##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 Commission File No. 0-26912 Vodavi Technology, Inc.   Delaware
    
    86-0789350(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)
 4717 East Hilton Avenue, Ste. 400, Phoenix, Arizona
    
    85034(Address of principal executive offices)
    
    (Zip Code)
 (480) 443-6000   Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes x No o. Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes o No x. The number of shares outstanding of registrants Common Stock, $.001 par value
per share, as of July 26, 2004 was 3,634,437.




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VODAVI TECHNOLOGY, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2004  
 TABLE OF CONTENTS PagePART I. FINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated Balance Sheets  June 30, 2004
and December 31, 2003
    
    
    3Consolidated Statements of Operations  Three and
Six Months Ended June 30, 2004 and 2003
    
    
    4Consolidated Statements of Cash Flows  Six Months
Ended June 30, 2004 and 2003
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    9Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    14Item 4. Controls and Procedures
    
    
    14PART II. OTHER INFORMATION
    
    
    16SIGNATURES
    
    
    17Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
  2




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##### Table of Contents



PART I  FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS VODAVI TECHNOLOGY, INC. 
 CONSOLIDATED BALANCE SHEETS  In thousands, except share and per share amounts
 June 30, 2004
    
    December 31,(Unaudited)
    
    2003CURRENT ASSETS:Cash
    
    $
    2,607
    
    
    $
    2,924Accounts receivable, net of reserves for doubtful accounts
and sales returns of $337 and $345, respectively
    
    
    7,703
    
    
    
    6,988Inventory
    
    
    4,119
    
    
    
    5,115Deferred income taxes
    
    
    445
    
    
    
    445Prepaids and other current assets
    
    
    665
    
    
    
    768Total current assets
    
    
    15,539
    
    
    
    16,240PROPERTY AND EQUIPMENT, net
    
    
    1,451
    
    
    
    1,453GOODWILL
    
    
    725
    
    
    
    725DEFERRED TAXES
    
    
    34
    
    
    
    34OTHER LONG-TERM ASSETS
    
    
    60
    
    
    
    71$
    17,809
    
    
    $
    18,523CURRENT LIABILITIES:Accounts payable
    
    $
    801
    
    
    $
    1,031Accrued liabilities
    
    
    1,826
    
    
    
    2,195Accounts payable to stockholder
    
    
    4,278
    
    
    
    4,208Current portion of long-term debt
    
    
    
    
    
    
    200Total current liabilities
    
    
    6,905
    
    
    
    7,634Long-term debt
    
    
    
    
    
    
    700COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS EQUITY:Preferred stock, $.001 par value; 1,000,000 shares
authorized, no shares issued
    
    
    
    
    
    
    Common stock, $.001 par value; 10,000,000 shares
authorized; 3,664,839 and 3,610,464 shares issued
    
    
    4
    
    
    
    4Additional paid-in capital
    
    
    11,238
    
    
    
    11,041Accumulated
deficit
    
    
    (186
    )
    
    
    (856
    )Treasury stock, 30,402 shares at cost
    
    
    (152
    )
    
    
    10,904
    
    
    
    10,189$
    17,809
    
    
    $
    18,523
 The accompanying notes are an integral part of these consolidated balance sheets. 3




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VODAVI TECHNOLOGY, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS  In thousands except per share amounts
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003REVENUE, net
    
    $
    11,240
    
    
    $
    10,214
    
    
    $
    21,027
    
    
    $
    19,277COST OF GOODS SOLD
    
    
    7,296
    
    
    
    6,770
    
    
    
    13,704
    
    
    
    12,654GROSS MARGIN
    
    
    3,944
    
    
    
    3,444
    
    
    
    7,323
    
    
    
    6,623OPERATING EXPENSES:Engineering and product development
    
    
    492
    
    
    
    517
    
    
    
    1,013
    
    
    
    1,070Selling, general and administrative
    
    
    2,712
    
    
    
    2,348
    
    
    
    5,209
    
    
    
    4,7373,204
    
    
    
    2,865
    
    
    
    6,222
    
    
    
    5,807OPERATING INCOME
    
    
    740
    
    
    
    579
    
    
    
    1,101
    
    
    
    816INTEREST EXPENSE
    
    
    4
    
    
    
    27
    
    
    
    14
    
    
    
    52INCOME BEFORE INCOME TAXES
    
    
    736
    
    
    
