive stock options. The maximum number of shares of common stock covered by awards granted to any individual in any year may not exceed 200,000 shares. If any award previously granted under the 2003 Plan is forfeited, terminated, canceled, surrendered, does not vest, or expires without having been exercised in full, stock not issued under such award will again be available for grant for purposes of the 2003 Plan. If any change is made in the stock subject to the
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2003 Plan, or subject to any award granted under the 2003 Plan (through consolidation, spin-off, recapitalization, stock dividend, split-up, combination of shares, exchange of shares, or otherwise), the 2003 Plan provides that appropriate adjustments will be made as to the aggregate number and type of shares available for awards, the maximum number and type of shares that may be subject to awards to any individual, the number and type of shares covered by each outstanding award, the exercise price, grant price, or purchase price relating to any award, and any other aspect of any award that the Board of Directors or Committee determines appropriate.
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. 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, but the exercise price may not be less than 100% (110% if the option is granted to a stockholder who at the time the option is granted owns stock representing more than ten percent of the total combined voting power of all classes of the Company’s stock) of the fair market value of the common stock at the time of the grant.
The following table sets forth the activity under the 1994 Plan and the 2003 Plan for each of the years presented:
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5. Income Taxes
The Company files a consolidated federal income tax return. The income tax provision (benefit) is comprised of the following:
The Company provides for deferred income taxes resulting from temporary differences between amounts reported for financial accounting and income tax purposes. The components of deferred income taxes at December 31, 2005 and 2004, were as follows:
A reconciliation of the federal income tax rate to the Company’s effective income tax rate is as follows:
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6. Related Party Transactions
LG-Nortel Co. Ltd. (LGN), the Company’s principal supplier, owned approximately 23% of the Company’s outstanding common stock at December 31, 2005 and has a designated member on the Company’s board of directors. The Company purchased approximately $21.2 million, $22.2 million, and $21.1 million of key telephone systems, commercial grade telephones, and voice mail products from LGN and an affiliate of LGN during 2005, 2004, and 2003, respectively, constituting approximately 84%, 88%, and 87% of our total purchases, respectively. The Company owed LGN and its affiliate a total of $4,097,000 and $3,990,000 for product purchases at December 31, 2005 and 2004, respectively. The Company’s payment terms with LGN and its affiliate are 60 days after shipment, except for shipments of single line telephones, which are 30 days after shipment. Current balances are non-interest bearing.
The Company conducts joint development activities with LGN for the design and development of hardware incorporated into some of the Company’s existing and planned telephone systems and commercial grade telephones. Generally, LGN contributes the ongoing research and development costs for the product hardware and produces the finished goods developed under the alliance, and the Company obtains the right to sell such products throughout North America and the Caribbean.
7. Supplemental Cash Flow Information
Cash paid for interest and income taxes for the years ended December 31, 2005, 2004, and 2003 was as follows:
There were no non-cash activities during the years presented.
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8. Summary of Quarterly Results (unaudited): (in thousands, except per share amounts)
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON SCHEDULE
To the Stockholders
VODAVI TECHNOLOGY, INC.
We have audited the consolidated financial statements of Vodavi Technology, Inc. and subsidiaries as of December 31, 2005 and 2004 and for each of the three years in the period ended December 31, 2005 and have issued our report thereon dated February 9, 2006 (included herein on page of this Form 10-K). Our audit was conducted for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The information included in the accompanying Schedule II - Valuation and Qualifying Accounts on page S-3 is presented for purposes of complying with the Securities and Exchange Commission’s rules and is not a required part of the basic consolidated financial statements. Such information for the years ended December 31, 2005, 2004 and 2003 has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.
/s/ Mayer Hoffman McCann P.C.
MAYER HOFFMAN MCCANN P.C.
Phoenix, Arizona
February 9, 2006
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SCHEDULE II
Valuation and Qualifying Accounts
For the years ended December 31, 2005, 2004, and 2003
In thousands
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EXHIBIT INDEX