    552
    
    
    
    1,087
    
    
    
    764INCOME TAX PROVISION
    
    
    283
    
    
    
    219
    
    
    
    417
    
    
    
    304NET INCOME
    
    $
    453
    
    
    $
    333
    
    
    $
    670
    
    
    $
    460EARNINGS PER COMMON SHARE:Basic
    
    $
    0.12
    
    
    $
    0.08
    
    
    $
    0.18
    
    
    $
    0.11Diluted
    
    $
    0.11
    
    
    $
    0.08
    
    
    $
    0.16
    
    
    $
    0.10WEIGHTED AVERAGE SHARES OUTSTANDING:Basic
    
    
    3,632
    
    
    
    4,193
    
    
    
    3,624
    
    
    
    4,271Diluted
    
    
    4,071
    
    
    
    4,354
    
    
    
    4,115
    
    
    
    4,407
 The accompanying notes are an integral part of these consolidated financial statements. 4




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VODAVI TECHNOLOGY, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS  In thousands
 Six Months EndedJune 30,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    670
    
    
    $
    460Adjustments to reconcile net income to net cash
flows provided by (used in) operating activities:Depreciation and amortization
    
    
    248
    
    
    
    234Tax benefit on stock option exercises
    
    
    65
    
    
    
    Changes in working capital:Accounts receivable, net
    
    
    (715
    )
    
    
    (625
    )Inventory
    
    
    996
    
    
    
    222Income tax receivable
    
    
    
    
    
    
    300Prepaids and other current assets
    
    
    103
    
    
    
    160Other long-term assets and deferred taxes
    
    
    (2
    )
    
    
    (38
    )Accounts payable and payable to stockholder
    
    
    (160
    )
    
    
    (786
    )Accrued liabilities
    
    
    (369
    )
    
    
    (115
    )Net cash flows provided by (used in) operating activities
    
    
    836
    
    
    
    (188
    )CASH FLOWS FROM INVESTING ACTIVITIES:Cash paid to acquire property and equipment
    
    
    (233
    )
    
    
    (242
    )Net cash flows used in investing activities
    
    
    (233
    )
    
    
    (242
    )CASH FLOWS FROM FINANCING ACTIVITIES:Net advances (payments) on revolving credit facility
    
    
    
    
    
    
    487Borrowings on term loan
    
    
    
    
    
    
    1,000Repayments on term loan
    
    
    (900
    )
    
    
    Stock repurchase
    
    
    (152
    )
    
    
    (2,063
    )Stock options exercised
    
    
    132
    
    
    
    Net cash flows used in financing activities
    
    
    (920
    )
    
    
    (576
    )CHANGE IN CASH
    
    
    (317
    )
    
    
    (1,006
    )CASH, beginning of period
    
    
    2,924
    
    
    
    1,141CASH, end of period
    
    $
    2,607
    
    
    $
    135SUPPLEMENTAL CASH FLOW INFORMATION:Cash paid for interest
    
    $
    4
    
    
    $
    27Cash paid for income taxes
    
    $
    592
    
    
    $
    203
 The accompanying notes are an integral part of these consolidated financial statements. 5




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VODAVI TECHNOLOGY, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
 (a) INTERIM FINANCIAL REPORTING The accompanying unaudited Consolidated Financial Statements have been prepared
by Vodavi Technology, Inc. and subsidiaries (Vodavi or the Company)
pursuant to the rules and regulations of the Securities and Exchange Commission
(SEC) and, in the opinion of management, include all adjustments (consisting
of normal recurring accruals and adjustments) necessary for a fair presentation
of results of operations, financial position, and cash flows as of and for the
periods presented. The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and revenue and expenses
during the period reported. Actual results could differ from those estimates.
Estimates are used in accounting for, among other things, customer incentive
programs, allowances for bad debts and sales returns, inventory obsolescence,
product warranty, depreciation, taxes and other contingencies. 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. The results for the three and six-month periods ended June 30, 2004 are not
necessarily indicative of financial results for the full year. These financial
statements should be read in conjunction with the audited Consolidated
Financial Statements and notes thereto included in Vodavis Annual Report on
Form 10-K for the year ended December 31, 2003. [SPACE INTENTIONALLY LEFT BLANK] 6




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(b) CALCULATION OF EARNINGS PER SHARE The Company displays basic and diluted earnings per share (EPS). Basic EPS is
determined by dividing net income (loss) 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: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(In thousands)Net income
    
    $
    453
    
    
    $
    333
    
    
    $
    670
    
    
    $
    460Weighted average common shares:Basic
    
    
    3,632
    
    
    
    4,193
    
    
    
    3,624
    
    
    
    4,271Effect of dilutive stock options (1)
    
    
    439
    
    
    
    161
    
    
    
    491
    
    
    
    136Diluted
    
    
    4,071
    
    
    
    4,354
    
    
    
    4,115
    
    
    
    4,407Anti-dilutive stock options (2)
    
    
    96
    
    
    
    600
    
    
    
    96
    
    
    
    607
  (1)
    
    Dilutive securities are calculated using the treasury stock method and
the average market price during the period.(2)
    
    Options having an exercise price greater than the average market price
during the reporting period are anti-dilutive, and therefore do not enter
into the earnings per share calculation. (c) STOCK OPTION PLANS Statement of Financial Accounting Standard (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. No stock-based employee compensation cost is reflected in net income as all
options granted under the Plan had an exercise price equal to or greater than
the market price of the underlying common stock on the date of grant. If the
Company had accounted for its stock-based compensation plan 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: 7




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Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(In Thousands, Except Per Share Amounts)Net income:As reported
    
    $
    453
    
    
    $
    333
    
    
    $
    670
    
    
    $
    460Options expense, net of taxes
    
    
    52
    
    
    
    29
    
    
    
    90
    
    
    
    61Pro forma net income (loss)
    
    $
    401
    
    
    $
    304
    
    
    $
    580
    
    
    $
    399Earnings (loss) per share:As reported  Basic
    
    $
    0.12
    
    
    $
    0.08
    
    
    $
    0.18
    
    
    $
    0.11As reported  Diluted
    
    
    0.11
    
    
    
    0.08
    
    
    
    0.16
    
    
    
    0.10Pro forma  Basic
    
    
    0.11
    
    
    
    0.07
    
    
    
    0.16
    
    
    
    0.09Pro forma  Diluted
    
    $
    0.10
    
    
    $
    0.07
    
    
    $
    0.14
    
    
    $
    0.09
 During the six-month period ended June 30, 2004, 53,750 options were granted at
a weighted average exercise price of $6.37. Also during the six-month period
ended June 30, 2004, 54,375 options were exercised with total proceeds of
approximately $132,000 that resulted in a tax benefit of $65,000. (d) STOCK REPURCHASES In June 2003, the Company repurchased 829,199 shares of its common stock for
$2.40 per share pursuant to a tender offer. The purchase was funded through
advances on a revolving line of credit and borrowings on a term loan. As of
June 30, 2004, there were no outstanding balances on the revolving line of
credit or term loan. The repurchased shares were retired. In May 2004, the Company commenced a stock repurchase program to purchase up to
$1.0 million of the Companys common stock through October 2004. As of June
30, 2004, the Company repurchased 30,402 shares at a total cost of $152,000.
The repurchased shares are held in treasury. (e) RECLASSIFICATIONS Certain reclassifications have been made to the consolidated balance sheet as
of December 31, 2003 to conform to the current periods presentation. (f) SEGMENT REPORTING 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. (g) COMMITMENTS AND CONTINGENCIES The Company is subject to certain asserted and unasserted claims encountered in
the normal course of business. The Company believes that the resolution of
these matters will not have a material adverse effect on its financial position
or results of operations. However, the Company cannot provide assurance that
damages resulting from the resolution of these matters, if any, will not have a
material adverse effect on the Companys financial position or results of
operations. 8




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS Business Overview We design, develop, market, and support a broad range of business
telecommunications solutions, including traditional and IP telephony products,
voice processing products, as well as computer telephony products, that address
a wide variety of business applications. Our telecommunications solutions
incorporate sophisticated features such as automatic call distribution,
scalable networking, Internet protocol, or IP, and wireless solutions. Our
voice processing products include Internet messaging, automated attendant, and
voice and fax mail. Our computer telephony products enable users to integrate
the functionality of their telephone systems with their computer systems. We
market our products primarily in the United States as well as in foreign
countries through a distribution model consisting 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 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. Bad Debts 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 Company. As of June 30, 2004, Graybar accounted for
31% and Target accounted for 24% 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. 9




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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 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 included in our Annual Report on Form 10-K for the year ended
December 31, 2003, which contains accounting policies and other disclosures
required by generally accepted accounting principles in the United States of
America. 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. Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold
    
    
    65.0
    
    
    
    66.3
    
    
    
    65.2
    
    
    
    65.7Gross
margin
    
    
    35.0
    
    
    
    33.7
    
    
    
    34.8
    
    
    
    34.3Operating expenses:Engineering and product development
    
    
    4.4
    
    
    
    5.0
    
    
    
    4.8
    
    
    
    5.6Selling, general, and administrative
    
    
    24.1
    
    
    
    23.0
    
    
    
    24.8
    
    
    
    24.528.5
    
    
    
    28.0
    
    
    
    29.6
    
    
    
    30.1Operating income
    
    
    6.5
    
    
    
    5.7
    
    
    
    5.2
    
    
    
    4.2Interest expense, net
    
    
    0.0
    
    
    
    0.3
    
    
    
    0.1
    
    
    
    0.2Pretax
income
    
    
    6.5
    
    
    
    5.4
    
    
    
    5.1
    
    
    
    4.0Income tax expense
    
    
    2.5
    
    
    
    2.1
    
    
    
    2.0
    
    
    
    1.6Net income
    
    
    4.0
    %
    
    
    3.3
    %
    
    
    3.1
    %
    
    
    2.4
    %
 10




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Quarter Ended June 30, 2004 Compared With Quarter Ended June 30, 2003 Revenue Revenue for the three-month period ended June 30, 2004 totaled $11.2
million, an increase of 10.0%, from revenue of $10.2 million for the same
period of 2003. Sales of our telephone systems increased 11.7% to $9.4 million
during the second quarter of 2004 compared to $8.4 million in 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 single line telephones declined from $592,000
in the second quarter of 2003 to $485,000 in the most recent quarter. During
the second quarter of 2004, we began de-marketing our 2700 Series of single
line telephones and in June 2004 we introduced the 2800 Series. We expect
sales of single line telephones to accelerate in the second half of 2004.
Sales of telephony applications, including voice processing, computer telephony
integration, and unified messaging remained unchanged at approximately $1.1
million during the respective quarterly periods. Sales through our direct sales office in the Phoenix Metropolitan area
totaled $491,000 during the second quarter of 2004 compared with $352,000
during the same period of 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 revenue is reported net of reserves for sales returns, discounts,
customer incentive programs, and inter-company eliminations, and includes
shipping and handling charges. These items resulted in a net reduction to
revenue of $229,000 in the 2004 period compared with a reduction of $241,000 in
the 2003 period. Gross Margin Our gross margin was approximately $3.9 million and $3.4 million for the
quarterly periods ended June 30, 2004 and 2003, respectively. Our gross margin
as a percentage of total revenue increased to 35.0% during 2004 from 33.7%
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 slightly to
$492,000 during the second quarter of 2004 from $517,000 in the same period of
2003. We continue to invest in the development of our next generation IP
telephone systems, the convergence of and enhancements to our traditional
telephone systems, and enhancements to our voice processing and other telephony
applications. Selling, General, and Administrative Expenses Selling, general, and administrative expenses increased to $2.7 million in
the second quarter of 2004 from approximately $2.3 million in the second
quarter of 2003. As a percentage of revenue, selling, general and
administrative increased to 24% in the second quarter of 2004 from 23% in the
same period of 2003. Factors that increased our expenses include increased
compensation, increased marketing and promotional activity, and an increase in
headcount. Interest Expense Interest expense decreased to $4,500 during the second quarter of 2004
from $27,000 for the same period a year ago. Income Taxes We provided for federal and state income taxes using an effective rate of
38.6% during the second quarter of 2004 compared to 39.7% in 2003. Our
effective tax rate in 2004 is expected to be consistent with our effective tax
rate that we reported for the 2003 fiscal year. 11




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Six Months Ended June 30, 2004 Compared With Six Months Ended June 30,
2003 Revenue Revenue for the six-month period ended June 30, 2004 totaled $21.0
million, an increase of 9.1%, from revenue of $19.3 million for the same period
of 2003. Sales of our telephone systems increased 11.7% to $17.4 million
during the first half of 2004 compared to $15.6 million in 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 single line telephones remained unchanged at $1.0 million
for each of the six-month periods of 2004 and 2003. During the second quarter
of 2004, we began de-marketing our 2700 Series of single line telephones and in
June 2004 we introduced the 2800 Series. We expect sales of single line
telephones to accelerate in the second half of 2004. Sales of telephony
applications, including voice processing, computer telephony integration, and
unified messaging decreased slightly to $2.5 million from $2.7 million during
the respective periods of 2004 and 2003. The decline in telephony applications
is a direct result 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 $900,000 during the first six months of 2004 compared with $614,000
during the same period of 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 revenue is reported net of reserves for sales returns, discounts,
customer incentive programs, and inter-company eliminations, and includes
shipping and handling charges. These items resulted in a net reduction to
revenue of $793,000 in the 2004 period compared with a reduction of $600,000 in
the 2003 period. Gross Margin Our gross margin was approximately $7.3 million in 2004 compared with $6.6
million in 2003. Our gross margin as a percentage of total revenue increased
to 34.8% during 2004 from 34.3% 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 were relatively unchanged
at approximately $1.0 million in 2004 compared to $1.1 million in the first six
months of 2003. Selling, General, and Administrative Expenses Selling, general, and administrative expenses increased to $5.2 million in
2004 compared to $4.7 million in the first six months of 2003. Factors that
increased our expenses include increased compensation, increased marketing and
promotional activity, and an increase in headcount. Interest Expense Interest expense decreased to $14,000 for the first six months of 2004
from $52,000 for the same period a year ago. Income Taxes We provided for federal and state income taxes using an effective rate of 38.4%
during the first half of 2004 compared with 39.8% for the same period of 2003.
Our effective tax rate in 2004 is expected to be consistent with our effective
tax rate that we reported for the 2003 fiscal year. 12




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Liquidity and Capital Resources Our net working capital position was approximately $8.6 million at June
30, 2004 and December 31, 2003. We had a cash balance of $2.6 million at June
30, 2004 compared with a cash balance of $2.9 million at December 31, 2003.
Factors that decreased our cash position during the first six months of 2004
included an increase in accounts receivable of $715,000 and the pay down of
accounts payable and accrued liabilities of $160,000 and $369,000,
respectively. We also used approximately $233,000 during the first six months
of 2004 for the purchase of property and equipment, $152,000 to repurchase
30,402 shares of our common stock, and $900,000 to pay off our term loan.
Sources of cash included positive income from operations, a reduction in
inventory of $996,000 and other current assets of $103,000, and $132,000 from
the exercise of stock options. Our accounts receivable days sales outstanding, calculated on a quarterly
basis, were approximately 62 days as of June 30, 2004 compared to 59 days as of
December 31, 2003. Our inventory turnover, measured in terms of days outstanding on a
quarterly basis, was 51 days as of June 30, 2004 compared to 67 days as of
December 31, 2003. The decrease in inventory days outstanding is a direct
result of our efforts to rationalize our product lines and an increase in
sales. Trade payables and accrued liabilities, including payables to third-party
and related-party manufacturers, were approximately $6.9 million as of June 30,
2004 compared with $7.4 million as of December 31, 2003. 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. We had a $15.0 million credit facility with General Electric Capital
Corporation that expired in April 2003. The line of credit bore interest at
2.5% over the 30-day commercial paper rate. Advances under the line of credit
were based upon eligible accounts receivable and inventory of our wholly owned
subsidiary, Vodavi Communications Systems, Inc., and were secured by
substantially all of our assets. The revolving line of credit contained
covenants that are customary for similar credit facilities and also prohibited
our operating subsidiaries from paying dividends to us without the consent of
GE Capital. In April 2003, we entered into a credit agreement with Comerica
Bank-California (Comerica) of a size that is more reflective of the current
capital 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 June 30, 2004, 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 4.0% at June 30, 2004, and requires monthly payments of interest
only with all unpaid principal and accrued interest due at its expiration in
April 2005. If we are unable to reduce the principal balance on the line of
credit to zero for at least 30 consecutive days during any fiscal year, then
any remaining balance will be converted into a term loan, or term balance, as
defined in the agreement. In addition to interest on the term balance, we will
be required to make monthly payments of principal in an amount sufficient to
fully amortize the term balance over a thirty-six month period. 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 May 2003, we commenced a self-tender offer to purchase up to 1,000,000
shares of our common stock for $2.40 per share. On June 13, 2003, we
repurchased 829,199 shares of our common stock at $2.40 per share pursuant to
the tender offer. The repurchase was funded through advances on our revolving
line of credit and term loan. As of June 30, 2004, there were no amounts
outstanding on our revolving line of credit. In April 2004, we repaid the
amount outstanding on our term loan with currently available funds. We have certain long-term operating lease agreements for our office and
warehouse facilities and short-term purchase commitments to our third-party
suppliers. We have no special purpose entities or off balance sheet 13




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financing
arrangements, commitments, or guarantees. The following table sets forth all
known commitments as of June 30, 2004 and the year in which those commitments
become due or are expected to be settled (in thousands): Payment due by periodContractual
    
    
    
    
    
    Less than
    
    
    
    
    
    
    
    
    
    More thanObligations
    
    Total
    
    1 year
    
    1-3 years
    
    3-5 years
    
    5 yearsLong-Term Debt
Obligations
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Operating Lease
Obligations
    
    
    6,173
    
    
    
    1,000
    
    
    
    1,639
    
    
    
    1,570
    
    
    
    1,964Purchase Obligations
    
    
    6,837
    
    
    
    6,837
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    13,010
    
    
    $
    7,837
    
    
    $
    1,639
    
    
    $
    1,570
    
    
    $
    1,964
 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 working capital and credit facilities are sufficient
to fund our capital needs during the next 12 months. Although we currently
have no acquisition targets, we intend to continue to explore acquisition
opportunities as they arise and may be required to seek additional financing in
the future to meet such opportunities. International Manufacturing Sources We currently obtain a substantial majority of our products under various
manufacturing arrangements with third-party manufacturers in South Korea and
Thailand, including LGE, which owns approximately 24% of our outstanding common
stock. We face risks associated with international manufacturing sources. For
a more detailed discussion of these risks, please see Item 1,
Business  Risk Factors  We face risks associated with international manufacturing
sources included in our annual report on Form 10-K for the year ended December
31, 2003. CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS This report contains forward-looking statements, including statements
regarding our business strategies, our business, and the industry in which we
operate. These forward-looking statements are based primarily on our
expectations and are subject to a number of risks and uncertainties, some of
which are beyond our control. Actual results could differ materially from the
forward-looking statements as a result of numerous factors, including those set
forth in our Form 10-K for the year ended December 31, 2003, as filed with the
Securities and Exchange Commission. 
 ITEM 3. 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 June 30,
2004, we had no outstanding borrowings on the line of credit or term loan. 
 ITEM 4. 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 June 30, 2004. 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 14




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##### Table of Contents



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. 15




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##### Table of Contents



PART II  OTHER INFORMATION Item 1. Legal Proceedings Not applicable. Item 2. Changes In Securities and Use of Proceeds Not applicable. Item 3. Defaults Upon Senior Securities Not applicable. Item 4. Submission of Matters to a Vote of Security Holders We held our Annual Meeting of Stockholders on May 17, 2004. 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: Nominee
    
    Votes in Favor
    
    WithheldWilliam J. Hinz
    
    
    2,353,798
    
    
    
    203,390Gregory K. Roeper
    
    
    2,355,393
    
    
    
    201,795Jong Hwa Choi
    
    
    2,354,893
    
    
    
    202,295Jack A. Henry
    
    
    2,522,130
    
    
    
    35,058Emmett E. Mitchell
    
    
    2,521,650
    
    
    
    35,538Paul D. Sonkin
    
    
    2,539,650
    
    
    
    17,538
 Item 5. Other Information Not applicable. Item 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits:31.1
    
    Certification of Chief Executive Officer pursuant
to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the
Securities Exchange Act of 1934, as amended.31.2
    
    Certification of Chief Financial Officer pursuant
to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the
Securities Exchange Act of 1934, as amended.32.1
    
    Certification of Chief Executive Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.(b)
    
    Reports on Form 8-K: Not applicable 16




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. VODAVI TECHNOLOGY, INC.Dated:
    
    July 26, 2004
    
    /s/ Gregory K.
RoeperGregory K. RoeperPresident and Chief Executive Officer(Principal Executive Officer)Dated:
    
    July 26, 2004
    
    /s/ David A.
HusbandDavid A. HusbandChief Financial Officer and Vice President  Finance(Principal Financial and Accounting Officer)
 17